New in Digital Assets: March 2023

Crypto markets pulled back over the last few weeks following a strong start to the year, though the market remains within the trading range established in mid-January. Over the past two weeks, the total crypto market capitalization fell –7.0% to close at $989.1b. Bitcoin (BTC) and Ethereum (ETH) fell –7.6% and -6.9% respectively over the same period.

The sideways price action in major crypto assets is reflective of the indecision across broader markets as investors digest hotter-than-expected inflation and employment data, a vigilant Federal Reserve, and a global economy that has remained resilient to date. Since the beginning of the year, this confluence of factors has raised questions as to the likelihood of a hard or a soft landing.

Layer 2 scaling solutions (L2s) are frameworks built on top of the Ethereum mainnet that allow for faster and cheaper transactions. They were ideated as a fundamental component of Ethereum’s roadmap to scale its transactional throughput capacity while benefitting from Ethereum’s security and decentralization characteristics. With leading decentralized applications deploying on L2 networks, users have been quick to migrate their on-chain activity away from the main Ethereum chain and onto L2 networks such as Arbitrum and Optimism.

While adoption has been strong since the debut of these L2s in August 2021, L2 adoption reached a milestone on February 21st, 2023, when the transaction count on the Arbitrum network surpassed that of the main Ethereum chain with a record 1,103,398 daily transactions.4 This positive development shows that Ethereum’s scaling efforts are moving in the right direction. The lower transaction fees and higher throughput provided by L2s allow more users to engage with the Ethereum ecosystem and expand the use cases of blockchain-powered applications.

News & Headlines

Crypto & Web3

Coinbase (COIN) Launches “Base,” An Ethereum Layer 2 Network

Coinbase announced the launch of the “Base” network. Base is a Layer 2 network built on top of the main Ethereum chain that will offer a secure, low-cost, developer-friendly way for anyone, anywhere, to build decentralized apps (dapps) on Ethereum. Layer 2 networks such as Base are also integral to the Ethereum network’s long-term scalability goals.

Built using Optimism’s modular and open source “OP Stack,” Coinbase’s launch of Base is a major show of commitment to scaling the Ethereum network. It also demonstrates Coinbase’s philosophical alignment with Ethereum’s principles of security and decentralization. Coinbase further solidified this commitment when it announced a collaboration with Optimism to continue to develop its open-source software stack and standards. The chain is currently in testnet with prominent Ethereum dapps such as Aave and Uniswap expanding their ecosystems to the new chain.

Coinbase’s roll-out of Base and partnership with Optimism indicate the early days of Coinbase becoming a key on-chain builder as well as an influential force shaping the adoption of on-chain crypto ecosystems.

Ethereum’s First Testnet Ahead of Shanghai Upgrade Goes Live

Ethereum has successfully conducted the first testnet for the much-anticipated Shanghai hard fork. The Shanghai upgrade will codify the ability for staked ETH to be withdrawn from the Beacon Chain, Ethereum’s Proof-of-Stake (PoS) consensus engine.

Since introducing the Beacon Chain in December 2020, network validators have been staking ETH and accruing ETH-denominated rewards in exchange for securing the network. In the leadup to Ethereum’s transition from a PoW to a PoS consensus mechanism in September 2022, an event called “The Merge,” the Ethereum network did not allow staked ETH tokens to be withdrawn from the Beacon Chain.

The success of the testnet is an important step towards implementing the upgrade on the live Ethereum blockchain, which is intended to take place in April 2023. The ability to withdraw staked ETH from the Beacon Chain is critical for the network’s long-term viability, as it will significantly de-risk staking, possibly attracting a new wave of capital to secure the network and earn yield in the process.

Ethereum Deploys ERC-4337, Paving the Way for Smart Accounts

 The Ethereum blockchain has implemented a new standard that allows developers to build functionality and conditions into user wallets. The ERC-4337 standard enables the concept of “account abstraction,” a feature that allows wallets and keys to operate as programmable smart contracts. The programmability of wallets and user keys has been a long-awaited enhancement to the network infrastructure.

By allowing wallets to create conditions, developers can simplify the UI front-ends of digital wallets and enable easier, simpler, and safer access for users to self-custody their assets. Today, users are provided with Externally Owned Accounts or “EOAs,” where only the private key holder can enact new transactions. With account abstraction, accounts can be programmed by smart contracts, providing greater flexibility in managing private keys, automating certain processes, and offering novel user experiences.

Adoption

Unity Software (U) Taps into Blockchain Gaming

Unity is one of today’s most popular gaming engines, allowing developers to create and publish games across multiple platforms. The publicly traded company has access to over 20 different platforms including iOS, Windows, and PS5, and is home to over 1.5 million monthly active creators.5

Last week, Unity announced the introduction of a new category of gaming developer solutions specific to Web3 gaming. Web3 gaming refers to games built on top of blockchains, where in-game economies can be tokenized and new gaming experiences can be created. This new paradigm allows gamers to own and monetize their in-game value.

