#60 The Context: CeFi and DeFi: A match made in heaven?
Coinbase and Optimism leading the Layer-2 charge
Hi, there, hope you had a good week. In this week's letter, we look at the burgeoning Layer-2 ecosystem as the major CeFi player, Coinbase, joins in on the action. How will their presence shape Ethereum's mission to achieve scalability and mass adoption? Binance continues to face hardships through its struggling management of customer assets and stablecoin collateral, spurring a game of cat and mouse amongst Binance officials. Elsewhere, liquid staking continues to enjoy its rise to stardom, this time overtaking crypto lending in popularity, just in time for the upcoming Shanghai upgrade.
The usual disclaimer: This newsletter collates the main themes and headlines of the week in DeFi/crypto/metaverse/web3/NFT land and tries to provide unbiased context. It's aimed at anyone who wants to monitor the space. It's put together by a team at YAP and doesn't contain any promotion of our clients (if one is mentioned, we'll flag that).
[tl;dr]
Coinbase is jumping on the Layer-2 bandwagon, spelling promise for the future of a scalable, modular, and, most importantly, collaborative Ethereum.
Binance in internal disarray as they struggle to manage the custody of its customer assets and stablecoin collateral.
Liquid staking overtakes the crypto lending market, confirming its position as the next pillar of DeFi.
[Base: Coinbase enters Layer-2]
Last Thursday, Coinbase announced the launch of its Ethereum Layer-2 network, Base, on testnet, serving as the new on-chain home for the second-largest exchange by trading and volume. Coinbase is the first major CeFi player to delve into the Ethereum Layer-2 ecosystem and could spell a new trend for the future of modular blockchain infrastructure.
Open source tech: Base is built on top of the OP Stack, an open-source development stack that powers Optimism, a fellow Layer-2 competitor. In doing so, Coinbase is working with Optimism as a core developer on the open-source OP Stack.
Collaboration: this provides an opportunity for Coinbase and Optimism to join forces and spearhead a positive-sum ecosystem. Jesse Pollak, head of protocols at Coinbase, states, "we believe that like Ethereum, Layer-2 must be open-source, freely available, and something that contributes back to the underlying public infrastructure". Keep an eye on potential future product integrations and a blossoming partnership between both projects.
Why now?: we've seen Coinbase adopting a more experimental approach to DeFi in recent years, most notably with the launch of its liquid staking token, cbETH, last August. Coinbase's foray into the Layer-2 ecosystem comes at a time when Ethereum is turning its attention towards a future upgrade, EIP-4844, aka proto-danksharding, touted for late 2023. The launch promises to reduce transaction costs for Layer-2s by a magnitude between 10x to 100x. Pollak confirms this thinking by recounting the start of Coinbase's relationship with Optimism: "when we started working on EIP-4844, they [Optimism] were the other team that raised their hand about a year ago… that built trust".
The future: Although Coinbase brands itself as a chain-agnostic company, this move suggests its bullishness on the future of Layer-2s. While this may improve on-ramp infrastructure, allowing users to reach other Layer-1 ecosystems, they may have to compete fiercely to grab user attention. And with Solana's most recent 20-hour network outage proving to be a chronic issue for the network, this may spell trouble, at least for Solana.
Sources: Stories by Shaurya Malwa of CoinDesk; Jason Yanowitz and Santiago Roel of the Empire Podcast (Blockworks); Marc Arjoon of Coinshares (report); Ezra Reguerra of Cointelegraph.
[Binance: USDC & BUSD cause CZ headache]
A recent investigation by Forbes has raised concerns about Binance's management and custody of customer assets and stablecoin collateral. Forbes discovered that $1.78bn worth of collateral moved out of Binance wallets intended to back stablecoins, particularly b-USDC. Of this sum, $1.2bn was sent to trading firm Cumberland DRW, amongst others.
Caveat: However, critically, this outflow was not accompanied by a parallel reduction of b-USDC tokens. The most accusatory interpretation of these findings is that Binance was engaged in some form of rehypothecation. Essentially, the funds backing b-USDC were loaned to counterparties or otherwise put at risk, which is comparable to the malpractices that led to the collapse of FTX.
Binance responded on three uncoordinated occasions:
Patrick Hillman (Chief Strategy Officer) of Binance claimed that the real tracking of assets occurs through an off-chain ledger, with on-chain wallets merely serving as "containers". As such, Hillman dismissed the significance of the reported on-chain transactions.
A Binance spokesperson contradicted Hillman's statement by saying they hold customer assets in segregated accounts instead of tracking them on an internal ledger. In essence, the spokesperson implied that customer funds are held in segregated on-chain wallets.
Finally, CZ referred to the transactions as "some old blockchain transactions that our clients have done", suggesting they were not mediated by Binance at all.
On March 1st, Binance released a blog post claiming the transactions were "simply a case of institutional clients withdrawing their own assets from our platform." However, this claim lacks detail and does not address the core finding that the "peg wallet" meant to back various wrapped assets has repeatedly been off its proper collateralisation level.
Our view: Binance's responses to the investigation do not inspire confidence, particularly in a post-FTX era of rightfully widespread suspicion of centralised custodians with off-chain balance sheets. It remains to be seen if Binance's vague and defensive responses will be sufficient to address these concerns.
Sources: Stories by David Z. Morris of CoinDesk; Forbes; Ram Ahluwalia, CEO of Lumida and Binance.
[Stake and fries: The rise of liquid staking]
This week, it seems like retail investors can have their stake and fries and eat it too. Liquid staking looks set to stay as it has overtaken the lending sector, ballooning to a whopping $14bn.
