Coinbase’s New Home Base

Last week, we saw a potential mass adoption catalyst for the Ethereum ecosystem: PayPal’s launch of its PYUSD stablecoin. With 435 million existing users, PayPal has the existing distribution channels (across both PayPal and Venmo) to seamlessly introduce the world to crypto rails. Despite the PayPal news, Ethereum and other crypto prices moved marginally lower week-over-week as the summer apathy and broader crypto bear market continue.

Shortly after PayPal, we had another potential adoption moment for Ethereum, with Coinbase launching its mainnet for Base, a Layer Two (L2) protocol built on top of Ethereum (utilizing Optimism’s tech stack). We have discussed Ethereum’s Layer Two scaling plan extensively, most recently addressing “fractal scaling” where users will live in a web of the L2 and Layer Three (L3) levels that would all ultimately settle onto ETH L1. However, while a plethora of L2s have been launched (e.g., Polygon, Arbitrum, Optimism, Starknet, zkSync), these L2s have largely been targeted at the relatively-small crypto-native universe.

Enter Coinbase. Coinbase has over 100mm users; although this is less than PayPal, Coinbase’s user base is more crypto native (i.e., they joined Coinbase to interact with crypto) and could have a higher “crypto conversion rate” for Base than PayPal for PYUSD. Additionally, Coinbase is an all-encompassing ecosystem where users can store USDC, store crypto (via Coinbase custody), stake, and trade. Therefore, adding seamless integration with Base from within Coinbase is something that has been largely missing for smooth onboarding onto L2s.

L2s, while the ultimate endgame for onchain user activity, are a pain to access. The current journey is as follows: (1) user acquires ETH (on Coinbase or a similar exchange), (2) user sends ETH to a self-custody wallet (like MetaMask, which requires knowledge of self-custody), (3) user finds the respective bridge from ETH to the desired L2 (e.g., the Arbitrum, Optimism, or Polygon bridges), (4) user initiates bridge transfer from ETH to L2, (5) user adds the L2 network to their self-custody wallet and waits for the bridging transaction to be complete, and finally (6) user has funds on L2. Users have to do the reverse to withdraw funds from L2.

Coinbase, by being an all-encompassing ecosystem, has the existing infrastructure to onboard users more directly to Base without these multiple steps. Indeed, Coinbase has made access to Base simple via a “Bridge” button in Coinbase’s self custody Wallet, and Base can be funded directly by credit card. While this seems like incremental change, UX is one of the biggest blockers for crypto adoption, and Coinbase’s ability to make Base seamlessly accessible is a huge step toward growing the Ethereum and L2 ecosystem.

Why will users ultimately live on L2s? The apps that may bring users onchain – from finance apps (trading, lending, borrowing, staking) to NFTs (digital collectibles) to gaming apps to social media apps – are not all accessible to everyday users due to volatile and potentially high Ethereum L1 gas fees. These fees are drastically reduced on L2s, therefore allowing the full user experience, functionality, and security of Ethereum with a manageable price. L2s are effectively the solution to the “Blockchain Scalability Trilemma,” and Coinbase is leading the charge toward mass adoption via incubating its own L2 via Base.

L2 TVL

• How has Base done in its infancy since launch last week? Remarkably well, a testament to the crypto-native audience that Coinbase has cultivated. In just a week, Base has accumulated ~$230mm ”total value locked (TVL),” a metric for the quantity of funds that are on the L2. This means that across the various applications on Base (trading apps like Uniswap, NFT apps, social apps), users have moved $230mm. The current L2 leaders, Arbitrum and Optimism, have $5.9bn and $2.8bn TVL respectively, but have been live for years. Base has a strong starting trajectory.
• Coinbase’s network effects will undoubtedly result in a renaissance of applications built on Base, which could attract even more TVL. L2 ecosystems like Base are effectively new App Stores. When Apple launched the App Store, the world did not know the potential for apps to draw users into the Apple ecosystem. Similarly, Ethereum and L2 ecosystems could draw in the next wave of crypto users.

ETH Economic Snapshot

• Looking at the overall Ethereum economic snapshot, activity continues to be weak. Although the vision for Ethereum is for hundreds of millions of users to be active in the L1 + L2 ecosystems (where Base could play a large role), the L2 users will pay enough fees in aggregate to saturate the ETH L1 blockspace. Full L1 blockspace would equate to high gas fees and high fee burn, which results in deflationary ETH and strengthens ETH’s monetary policy and therefore L1 security.
• However, in the depths of the current bear market, fees continue to be anemic. Last week’s fees result in an annualized amount of < 1mm in ETH. This translates to a low staking yield (approaching sub 4.5%).
• Nevertheless, despite low fees and an increasing amount of ETH staked (nearly 20% of total supply is now staked), ETH inflation is barely inflationary at 0.09%, highlighting the strength of Proof of Stake issuance.