Fulfilling the promise of regulated crypto? Based.
Photo by Amanda Phung on Unsplash
From a regulatory standpoint, it is easy to look at crypto with skepticism, pointing to a litany of broken promises of what crypto was meant to deliver: seamless payments, banking the unbanked, financial freedom… for some, perhaps. And despair is understandable, particularly after the spectacular implosion of FTX last year. After all, SBF was meant to be the golden boy that would bring salvation to crypto and access to the masses.
Instead, all we got was widespread wealth destruction, with FTX being the grand finale after a cacophonous crescendo of trouble: from Luna to Three Arrows to Celsius, Voyager, Genesis and of course FTX. Collateral damage included Greyscale (arguably not entirely innocent in the entire debacle) and the who’s who of crypto investment royalty that were hung out to dry, not to mention the legions of retail investors who saw their dreams evaporate in one chapter 11 filing or another.
The enforcement actions of the past month or so by the SEC, firstly on Kraken for their staking service and secondly on Paxos on BUSD, give further cause for misery. The banks that sought their fortunes in crypto, especially Silvergate and to a smaller extent, Signature Bank, find themselves in the crosshairs of both the regulators and investors delivering class action lawsuits against them. Even this week, we saw some rather dramatic action by the Australian regulators, causing Binance to forcibly shut down perpetual futures positions and accounts of users who had failed to qualify themselves as “wholesale investors” in Australia, reportedly at the behest of the regulator.
But amidst all the action, perhaps dogmatically holding true to their raison d’être, a handful of players have stayed the course and come through relatively unscathed. For one, there is Zug-based Seba Bank, who are our bankers and are custodians for our crypto fund, have emerged as the gold standard for crypto best practice, steering clear of the weird and wonderful frontiers of crypto and wild leverage and cementing their position as a safe, reliable institution.
Indeed, when chaos erupts and the bull market implodes, “boring” immediately flips to “safe and reliable”.
The other is Coinbase.
Like Seba, they have played the regulatory game as best they could, staying on the front foot when it comes to regulators. Conservative, yes, but being on the front foot and playing a conservative game precludes accusations of malicious intent to sidestep regulations. It’s hard to be charged with flouting the rules when you’re the one knocking on the regulator’s door asking for regulatory clarity. Sure, for the past few years, the complaint against Coinbase was that it’s “boring” – no crazy leverage, access to instruments has been limited compared to the wild west of unregulated exchanges, and KYC and form-filling, such a pain, wasn’t it?
Of course, their revenues have been impacted drastically as a result of all that came to pass last year. But their business remains intact, and their position as a thought leader when it comes to shaping regulation has never been stronger – especially with the demise of most of their competitors, especially onshore in the US.
And this week, against the backdrop of apparent despair, they pulled off a masterstroke – one that could fundamentally change the trajectory of crypto vis-à-vis regulation.
Nothing new, but fundamentally different.
Just this Thursday, Coinbase made an announcement: that they were launching a new Ethereum Layer 2 rollup (we wrote about rollups here – for context) called Base, which would be built on the same tech stack as Optimism, which is another L2 rollup.
To be clear, there isn’t a token for the network, although crypto being crypto decided that they would look for the closest sounding thing and pump it (yes, crypto apes are well and alive, regardless of what anyone says), sending this similarly-named token $BASE (same name, completely unrelated) on a 300%+ round trip up and down, an occurrence which led to a few chuckles when we saw it.
On a more serious note though, one could argue that launching a new L2 doesn’t really change anything. There is no shortage of L2s out there, and in fact, the demise of the entire Eth-killer/Alt L1 narrative more or less suggests that we’re not (at least not yet) at the point where we need billions of transactions per second, and that the debates around speed vs centralisation are rather moot.
Exchanges having their own chains are not a new thing either. Most famous of them all is Binance’s BSC, which despite being the subject of its fair share of controversy over the years (even up till recently with its pegged BUSD), has been extremely successful in drawing in users with high speeds and cheap fees, especially in the developing world.
But where L2s and alt L1s in their native form are largely non-KYC-ed, albeit decentralised, and Binance’s BSC is run by US regulatory enemy #1, even if they’re the largest exchange in the world, they all miss the sweet spot needed for broad-based crypto adoption: the ability to ensure that every cent of value in the ecosystem is “clean”.
