Coinbase’s first-quarter earnings report — released May 2 — indicated the company has been thriving thanks to a vibrant market for Bitcoin

Launched in August 2023, Base is a secure, low-cost Ethereum layer-2 solution built to scale Coinbase’s user base on-chain to make transactions faster. Coinbase’s vision is to decentralize Base and create an open, global crypto ecosystem leveraging the security of the Ethereum mainnet, which is accessible to everyone.

According to Coinbase’s Q1 report, volume on Base has surged past its competitors, particularly after the rollout of Ethereum’s Dencun upgrade. DeFi crypto exchanges on Base saw daily trading volume surpass $1 billion per day, narrowing the gap between Coinbase’s main centralized exchange trading volumes, where almost 250 cryptocurrencies are traded.

The Dencun upgrade significantly boosted activity on Base. Within a short span, Base experienced a surge in daily transaction volume and revenue, surpassing competitors like Optimism and Arbitrum. The upgrade reduced costs for layer-2 scaling chains such as Base and led to a surge in user engagement and transaction volume.

Since the upgrade, Base has consistently processed more than 3 million transactions daily, substantially lifting its fee revenue. If this pace is sustained, Base could become a big growth driver for Coinbase. Since the Dencun upgrade, the fees that Base has earned have surpassed the other major Ethereum scaling networks.

The spike in Base’s revenue is attributed to its support for DeFi protocols, with roughly 250 protocols currently operating on the network. Its impressive rise in market share in such short period of time illustrates Base’s potential — and undergirds the case that Coinbase could become the NVIDIA of DeFi as a long-term industry leader.

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Outlook for Q2

Now that Bitcoin’s halving — one of its major price drivers — is over, the outlook for cryptos may turn back to macroeconomic factors such as interest rates, inflation, the direction of stock markets and geopolitical tensions. The Federal Reserve’s “higher for longer” stance is one of the catalysts that could set a risk-off mood in the markets and exert downward pressure on riskier assets.

Coinbase provided good guidance for the second quarter of 2024, but cautioned that results will depend on crypto prices. Since Bitcoin peaked in mid-March trading volumes have been declining, and the second quarter is likely to be weaker than the first, especially if crypto prices continue to slide.

Over the long-term, Bitcoin’s bull run is likely to resume. Higher price levels are in the cards. But in the short-term, further weakness is likely to unfold.

Coinbase custodian fee revenue is expected to rise

Coinbase revenue from transactions is roughly half of net revenue. The other half comes from non-transactions revenue, which encompass subscriptions and services: stablecoin revenue, custodial fees, blockchain rewards, and interest income. The non-transactions revenue has seen a strong growth over the past two years and could offset fluctuations in transactions revenue, which is highly correlated to cryptocurrencies prices.

Coinbase is the custodian for eight of the 11 new Bitcoin ETFs launched on Jan. 10. These ETFs have reached close to $60 billion in assets under management in the first quarter of 2024. Coinbase charges a fee for assets under custody, which are a few basis-points on the assets under custody.

As the assets under management in these ETFs increase, Coinbase custodian fees would rise too. Coinbase custodian fee revenue was $19.7 million in Q4’23. After the launch of the Bitcoin ETFs in mid-January, Coinbase revenue from custody fees rose 90% to $32.3 million.

Cryptocurrency custodians have a similar role to banks in traditional finance – to settle trades, manage regulatory reporting, keep, and manage clients’ assets. However, for crypto markets the process is more complex as it is more specific to digital assets. Also, the technology, security and storage requirements are different.

Base could offset some future declines in trading volumes

While Base is likely to become a contributor to Coinbase’s top line revenue, it is likely to take some time. The additional — possibly substantial — source of revenue could help Coinbase’s share price loosen its correlation to cryptocurrency price in the future.

Overall, there is still huge potential for cryptos to grow thanks to the United States’ 11 Bitcoin ETFs. Likewise, six Bitcoin and Ethereum ETFs launched in Hong Kong in April, and the Australian Securities Exchange may also approve its first Bitcoin ETFs before 2025.

These factors are likely to offer consistent support for crypto in the long run, which will be beneficial for Coinbase transaction and non-transaction revenue. While declining crypto prices are likely to weigh on Coinbase’s share price in the short-term, Coinbase’s diversification of revenue drivers is likely to lead to higher share prices in the long-term.