All About That Base: Behind Coinbase' Explosive Layer 2
Worldcoin, friend.tech, $BALD - why are projects flocking to Base, the new L2?
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In an era where blockchain technology continues to advance at an unprecedented pace, major centralized exchanges (CEXs) are maneuvering to stay ahead of the curve. The race to capture a share of the onchain market within the Ethereum ecosystem is well underway.
By capitalizing on the network effects of Ethereum and its growing number of Layer-2 (L2) chains, these exchanges are bridging the gap between CEXs and decentralized finance (DeFi). What exactly lies at the heart of this strategic alignment, and who is poised to benefit the most from these initiatives?
CEXs such as Coinbase, Bybit, and Binance have launched L2 chains like Base, Mantle Network, and opBNB within the last few months. By doing so, they look to forge a path that leverages the Ethereum ecosystem’s momentum, liquidity, and users. This alignment not only allows CEXs to tap into a resilient and growing market but also enables CEX users, whether seasoned or new to blockchain, to gain easier access to DeFi applications, creating a synergy between centralized platforms and DeFi.
Thus far, one crucial piece of architecture has been a constant amongst the three newly launched L2s — the OP Stack. Of the three newly minted L2s, one has stood out due to its meteoric rise in total value locked (TVL), users, and fees generated — Base, the new Ethereum L2 chain backed by Coinbase.
In the weeks since its launch, Base has seen a memecoin reach ~$80M market capitalization (before its deployer pulled liquidity) and the emergence of Friend Tech, a viral social app. As of the time of writing, Base has had over $240M in total value bridged since its launch. Its user metrics have also exploded, putting it in contention with market leading L2s Arbitrum and Optimism.
In this week’s report, we dive into its architecture, analyze how value accrual interacts with key players such as Optimism, explore whether this momentum is sustainable, and discuss what it means for Coinbase and others in the ecosystem.
What is Base?
Base is an Ethereum Layer 2 (L2) blockchain — more specifically, an optimistic rollup, incubated within Coinbase. Base supports the Ethereum Virtual Machine (EVM) codebase and provides seamless integration with Ethereum and Coinbase by leveraging Coinbase's existing infrastructure and reach, providing easy fiat onramps, and access to a broad user base.
Base’s launched its closed mainnet on July 14, 2023, before opening it up to the public on August 10, 2023.
Team
Base is incubated by Coinbase, one of the largest cryptocurrency exchanges in the world, and the largest regulated exchange in the United States, with more than 110M verified users. At the forefront of this effort is Jesse Pollak, Protocols Lead at Coinbase and the creator of Base.
Pollak started his career as co-founder of Clef, a passwordless two-factor authentication product to more than 200,000 integrations, before moving to Coinbase via an acquisition in 2017. Over the last 6 years at Coinbase, he spent most of his time there as Director of Engineering before moving to work on Base last year.
What are Rollups?
For those who need a refresher on rollups, you can visit our piece on Arbitrum vs. Optimism here. For others, here’s a refresher on the key stakeholders in an optimistic rollup network.
Sequencers
A sequencer operates like a trusted clerk that organizes and summarizes transactions happening off the main blockchain (L1), effectively offloading the computational workload. Think of it as creating a digest of many smaller events, then posting a summary, or "state root" to the main ledger (L1).
The sequencer's job is to present this information accurately. If it does so, it gets rewarded, aligning its interests with honest behavior. However, if the sequencer posts an incorrect summary, other network participants called verifiers can challenge this error within the 7-day challenge period, like auditors in a financial system spotting a mistake.
Today, block production on optimistic rollups is is typically handled by a single, privileged sequencer run by the team. Thus, these rollups remain centralized as teams work towards decentralization of the sequencer.
On Base, there is a single sequencer which is run by a single operator (in this case, the Base team).
Verifiers
So we just learned that ORUs have a sequencer(s) that submits state roots to the L1, and a challenge period in which state commitments can be challenged by verifiers via fraud proofs.
Verifiers are the “security guards” or “auditors” of the L2, serving a crucial oversight function within the system, acting as a counterbalance to the sequencers. Verifiers monitor and validate state commitments submitted by the sequencer(s). During the challenge period of 7 days, If a verifier suspects that a state commitment posted by the sequencer is incorrect, it can initiate a challenge by submitting a fraud proof — a piece of proof that a verifier submits that challenges the state commitment — much like an auditor flagging a discrepancy in financial records.
Verifiers are motivated by economic incentives, receiving rewards for successfully identifying incorrect state roots. Conversely, if a verifier challenges a correct result, it can be penalized, preventing false alarms or malicious attacks.
Now, a successful challenge doesn't affect the network itself or the transaction order but only removes the questioned commitment, which will eventually be replaced by another proposed commitment. This mechanism ensures the integrity of state commitments without altering the actual state of the chain.