The recently announced “Decentralization” category within the asset store will help developers integrate technology such as digital assets and smart contracts into their games and allow them to tap into blockchain networks. Unity will support various software developer kits (SDKs) from thirteen different projects. The list of Unity’s partners in this endeavor includes prominent projects such as Immutable X, Infura, Metamask, Solana, and Tezos.

Spotify (SPOT) Enters Web3 with a Token-Gated Playlist Pilot

Spotify announced that it is experimenting with token-gated and curated playlists for a subsect of its more than 489 million monthly active users.6 Token-gated playlists can allow fans and community members to access exclusive content such as behind-the-scenes clips, interviews, and first access to content. While only in the early days of development, the success of token-enabled initiatives could prove a powerful blueprint for NFT utility and provide a path to onboard a new group of users to the world of Web3. Spotify’s pilot program is accessible to certain NFT communities and is currently limited to Android users in the U.S., U.K., Australia, Germany, and New Zealand.

Google Cloud (GOOG) Becomes a Tezos Validator

The Tezos Foundation partnered with Google Cloud to onboard users to the Tezos Blockchain. Google Cloud will serve as a validator for Tezo’s Proof-of-Stake (PoS) chain, allowing developers to deploy Tezos nodes and create Web3 applications using Google’s cloud infrastructure.

The partnership announcement is the latest example of Google’s continued expansion into Web3. In late 2022, Google began running a node-hosting service for the Ethereum blockchain and became a validator on the Solana blockchain.

Digital Asset Equities

Coinbase Annual 2022 Report Shows Progress in Subscriptions and Services

In a quarter marked by increased regulatory scrutiny, concerns over the solvency of centralized exchange platforms, and declining prices of cryptocurrencies, Coinbase’s Q4 2022 earnings provided much to be encouraged about. Of particular note was Coinbase’s success in diversifying its service offerings and revenue streams away from trading fees. Subscription and services revenues were up 34% QoQ, a category which includes staking, asset custody, interest income, and subscriptions to products such as Coinbase One. Trading revenue came in at $322.1m, a -12% QoQ decline.

Coinbase’s focus on growing its subscription and services revenue is part of a larger strategic reorganization of the exchange’s business model. Historically, Coinbase has relied predominantly on trading fees to generate the bulk of its revenue. This strategy has proven highly profitable in bull market conditions but has left the company vulnerable during prolonged market dislocations. While shifting to a more subscription-based business model will likely occur incrementally, this quarter’s earnings demonstrate Coinbase’s success in building out a foundation that will bring greater stability to the exchange’s revenues and cash flows in all market conditions.

Coinbase Seeks to Expand Institutional Business, Purchases Asset Manager One River Digital Asset Manager

Coinbase announced its acquisition of SEC-registered investment advisor One River Digital Asset Management (ORDAM), a One River Asset Management subsidiary. The acquisition is a key component of Coinbase’s strategy to continue to diversify its service offerings and move into institutional advisory and investment management.

According to the official announcement, ORDAM will become Coinbase Asset Management (CBAM) and will operate as an independent business and wholly-owned subsidiary of Coinbase. One River Digital Asset Management is a provider of digital asset investment solutions for institutional investors, featuring product offerings such as the ONE Digital SMA, a suite of strategies and indexes that power separately managed account (SMA) strategies.

Silvergate Capital (SI) Delays Public Disclosures, Customers Start Walking Away

Silvergate Capital Corp. (SI) filed a report with the SEC stating concerns about the bank’s ability to operate as a going concern. Silvergate is a regional bank that made its name by aligning with and supporting the crypto industry. Known for product offerings such as the Silvergate Exchange Network (SEN), a 24-hour payment network allowing transfers between retail investors and crypto platforms, Silvergate has played a central role in promoting the growth and accessibility of crypto. Silvergate has also partnered with some of the industry’s most influential enterprises, including crypto exchanges, investment managers, stablecoin issuers, and more.

Silvergate’s troubles came on the heels of financial stress in crypto markets due to the collapse of FTX and Alameda Research among others. In the immediate aftermath of these events,

investors rushed to withdraw funds from centralized crypto platforms of all types. While Silvergate was able to meet all withdrawal requests, the events led to a $1b net loss for the bank in Q4 2022.

In the wake of the SEC filing, Silvergate saw many of its institutional partners distance themselves from the bank, including Coinbase, Circle, Paxos, and Galaxy Digital. Silvergate’s equity shares closed the week of February 27th, 2023, at $5.77, down -60.5%.

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