What Happened

Coinbase officially launched the public mainnet for its long-awaited Base layer 2 blockchain network on August 9. Base is a new network that aims to improve the ability to run decentralized applications (dapps) on Ethereum ETH more efficiently and with improved user interfaces.

Base inherits the security of Ethereum, while offering faster and cheaper transactions, full compatibility with the Ethereum Virtual Machine (EVM), and seamless integration with Coinbase COIN products and services. Base is built on the OP Stack, an open source framework for creating optimistic rollups, in collaboration with Optimism OP , a foundation that is the leading developer of this technology.

To support the launch, Coinbase held the Onchain Summer Web3 Festival, a multi-week series of activations across art, gaming and music. As part of the celebration, over 50 brands such as Coca-Cola KO , Nouns DAO DAO , Friends With Benefits, and Atari are hosting non-fungible token (NFT) mints on the Base network. These events are meant to foster community engagement and exposure for Base, encouraging new users to send assets to the network and set up their first wallets.

Broader Context

Layer 2 rollups are meant to relieve congestion on the Ethereum blockchain, which would help increase transaction speeds and cut costs. To achieve lower fees without a loss of security, the layer 2 transactions are executed on a separate network and batches of them are periodically transferred to the underlying Ethereum chain. This method of rolling up transactions is similar to a bar tab: patrons can order multiple items and then settle up with one payment at the end of the night.

Base joins dozens of competing layer 2s including market leaders Arbitrum ARB , Optimism, zkSync, Starknet, ImmutableX IMX , Loopring LRC , Mantle, Metis and Polygon MATIC . In the few days since its launch, Base already ranks fifth among all Ethereum layer 2s in terms of total value locked (TVL), the amount bridged over to the Base network and actively being used within its ecosystem of applications.

Base already attracted over $200 million in TVL, capturing roughly 2% of the $10.6 billion across all networks. The largest layer 2s, Arbitrum and Optimism, have considerably higher TVL with $5.9 billion and $2.8 billion, respectively.

The TVL of all layer 2 protocols on Ethereum has reached 23% of the aggregate TVL of $45.3 billion across all Ethereum-based applications. Liquid-staking provider Lido retains the top spot with $15.1 billion in TVL, 42% greater than all layer 2 protocols combined.

Competing networks Arbitrum and Optimism launched their mainnets in August and December of 2021, respectively. A project’s mainnet is the live, primary network where transactions with real value are recorded on its blockchain. Both employed token rewards and airdrops to supercharge early usage. Perhaps due to regulatory considerations, Coinbase announced it would not launch a token to support the network. Instead, the network uses ETH as the payment token for transaction fees. Thus, Base’s growth has been entirely organic in comparison to others relying on token incentives.

Base already has over 100 dapps and service providers available. Among them are DeFi mainstays such as the Uniswap UNI , Sushiswap and Balancer BAL decentralized exchanges, the Aave AAVE borrowing-and-lending service, wallet providers Exodus, Trust Wallet and Brave, as well as infrastructure providers DRPC, Nansen, TheGraph and Etherscan.

One application on Base that has been receiving a lot of attention is social app Friend.tech. In a similar vein to previous attempted blockchain-based social networks BitClout and DeSo, Friend.tech allows users to tokenize, and potentially earn money from, their social networks. The app claims to be “the marketplace for your friends” in which users create a profile to sell shares of themself to their followers. Buying a user’s share grants owners the ability to direct message that person.

The application has seen strong trading volume of 6,900 ether (ETH), about $12.8 million, and 286,000 transactions since its launch on August 10. Decentralized social-media experiments like Friend.tech aim to clash with incumbents such as Twitter, which recently launched its own version of creator payments through ad-revenue-sharing.

Key Quote

“The adoption of layer 2s is validation for Ethereum's roadmap, and will further cement ETH as settlement money. Big questions that remain include how Ethereum layer 2s will defend their networks in a highly competitive landscape, how interoperability between layer 2s will play out, and how their native assets will accrue value relative to ETH.”

“Unless they achieve a form of moneyness, which would require pricing goods and services at large in their native assets, the native assets of layer 2s will likely be valued according to transaction fee demand and growth.”

• Chris Burniske, Partner at Placeholder VC

Key Stat

Although Base just launched its mainnet last week, it already has a greater number of daily transactions (573,000) than layer 2 networks Arbitrum (543,000) and Optimism (395,000). In comparison, the Ethereum base-layer averages about 1 million daily transactions.

Outlook and Implications

Although most layer-2 scaling networks are early in their development, they provide a glimpse of how blockchains may grow to support new uses and attract billions of potential users.

Coinbase–the largest exchange in the United States, with over 108 million registered users– has served as the primary gateway for new users to enter the crypto economy. Just as America Online and Netscape brought hundreds of millions of people online, Coinbase has the opportunity to bring them onchain. First, however, the company must enhance the user experience and security of interacting with these protocols.

Coinbase CEO Brian Armstrong acknowledged this point stating, “OnChain Summer is exposing just how broken our UX is in the main Coinbase app for NFTs, dapps, and L2s today. These need to be first class experiences, and Onchain Summer is a great impetus to have every employee feel that pain ourselves and fix it.”

The current user flow to enjoy the benefits of layer 2s requires users to bridge over assets from one network to another. This activity causes security vulnerabilities and the potential for user error. Considering most large dapps live on multiple chains, interoperability between networks remains a thorny issue that must be resolved.

It is not yet clear if the burgeoning activity on layer 2 networks will lead to more value accrual among their native tokens or the tokens of the base-layer blockchains that operate beneath them.

Since Ethereum implemented EIP-1559, where transaction fees are burned thus reducing the ether supply, the network more closely aligned its value with actual usage of the platform. If layer 2 transactions rise and start to crowd out layer 1 activity, the demand for Ethereum blockspace may decline, causing more value to accrue to the native tokens of the layer 2s.

On the other hand, if ether remains the native currency for most transactions within the Ethereum ecosystem, regardless of whether activity happens on it or on a layer 2 network, users will still demand ETH, putting upward pressure on its price. Additionally, the growth of layer 2 networks is beneficial for the entire Ethereum ecosystem, as it translates to more applications being created, generating new sources of demand.

As activity surges due to these new applications, more ETH will need to be bridged between the networks, requiring usage fees to be spent to process these transactions. In fact, layer-two transactions accounted for 9% of all gas burned on the Ethereum network in the last 30 days. As layer-two adoption increases, this amount is expected to rise.

Decision Points

If Base emerges as a dominant layer 2 network, it would be a major revenue boost for Coinbase. For now, Coinbase is the sole sequencer on the network, meaning it is the only entity to validate, execute and “sequence” transactions on the network and claim fees for doing so. However, other sequencers are expected to join the network.

Since the Base launch, Coinbase has earned $2 million in revenue from sequencer fees, and assuming it retains this level of activity, Coinbase would earn over $120 million annually. In addition to sequencer fees, Coinbase hopes to profit from Base by building trusted applications on top of the network.

Base’s success may influence the performance of the Optimism governance token (OP). The treasury of the Optimism Collective, which is a band of stakeholders building public goods infrastructure for the Optimism ecosystem, receives 15% of the Coinbase sequencer fees. These payments provide funding for the development of public goods, which may accelerate growth of the ecosystem.

Although the Base launch had earmarks of success, it was not enough to lift the prices of COIN and OP since the network went live.

For investors bullish on Base and the layer 2 thesis, they may opt to disregard the recent negative price action and purchase Coinbase shares or optimism tokens to express their bullish views. Assuming the network continues its performance from a fundamental perspective, those two instruments may be the biggest beneficiaries.