As of the time of writing, neither Base nor Optimism (or any other optimistic rollup besides Arbitrum and Fuel v1) have functioning fraud proof systems — users have to trust that the sequencer(s) is submitting the correct state commitments to the L1.
Notice that despite not having fraud proof systems, these rollups still impose a 7-day challenge when withdrawing assets for two reasons (Sources: 1, 2):
To get users used to the delay.
Time buffer incase of an exploit.
Regardless, users can still bypass the challenge period by directly sending funds to CEXs or by using a third-party bridge.
OP Stack & the Superchain
Base has partnered with Optimism to co-develop the OP Stack, which also powers the Base L2 along with chains like opBNB, Zora, and DeBank. The OP Stack is a fully open-source system that powers Optimism and other L2 blockchains, enabling interoperability within the Superchain (the network of chains using the OP Stack) ecosystem and allowing developers to easily spin up new rollups that will be compatible with the Superchain.
The Superchain, once realized, will result in the merger of Optimism and other rollups into a unified network of OP Stack powered rollups. These rollups will end up sharing key infrastructure such as a fraud prover run by a decentralized set of validators, sequencers, as well as various tools and modules, like block explorers and governance systems.
Decentralization of the Superchain
Transactions on Base and other OP Stack ORUs are currently handled by a single sequencer managed by their respective teams, with no fraud proof system in place. This means that users have to trust that the centralized sequencer is accurately submitting the correct state commitments to the L1.
As part of their partnership with Optimism, Base have committed to progressively decentralizing the chain. Key initiatives include:
Launching at least one fraud prover for the OP Stack, securing both Base and Optimism Mainnet.
Decentralizing upgradeability of the Base and Optimism Mainnet smart contracts to a security council with no centralized control.
Launching an initial version of the Superchain for sequencing transactions for Base, Optimism Mainnet, and any OP Stack rollup.
Their decentralization roadmap runs until 2024, and looks to take Base from a “Stage 0” to “Stage 2” rollup, as defined by Vitalik in this post, where:
Stage 0: Full training wheels
Stage 1: Limited training wheels
Stage 2: No training wheels
Adoption Metrics
Daily Active Addresses
Daily Transactions
Fees & Revenue
Total Value Locked
Metrics Commentary
As of August 21, 2023, Base has surpassed both Arbitrum and Optimism in daily active addresses (DAA), daily transactions, and fees generated. However, in terms of total value locked (TVL), Base lags significantly behind both networks, with Arbitrum and Optimism outpacing it by 9.34 times and 3.8 times respectively. This disparity signals that Base's activity aligns with a different vertical compared to Arbitrum and Optimism, which mainly consist of DeFi dApps and related activities.
Friend Tech
Analysis of on-chain data reveals Friend Tech as one of the key activity drivers on Base, accounting for up to 25.3% of all active addresses on Base at one point. As of the time of writing, Friend Tech has already seen more than 100k users on the platform (Source). This new social media app allows users to purchase 'keys' (formerly referred to as 'shares') of other users, granting access to gated chats where they can communicate via text.
For a comprehensive deep dive on Friend Tech, check out our previous report here.
Operating on an invite-only basis, Friend Tech quickly went viral as users and traders began speculating on large accounts joining the platform, generating more than $6.8 million in fees since its launch on August 10, 2023, accounting for up to 55% of all fees generated on Base at its peak.
To put this into perspective, this figure exceeds the fees generated by any other on-chain perpetual DEX across all chains and surpasses the combined total of GMX and Synthetix during the same period.
Looking a little deeper, we observed that MEV bots made up to 10% of all trading volume on Friend Tech, due to a leak from the project’s RPC nodes allowing bots to back-run key purchases within the same block of an account joining the platform. This was later patched, causing MEV bot volumes to cease almost completely.
Back-running refers to a strategy in which a transaction sender aims to have their transaction placed right after a specific unconfirmed "target transaction" on a blockchain. This is commonly used in cases such as quickly purchasing tokens after their launch on platforms like Uniswap — and in this instance, Friend Tech.
Proxies to a BASE Token
Since its inception, the team behind Base has stated that they do not intend to launch a proprietary token, nor are there any current plans to introduce one in the future.
Side note: For what it's worth, the Arbitrum team followed a similar approach but ultimately released a token via the Arbitrum Foundation.
Therefore, investors interested in gaining exposure to Base's success must consider alternative investment opportunities — at least for now. In the following section, we will explore three potential proxies to a Base token and analyze how value may accrue to these respective options.
