Coinbase Building Ethereum Layer 2: Moving Users Away from Centralized Exchanges

#514

GM,

I believe that everyone's attention has been occupied by AI and ChatGPT recently. Last week, I read an article titled 'ChatGPT and Midjourney: We Are All AI Proletariat,' which pointed out that AI improves productivity, while blockchain focuses on improving production relationships. If productivity improves but production relationships remain the same, you and I may become the proletariat of AI. I recommend it to everyone, and I will also extend the discussion on this topic in the future.

Now, getting to the point.

Before the 228 holiday, Coinbase, the world's second-largest exchange by trading volume, announced the launch of its Ethereum Layer 2 network called Base. This news caused a stir in the crypto community. Not only did the announcement of 'Writing NFT' sell out within minutes, but the commemorative NFTs launched by Coinbase also sold more than 480,000 copies in a matter of days.

It seems that many people consider this a historic moment. However, there is another camp that believes that exchanges launching their own blockchains is not news anymore, and the purpose behind it is simply to give new value to their own tokens and boost their prices. Binance and Binance Chain are the most representative examples. Moreover, Base is just another blockchain launched by Coinbase, and it's late by several years.

This article will first explain the reasons behind Coinbase's launch of its own blockchain and then discuss the significance of Base's emergence.

Moving Users Away from Exchanges

Coinbase is an idealistic company. Although it operates as a centralized exchange, unlike most exchanges that aim to be the 'end' for users, Coinbase aims to be the 'start' for users entering the decentralized world. The launch of Base is intended to push users towards the decentralized world and not keep them confined within centralized exchanges.

According to Coinbase's announcement:

Today, we're announcing the launch of the Base testnet. It's a Layer 2 network for Ethereum that provides a secure, low-cost, and developer-friendly environment for building decentralized applications anywhere. Our goal in building Base is to make 'onboarding' onto Layer 2 as ubiquitous as 'getting online,' bringing a billion users into the world of on-chain economics. To achieve this, Base will be the headquarters for Coinbase's on-chain products and an open ecosystem that anyone can participate in.

Layer 2 network is a technical term. Bitcoin and Ethereum, which most people are familiar with, are considered Layer 1 networks. However, Ethereum's gas fees are too high, and in the future, both developers and users will need to move to Ethereum Layer 2 networks such as Optimism, Arbitrum, or zkSync to save on fees. Base, launched by Coinbase, will also be one of the options.

Currently, there are nearly 10 Ethereum Layer 2 networks, each using different technologies and varying operating costs. Base is not here to grab market share or compete for existing users in the crypto community; it's about completing Coinbase's development blueprint - bringing 1 billion users into the on-chain economy.

Since its inception, Coinbase's goal has been quite clear: to create an open financial system to increase global economic freedom. Currently, most of Coinbase's products are not built on smart contracts but use the same infrastructure as other Web2 companies. While this allows users easy access to cryptocurrencies, these services are not built on the blockchain. Over the past few years, we have been slowly changing this, with examples like USDC, Coinbase Wallet, and cbETH being native on-chain products. We want to create more such products that fully utilize the characteristics of the blockchain.

Coinbase has over 100 million registered users globally. These individuals may have bought or traded cryptocurrencies but may not necessarily know the difference between cryptocurrencies and stocks. Many have never withdrawn cryptocurrencies from the exchange, let alone interact with on-chain applications.

Perhaps some exchanges see this as 'success.' However, Coinbase believes that for users to truly enter the open financial system, just buying cryptocurrencies is not enough. Users must also be 'moved out' of exchanges.

However, the online world is like a wilderness. Many people are already discouraged by the expensive withdrawal fees on exchanges. Therefore, Coinbase has decided to take the initiative and build Base as a 'bridge' to help users enter the decentralized world.

Base Joins the Superchain

Coinbase is not just an exchange; it also issues two cryptocurrencies, USDC and cbETH, on the blockchain, and will launch more on-chain products in the future.

