Bitwise: Why are we bullish on Base Chain and Coinbase?

Author: Bitwise

Translation: Wenser, Odaily Star Daily

Editor's Note: Since the mainnet went live in August last year, Base has gradually stood out from various L2 networks, with TVL soaring to over $5 billion, gaining support and recognition from many market users, and attracting attention and optimism from large institutions. Recently, the cryptocurrency asset management company Bitwise introduced Base and its underlying Coinbase on its official account, expressing confidence in the future development of the Base ecosystem and Coinbase. Odaily Star Daily will provide a brief translation of this.

Everything is About Base

Coinbase released its financial report last week, showing outstanding performance. The company's financial report indicates that in Q1 2024, net revenue reached $1.6 billion, a 72% increase from the previous quarter and a 116% increase year-on-year, significantly exceeding Wall Street's expected $1.36 billion. Profit also performed well, reaching $1.2 billion, with total cash on hand increasing to $7.1 billion, far exceeding Wall Street's expectations.

(Note: You may have seen reports about the company's earnings per share being $4.84, compared to an expected $1.15. While technically correct, these figures exaggerate the "Beta" income per share. The company's earnings this quarter benefited from a one-time change in the accounting treatment of cryptocurrencies on the balance sheet. Excluding this change, the company's earnings per share are $1.92, although at a relatively more reasonable level, still below expectations. We believe this is a more appropriate comparison.)

All business lines performed remarkably well. By quarter:

• Consumer trading revenue increased by 93%;
• Institutional trading revenue increased by 105%;
• Stablecoin revenue increased by 15%;
• Blockchain reward revenue increased by 59%;
• Custody revenue increased by 64%.

Since the news broke, Coinbase's stock has been consolidating, but make no mistake: Coinbase is a leading company in the rapidly growing cryptocurrency industry and is developing steadily. However, hidden behind the broad numbers is a little-known native crypto business line that we believe, in the long run, could be the company's "game-changer" — it's called "Base," accounting for less than 1% of the company's revenue in Q1 2024, with limited media or analyst attention.

But it has reasons worth paying attention to.

What is Base?

In August last year, Coinbase officially launched Base, a new L2 network built on Ethereum. L2 networks are connected to traditional L1 blockchain networks like Ethereum, aiming to increase the throughput of L1 blockchain networks and reduce operating costs.

The best way to understand how L2 networks work is to see them as a bar tab. If you go out for drinks with friends, every time the bar serves you a drink, they use a credit card and settle the bill, which is both expensive and slow. So, they open a tab — they tally up the total number of drinks and settle them all at once in a single transaction.

Similarly, directly executing transactions on L1 blockchain networks like Ethereum can be expensive and slow. Historically, transaction costs on Ethereum have ranged from less than $1 to over $200, and settlement times are measured in minutes, relatively slow.

The operation of L2 networks involves tracking individual transactions, recording them in a batch, and periodically "publishing" these transactions to Ethereum. Coinbase's goal with Base from start to finish is to facilitate transactions settling in less than a second and costs controlled within $0.01.

The usage of L2 networks is skyrocketing, driving explosive growth in transaction activity on the Ethereum blockchain. It's obvious: if something is cheaper, faster, and easier to use, people will use it more. Base is the fastest-growing L2 network, with a 74% increase in transaction volume in Q1 2024.

But the key is: this is just the beginning.

In April alone, Base processed 40% more transactions than in Q1.

(Note: You may wonder: why the explosive growth in Base's transaction volume? The answer is simple: in March this year, the Ethereum blockchain underwent the Cancun upgrade, making L2 networks like Base more efficient. Many experts say the Cancun upgrade can reduce transaction costs on L2 networks by up to 90%, helping Coinbase achieve its goal of low-cost transactions. The Cancun upgrade has significantly reduced transaction costs on L2 networks, thereby increasing their usage.)

Therefore, Base's transaction volume could increase further. Coinbase CEO Brian Armstrong stated that the number of developers building products on Base in Q1 increased by 8 times. With these developers bringing more and more new applications, user numbers may continue to grow rapidly.

What Does Base Mean for Coinbase?

All of this is important because, with its high gross margin, Base could become a huge revenue source for Coinbase.

When people use Base, they submit transactions to the network they want to process. Coinbase acts as the "sorter": verifying these transactions, batching them, and publishing them to the Ethereum L1 mainnet. It's worth noting that Coinbase is currently the only sorter on the Base network.

Coinbase charges corresponding fees for this service. For example, in Q1 2024, users paid $27.4 million in transaction fees to Base (all fees included), of which Coinbase was able to earn $15.5 million. In April alone, Coinbase earned another $11 million through this. All these funds go into Coinbase's pocket.

If Base continues to grow, it could bring relatively stable profits of $10 million, $20 million, or more to Coinbase each month. In the long run, if Base becomes the primary network for developers to build applications, Coinbase could ultimately own a core part of the crypto infrastructure.

Some crypto industry observers point out that this could put Coinbase in a position similar to Amazon. Amazon started as an online bookstore and later expanded to offer various retail products. But currently, over half of the company's profits come from Amazon Web Services, currently the world's largest cloud computing service provider.

People see Coinbase as a cryptocurrency exchange, and it is one of the largest exchanges in the world.

But from the early returns of Base, it is evident that Coinbase could eventually play a more powerful role: a provider of core infrastructure for the crypto ecosystem.

This is indeed a far-reaching development.