Optimism
Economic Partnership
On August 25, 2023, Optimism announced the framework for their economic partnership with Base, which serves as blueprint for all Superchain members moving forward. Transaction fees from Base will be shared with the Optimism Collective via an onchain contract — Optimism Collective will receive the greater of either:
2.5% of Base's total sequencer revenue, or
15% of Base's net on-chain sequencer revenue, which is calculated as Layer 2 transaction revenue minus Layer 1 data submission costs
Based on Artemis data as of August 22, 2023, Base has recorded $2.64M in 30-day revenue*. If we project this linearly, a 15% cut for the Optimism Collective equates to an additional ~$4.8M in annualized revenue for the Collective. These funds are designated for public goods funding to develop the Superchain ecosystem. For context, Optimism has accumulated ~$5.7M in year-to-date revenue, which when projected linearly, amounts to ~$8.8M on an annualized basis.
This means that, should Base continue its current run, revenue from Base would make up a decent portion of the Collective’s revenue — up to 35% based on current projections.
*Note that revenue here is taken to be total fees collected less L1 calldata fees. Costs of L2 nodes for computation and storage were not included in this assumption.
Governance
The announcement also outlined a significant token grant for Base, allowing it to earn up to 118M OP tokens, approximately 2.7% of the total supply, over a six-year period. However, Base is restricted from voting or delegating more than 9% of the total staked supply available for voting.
This grant acts as a retroactive reward for Base's contributions to the OP Stack. Importantly, this governance partnership with Optimism compensates for the absence of a Base-specific token, encouraging Base community members to acquire OP tokens to influence ecosystem-wide governance.
Incentives for Base
The Base team has been working closely with OP Labs as core contributors on the development of the OP Stack. This collaborative economic and governance partnership encourages cross-platform innovation and mutual growth, tying the trajectory of the two chains — and, indeed any chain that decides to join the Superchain, together.
While Ethereum's strong network effects enable standalone L2 solutions like Arbitrum, Mantle, and opBNB, to forge their own ecosystems, the L2 space will only become more competitive in the midst of shrinking liquidity. This makes it advantageous for Superchain participants to benefit from the collective growth and network effects driven by Optimism and its broader ecosystem. Not to mention reduced costs due to shared sequencers, bridging, security, and other infrastructure. Therefore, it makes strategic sense for L2s like Base to align closely with Optimism to maximize these benefits. In the case of Base, their contributions to Optimism's ecosystem are not just a cost, but an investment in a mutually beneficial future.
Coinbase
Coinbase is listed on the NASDAQ (NASDAQ:COIN). As of the time of writing, COIN is trading at a price of $75.28, valuing it at $17.58B market capitalization. As the builders and incubators of Base, Coinbase would be the obvious proxy to capitalize on any upside from the rollup. Due to the timing of Base's launch, which came after the closing period of reporting, the latest 10-Q report does not detail how much of Coinbase's revenue can be attributed to Base. However, some assumptions can be made here based on what we know.
It's reasonable to assume that, net of costs and Optimism's cut, Coinbase would receive a significant portion of Base's revenue. However, this scenario will change when the sequencer is decentralized. At that point, revenue would be distributed among the node runners in the sequencer set, reducing their share of the revenue.
Factoring in the revenue share of 15% to the Optimism Collective, we can estimate approximately 85%, or $6.7M in quarterly revenue* for Coinbase. When integrated into the latest 10-Q report, this would have represented around 1% of Coinbase's total quarterly revenue.
*Note that revenue here is taken to be total fees collected less L1 calldata fees. Costs of L2 nodes for computation and storage were not included in this assumption.
Aerodrome
Aerodrome is a deployment of Velodrome on Base. Velodrome is an automated market maker (AMM) DEX based on Solidly’s ve(3,3) mechanism and is the largest liquidity protocol on Optimism.
Aerodrome aims to be the business development layer for the Base ecosystem via its token, AERO. AERO’s role on Base is significant as it's slated to become the de facto financial instrument for ecosystem advancement on Base, filling the gap left by the absence of a BASE token. With 25% of AERO dedicated to public goods funding, it is poised to play a crucial role in Base's ecosystem growth and business development. Thus, AERO is expected to fill the void left by the absence of a BASE token, offering users and community members a stake in Base's ecosystem.
Final Thoughts
In the month following its debut, Base has shown impressive gains in onchain activity and user growth, making it a noteworthy player in the L2 arena. What is interesting is that its trajectory has been notably driven by Friend Tech and its Onchain Summer campaign, differentiating it from Arbitrum and Optimism, which have been driven primarily by DeFi. This suggests that Base is carving out a distinct niche, contributing to its rapid growth. However, its ability to sustain this momentum amid growing L2 competition, regulatory uncertainties, and a tepid crypto market remains to be seen.
References
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since then, base just launched a creative studio and broke up with optimism in the same quarter. the shift from "defi chain" to "consumer layer" is the real story