Liquid staking, which allows users to deposit funds and earn rewards for locking them away in the form of a liquid token which represents the value of your stake, has just overtaken decentralised lending and borrowing within the sector in terms of total value locked (TVL). This brings the total value of all deposited crypto assets in liquid staking protocols to $14.1bn, with the lending and borrowing sector standing at $13.7bn. Decentralised exchanges have remained at the top spot with a total value of $19.4bn.
The increase in the popularity of liquid staking could be attributed to its flexibility and ease of use compared to traditional staking. It allows users to maintain liquidity while still earning rewards and participating in a network's security. Additionally, it can provide a new revenue stream for asset holders who may not have been able to participate in traditional staking due to certain staking requirements.
Facts at-a-glance: Currently, only 14% of all Ether is being staked compared to the 58% average staking rate amongst rival Layer 1 tokens.
16.5 million Ether is staked on Ethereum's blockchain, helping secure the Proof-of-Stake mechanism introduced by The Merge in September 2022.
Over 5.6 million Ether is staked on Lido (a YAP client) alone, the leading liquid staking provider.
Lido's stETH can be utilised and is intended to be utilised across decentralised finance in lending protocols, liquidity pools and yield farming.
The 'Meal' Deal: The reason why liquid staking seems to sit above almost all else is because it is at the top of the proverbial pyramid - liquid staking doubles as an asset and a service. This all comes with Ethereum's EIP-4895, aka the Shanghai upgrade, in the background, which is set to allow users to unstake their staked Ether from Ethereum's smart contract in a matter of weeks. Some sceptics of the update have cited liquidity constraints as a possible issue in the immediate aftermath of the upgrade, but only time will tell how much this issue may proliferate across the Ethereum ecosystem.
Many signs seem to indicate that post-Shanghai, staking may be here to stay, as staked users will have the option to withdraw and move their funds, fulfilling the range of services that liquid staking protocols have to offer.
Sources: Stories by Omkar Godbole of CoinDesk; DefiLlama; Lido's blog; Binance Research report (PDF).
[tidbits]
Ethereum has executed its Shapella hard fork, successfully processing staked Ether withdrawals for a second time, this time on the Sepolia testnet. While this is a great step forward towards the Shanghai upgrade, should developers continue to run test upgrades three weeks apart, we could be waiting until early April for the mainnet launch.
Binance has been hit hard by the SEC's lawsuit against Paxos, an issuer of the Binance stablecoin (BUSD), leading to a significant outflow of $6bn of BUSD. Despite CZ's claims that BUSD was never "big business", it still represented around 20% of their trading volume. This could have a significant impact on the exchange's revenue as Binance generates "90 per cent of its revenue from transaction fees", stated David Moreno Darocas.
The hosts of Bankless are raising a $35mn crypto venture capital fund to invest in emerging web3 startups. The popular crypto newsletter and media platform is continuing to venture beyond its roots and into the world of venture capital. "Bankless is going beyond media", said Ryan Sean Adams in a blog post. Is this the start of crypto media expanding beyond their initial remit and taking on more responsibility for the growth of web3?
Shares of Silvergate lost "almost half their value" after disclosing its ability to survive as a "going concern". Hit hard by the collapse of digital token prices and the implosion of FTX, the bank states it will miss the March 16th deadline to file its annual report due to its deteriorating capital position. Silvergate is currently evaluating its ability to continue operating for the next year. For now, Coinbase and Galaxy Digital have stopped accepting initiating payments or transfers to Silvergate.
[reading]
Crypto Update: Bank Of England Cautious On Prospects For CBDC, Forbes' Mark Hooson covers the Bank of England's statement, which indicates that a British CBDC is still likely years away from being implemented.
[Tweet of the Week]
[Events]
Buidl Week / EthDenver | February 23rd - March 5th 2023 | Denver, Colorado, USA
GDC San Fran | March 20th - 24th 2023 | San Francisco, California, USA
Wow Summit HK | March 29th - March 30th 2023 | Hong Kong, China
[DeFi Definitions]
An occasional segment exploring one particular aspect of DeFi
This week "Hard Fork" by Damian Alvarez.
A hard fork refers to a network upgrade that significantly diverges from an existing ecosystem. Because blockchain technology is decentralised at its core, there is no central administrator that can "upgrade the system", so to speak. These changes are decided upon by different subsets (parties) who secure the blockchain. If the majority agrees to a new Ethereum Improvement Proposal, the hard fork is implemented.
For example, in a traditional business, a central administrator can propose and enforce changes to the internal system, and employees are forced to accept these changes. Within the context of Ethereum, for instance, it is not possible to do this as Ethereum clients (transaction validators) must decide to update their code themselves to accept these changes, and then transactions on-chain have to be validated against the new system's rules.
On Ethereum, Ethereum Improvement Proposals (EIPs) have sought to upgrade the Ethereum network successfully to make important changes; most notably, the EIP-3675 ('The Merge') update which scrapped Proof-of-Work (PoW) on Ethereum and introduced a Proof-of-Stake (PoS) mechanism.
A 'hard fork' is essentially the act of an existing network being 're-created' anew.
The team: founder Samantha Yap and consulting editor Jeremy Wagstaff, Sam O'Donohoe, Ewan Brewster, Tiffany Mac Sherry, Becky Corbel and Delon Chan, special shoutout to Andrew Wickerson and Damian Alvarez for their help on this week's edition. Your feedback is, as always, welcome. Ping us at thecontext@yapglobal.com. Old newsletters can be found here.
This newsletter is prepared by YAP Global, an international PR Consultancy focusing on helping cryptocurrency, Decentralised Finance (DeFi) and Web3 brands through impactful storytelling. Find out more about us here.