Now, for the libertarians among us, KYC-ed crypto is anathema. But the stark reality is that for crypto to have a chance of gaining any widespread adoption, at least in the US, the regulators need to be brought on side. And with Coinbase’s Base chain, the onramp to the world of on-chain applications – hitherto closed to most users in the US (Binance only offers a limited range of instruments under Binance US), or only available on-chain with major restrictions on geographic location (e.g. US citizens excluded from airdrops etc, leading to the use of VPNs to circumvent regulations or, for those who are able to, outright emigration to jurisdictions that are less hostile) – is now opened wide.
If the opportunities this brings isn’t yet obvious to the average bystander, it’s definitely obvious to the list of partners that have signed deals with Coinbase. From DeFi protocols to oracles to data management to analytics to defi, this image on Coinbase’s blog has a collection of the who’s who of crypto infrastructure.
But here is where the magic begins to show – no one really NEEDS to sign a deal with Coinbase to launch a protocol on Base. The code base runs on the Ethereum Virtual Machine, and being built on the Optimism OP stack, it’s simply a matter of deploying code onto the network in a permissionless manner.
The details are still coming out but we would think that true to their crypto roots, this is likely the direction that Coinbase would take. And why not? As long as the inflow of assets into Base is 100% KYC-ed, does it matter what sort of applications are deployed on chain?
No wonder that from a developer’s perspective, this could be the most comfortable ecosystem to build in. Sure, the rules around token offerings etc still need clarification, but at the very least, there’s no risk of being charged with something grievous like Money Laundering. Who knows, maybe even Privacy coins could have a renaissance, insofar as all inflows are already “clean”.
Furthermore, by biding their time and observing the ventures of others, including peers like Binance, Coinbase enjoys the benefit of hindsight and the lessons from their competitors: avoiding the pitfalls that BSC encountered in its early days, while also navigating the convoluted path of regulatory compliance which Binance has avoided completely (thereby foregoing the US as a key market), puts Base and the developers that build on it in a much less precarious position – both in terms of tech and in terms of regulations.
It does seem like Coinbase has squared the circle, finding what seems to be a reconciling path between deploying decentralised technologies and satisfying regulatory requirements. It doesn’t make the purists (on either side) happy, but that’s what compromises look like.
This one unlocks much more than it compromises.
Validated Optimism
The pun was irresistible. Our optimism about what this brings for the crypto ecosystem in the years to come is palpable.
Perhaps this is the masterstroke that solves the catch-22 crypto has faced so far, allowing it to fulfil all the promises from years of development work, within a safe space for development to progress without fear of stepping into landmines and accidentally being contaminated with blood money or some other transgressive transaction.
For the underlying tech stack, the Optimism L2 stack also gains much from this, especially in terms of validation. To be sure, there is probably truth in what the skeptics say about this not being particularly bullish for Optimism. Coinbase may have committed contributions back to the Optimism treasury, and yes, it is a valid argument that Base building on top of OP code doesn’t necessarily allow accrual of value directly to OP, nor does it guarantee – given cross compatibility with other EVM-compatible chains – that Base will live on OP forever, hence “not that bullish”.
But that misses the point. As we wrote before, the rollup narrative is an attractive one. As it stands, the two largest L2 rollups are Arbitrum and Optimism. Arbitrum doesn’t have any public plans for a token drop, even though the crypto world has convinced itself that a token is coming; that leaves Optimism as really the only instrument through which a view can be expressed on L2 optimistic rollups.
Coinbase’s validation of the OP tech stack is a huge stamp of approval – not just of the technology, but of the legality and compliance of everything else that is built on OP.
Ultimately, there is room in crypto for everyone – a multi-chain world already exists, and it seems like that is the way forward. Bridges will need to be built between these chains: fully regulated money seeking to access DeFi in a regulated manner, on the same code base as their unregulated counterparts could access it via Base; while those who do not require (or desire) such regulatory oversight have options outside of Coinbase’s walled garden.
Optimism’s benefit from its involvement here is significant but set up for much bigger success is Coinbase.
Whether they get there is now up to them and how they execute on their plans. Succeeding would be an achievement that is, for lack of a better word, based.