Coinbase Blockchain Plan Gets Warm Reception; Success depends on the conversion of Crypto Diehards

Coinbase, the giant US crypto exchange is entering the blockchain business with a bang, but the road from announcement to activation is littered with challenges as the company renews its attempt to diversify from its core trading business.

Base, officially announced last week, is a new blockchain platform compatible with Ethereum, the largest multi-purpose distributed ledger. Base will be a layer 2 platform that sits on top of Ethereum and offers users faster and cheaper transactions while remaining in sync with the underlying blockchain.

“The thesis is that with Base, we’re going to enable millions of new applications that are really useful in crypto, that are going to bring billions of users on-chain,” said Jason Pollak, Coinbase Head of Protocol and Base Lead.

The market reaction to the news was swift. Coinbase stock jumped 5% on Feb. 23 following the announcement, and even after giving back some of its gains, it’s still 8.41% higher as of this morning. Op, the initial token of the Optimism network, another Layer 2 platform whose software was used by Coinbase to build Base, surged 22% over the following days before giving back virtually all of its gains since. Op is still up 192% in 2023, indicating that the withdrawal on February 23 is likely due to buyer exhaustion and some investors taking profits off the table.

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Coinbase does not plan to issue a token for Base, likely to avoid speculators, not to mention questions from the SEC about whether such an asset would qualify as a security. In fact, an existing token called base, which has nothing to do with the new blockchain, jumped 750% immediately after the announcement, though it soon gave up all those gains, presumably as speculators realized their mistake.

Despite this auspicious start, Coinbase has more than a few questions to answer. The elephant in the room is that for all its success in building a crypto exchange with millions of users, many of the company’s other product development efforts have fallen flat. Interrupted by the launch in May of a marketplace for non-fungible tokens, which have yet to pass the $6 million mark in cumulative sales, is a failure that rivals the failure of the Apple Maps launch. By comparison, market leader Blur averages $18 million daily sale. Coinbase’s Chief Product Officer Surojit Chatterjee, who was poached from Google in February 2020, recently left the firm with two years left on his contract and joined venture firm Andreessen Horowitz, a sort of gated retirement or sabbatical community for crypto executives.

Coinbase Wallet, a software program that allows users to take care of their own tokens and explore other decentralized applications, has just 45,950 monthly users, a tiny 0.5% of Coinbase’s monthly 8.8 million active trader base. In March 2022, market leader MetaMask reported 30 million monthly users.

There are a couple of possible explanations for these Coinbase deficiencies. One is that the company has lost touch with building products that people want. Another is that with products like Coinbase NFT and Coinbase Wallet, it tries to cater to sophisticated users who are more connected to core crypto principles of privacy and decentralization than most traders. For these target users, a massive centralized exchange is at best a necessary evil for crypto and at worst anathema to its ideological pillars.

If the latter explanation is correct, it may not bode well for the immediate future of Base. After all, most users of Layer 2 protocols such as Optimism and Arbitrum fall into the ideologically demanding category. The most popular applications on each network are a mix of decentralized gaming and financial (trading and lending) applications. Some of the blue-chip names operating on these networks include derivative platform dY/dX, AAVE, 1inch and Curve. Many more are likely to come, as these platforms begin to compete with Ethereum for users.

In fact, Arbitrum briefly passed Ethereum in transactions per day last month, and Optimism came close in early January, according to data from Blockworks. Together, they are slightly behind Ethereum as of today.

There are other key questions for Coinbase to answer. For example, how will it attract a large and engaged user base to its new blockchain without the promise of free tokens? So far, the company has had more than 10,000 smart contracts deployed on the network and users have created more than 400,000 memory NFTs that the company is giving away for free. Still rightly or wrongly, users of new blockchain platforms and applications have come to expect compensation in exchange for their help launching a product in the form of airdrops, tokens sent to their crypto wallets at no cost.

Optimism conducted its first airdrop in May 2022, when it issued $200 million to nearly 250,000 addresses. Another airdrop happened last month and reached 300,000 users. In total, the asset has a fully diluted market value of $11.9 billion, but a circulating supply of just $850 million. This relatively small float can fuel a speculative frenzy, but it provides an attractive hook for those who get in early. Arbitrum has yet to issue a token, and it hasn’t promised one, but that doesn’t stop users from interacting with the platform in hopes of increasing their allocation in a future giveaway.

“Our thesis about a token is as a tool that can be used to drive behavior as an incentive. What we’ve actually seen over the last few years is that the incentive can overshadow the amount of product-market fit that these underlying chains actually have,” Pollak says.

Perhaps users of Base will be compensated for their activity in future Optimism airdrops, but that could dilute the value of Coinbase stock and make regulators at the SEC wonder if the op is a security.

Additionally, not much information is available yet about how Coinbase will operate within Optimism’s governance structure. Right now, that might not be too much of an issue, as Coinbase’s near-term activity will likely focus on launching Base (it remains in testing phases), and adding users and developers. “We’re working very closely with Optimism on the steering components, but we’re still in the testing phase,” says Pollak. “We’ll be sharing more about governance as we get closer to the main web launch (in the next few months).”

Coinbase’s long-term vision for Base is to operate alongside Optimism as part of a network of platforms it calls a “Superchain”. An open secret in crypto circles is that Decentralized Autonomous Organizations (DAOs) are not as decentralized as their name suggests, and Coinbase needs to carefully measure the level of participation in Optimism’s governance so that it can manage the network properly without disrupting users or running. nonsense of regulators.

Some organizations with large voting rights in the DAO actually delegate some votes to trusted third parties as a way to decentralize. However, this setup can have difficult consequences when these third parties vote against the sponsor’s wishes.

A recent case that could have important implications concerned the vote on a plan to expand the leading decentralized exchange Uniswap to the Binance Smart Chain. Andreessen Horowitz delegated a majority of its voting power at Uniswap to other parties who voted to use a software vendor other than the VC firm’s preferred choice.

Coinbase will have to come up with its own answers to these kinds of questions.

“We see the NFT market as an experiment, we see Base as an experiment,” says Pollak. “Some experiments are going to work, some aren’t. But if we don’t hit those shots, there’s no way we can continue to innovate as a company.”