To help users enter the decentralized world, Coinbase started looking for a blockchain ecosystem with low transaction fees and rich applications. Unfortunately, after years of research, they couldn't find one. In the end, Coinbase chose an entirely new path - building Base, an Ethereum Layer 2 network, based on the Optimism open-source toolkit (OP Stack).

This is not only a pioneering move by Coinbase but also a significant transformation for Optimism. According to Optimism:

To compete with Web2 giants, Ethereum must have the scale of the current Internet. Unfortunately, no single blockchain has achieved this goal so far. Moreover, the multi-chain world has its problems. It sacrifices user experience but is far from achieving global scale. Therefore, we must undergo a paradigm shift.

Large ecosystems like Coinbase face a difficult decision: they can deploy applications on Ethereum and give up scalability, or choose specific Layer 2 networks and rely on someone else's ecosystem, or deploy and maintain their own blockchain, ultimately fragmenting liquidity and network effects.

Optimism is an open-source project. But now is the time to build a unified blockchain network, not to go solo. Optimism is time to become a platform for chains. This is not just about creating many chains; it's about connecting all these chains into one network. We call this a 'superchain.'

In the past, people would argue about the future of blockchains, whether it should be a single dominant chain or multiple chains coexisting. This time, Optimism has proposed a cunning answer - to have multiple chains coexist on Ethereum's secure foundation and interoperate with each other. This ecosystem is called the 'superchain.'

In essence, Optimism is making the toolkit it originally used to build Layer 2 networks open to everyone. Blockchains built using this toolkit are like products made from the same mold (OP Stack), making them easier to interoperate. Coinbase's Base blockchain is the first superchain member to use this mold.

It's easy to imagine that after the launch of Base, the on-chain transaction fees will be similar to what Optimism currently offers. Developers who already have applications on Optimism can easily expand to Base. The most significant challenge will be how Coinbase guides its 100 million exchange users onto the Base blockchain.

Onchain Business

One significant difference between Coinbase and other exchanges is that Coinbase's app automatically creates cryptocurrency wallets for users within the exchange app. This wallet is separate from the user's exchange account balance, and the private keys are managed by Coinbase.

If we were to compare it to a more familiar Taiwanese exchange, it's like MaiCoin, an exchange that also has the Qubic wallet built into its app, with the wallet's private keys being managed by the exchange on behalf of users.

Coinbase does this to allow users to use Web3 applications like Uniswap, ENS, or OpenSea directly without having to manage private keys or download wallets separately.

In other words, Coinbase doesn't want users to stay exclusively within the exchange but rather sees the exchange as the entry point to Web3. However, currently, the withdrawal fees from Coinbase exchange accounts to wallets are not cheap. This is a significant barrier for users to enter Web3, and it's the first thing that can be improved after Base goes live.

According to Coinbase:

Building Base is our complete commitment to on-chain. We believe that blockchain is the most important developer platform since the internet ('getting online'). We believe that blockchain should be open, free to use, and globally available. ... When designing Base, we will make sure that it can easily interoperate with Ethereum L1, other L2 solutions, and other L1 ecosystems like Bitcoin, Solana, and Cosmos. We'll encourage users to explore from Base. We'll see Base as the bridge for users to enter the on-chain economy, a user-friendly on-chain experience.

Now, as long as you deposit any amount of cryptocurrency into the wallet built into Coinbase, you will automatically receive a set of commemorative NFTs within minutes, congratulations on becoming a pioneer in Web3. Base blockchain may also have similar reward mechanisms in the future.

If Base's on-chain transaction fees are low enough, Coinbase may even subsidize the withdrawal fees from the exchange to Base wallets to significantly lower the psychological barrier for people to start using Web3 applications. As users become more familiar with on-chain applications, they may move to other blockchain ecosystems through more advanced cross-chain bridges.

In the long run, Coinbase's users and revenue may increase due to the development of a completely new on-chain market, leading to more developers and users joining the new Optimism superchain ecosystem."