Coindesk

President Donald Trump is just about done naming the key figures he’s seeking to get into financial regulation posts that will direct the future oversight of the crypto industry, now including lawyer Jonathan Gould as a nominee to run the Office of the Comptroller of the Currency that oversees U.S. national banks.

With a widely circulated White House nominations document showing Trump has settled on Gould, a partner at law firm Jones Day who was a top lawyer at the OCC and a former crypto executive, and the president will reportedly nominate the Federal Deposit Insurance Corp.’s Jonathan McKernan to run the Consumer Financial Protection Bureau, the slate is almost clear.

Gould had briefly worked as the chief legal officer for blockchain technology company Bitfury after he left the OCC as senior deputy comptroller and chief counsel during the first Trump administration. At Bitfury, he worked for CEO Brian Brooks, who Trump had once installed at the OCC as an acting comptroller and also tried to make it permanent. At the OCC, Brooks worked to open U.S. banking for crypto firms, and he elevated Anchorage Digital as the first and only crypto bank chartered by the agency. Now the industry will find out if Gould will follow in those footsteps.

“For crypto, we believe Gould could seek to revive the concept of a limited-purpose national bank charter,” said Jaret Seiberg, a policy analyst at TD Cowen, in a note to clients on Wednesday. “That could lead to banks that specialize in crypto. We also believe he would permit banks to get more involved with crypto including stablecoins.”

Rodney Hood, a former Republican chief of the National Credit Union Association, had been placed as Trump’s temporary comptroller and would be replaced by Gould if he wins his Senate confirmation. Temporary Republican replacements like Hood are now leading most of the financial regulators, including banking agencies, the FDIC and OCC; the pair of markets regulators, the Securities and Exchange Commission and the Commodity Futures Trading Commission; and the consumer watchdog CFPB.

At the CFPB, the Trump administration’s effort to gut the regulator with the assignment of his budget director, Russ Vought, as its interim leader has drawn vigorous protests from congressional Democrats. Now he’s announced the name he wants to eventually replace Vought there: McKernan, a Republican member of the FDIC. McKernan had served as a staffer for former Senator Pat Toomey, a Republican who had led an early (failed) charge to get stablecoins regulated in the U.S.

Ian Katz, a veteran financial-regulation analyst in Washington, noted the “conventional” pick of Gould for the OCC and the other recent choices for permanent chiefs of the Commodity Futures Trading Commission and the Consumer Financial Protection Bureau that probably won’t ruffle feathers among the U.S. senators that will evaluate their nominations. The relatively sedate choices seem to hew closely to Trump’s model for financial regulators during his first term: No dramatic surprises.

Unlike some of Trump’s personnel decisions in his cabinet and other agencies, the choices are experienced and are absent political firebrands, including the pick of longtime securities consultant and former Commissioner Paul Atkins to run the Securities and Exchange Commission. Virtually all of the names — temporary and those nominated for permanent roles — have crypto backgrounds or have demonstrated support.

The Senate must still confirm all of these nominees, and that process often takes months into an incoming president’s first year. Sometimes the confirmations fail entirely, and agencies are left with permanently acting heads, like the OCC was during the Biden administration.

Meanwhile, Trump also picked former Commissioner Brian Quintenz to run the CFTC, where sitting Commissioner Caroline Pham has been holding down the fort and making major agency changes as acting chairman. So far, Pham and other acting agency heads have already begun work to overhaul Biden-era crypto policy.

Crypto mid-caps are struggling. While some digital asset investors may seek hidden gems and future powerhouses in the next tier of market capitalization and liquidity, that pursuit has generally not been rewarded. Furthermore, mid-caps have delivered significantly higher volatility. Less reward, more risk. What gives?

Is this a mirror of “Mag 7” dominance in equities, a lack of promising assets in the mid tier or just the future of finance taking longer to bear fruit than we previously thought?

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We define our size segments using the CoinDesk 20 and CoinDesk 80 indices. CoinDesk 20 captures the performance of top digital assets with some constraints to promote adoption in a number of places and products — specifically, no memecoins, access to U.S. investors, select exchange listings and liquidity in specific pairs. CoinDesk 80 captures the next 80 assets outside of CoinDesk 20 — still reasonably large and still measurably liquid with fewer restrictions and more trading pairs allowed. In other words, the mid-caps.

Both indices have a base date of Oct. 4, 2022 and a base value of 1000. As of this writing, CoinDesk 20 sits at around 3200. CoinDesk 80 sits at 970. You read that right: the CoinDesk 20 index has delivered a 320% return since its base date, while the CoinDesk 80 index has lost 3%.

The volatility of CoinDesk 80 sits well above that of CoinDesk 20, although its patterns follow those of the other index and majors bitcoin and ether.

What are these difficult digital assets in the mid-cap segment? Ill-conceived platforms? Frivolous projects? Not really. Although there are some highly volatile memecoins in the mix (I’m looking at you, PNUT), many constituents are household names.

If we narrow our view to year-to-date performance of current constituents (CoinDesk 80 was reconstituted on Jan. 31) we see that only one constituent is up on the year, yet many of the leaders (and laggards) are names we have known for some time.

Of course, pinpointing the underlying cause of the mid-cap underperformance is just as difficult in crypto as in other asset classes. Although size is one of the three classic Fama-French factors (suggesting that small-cap equities should outperform), it has not always been demonstrated in performance.

We suspect that while the crypto community will trade just about anything, it tends to invest in the biggest, the longest-tenured and the most familiar names. Regulatory accommodations (e.g., ETFs) will also follow this pattern, leading to a broader set of investors.

Does this suggest that a large-cap tilt in digital asset investing — the inverse of the Fama-French size factor — will deliver excess returns? We shall see, but in the meantime, we can keep an eye on the values of CoinDesk 20 and CoinDesk 80.

In traditional finance, the “risk-free rate,” the interest rate an investor can expect to earn on an investment that carries zero risk, serves as a fundamental benchmark for all investment decisions. Today, DeFi has quietly established its own equivalent: the base rate for lending stablecoins. Through battle-tested protocols like Morpho and Aave, lenders can now access double-digit yields that substantially outperform traditional fixed-income instruments, all while maintaining remarkable transparency and efficiency.

The emergence of this new base rate isn’t just a passing trend — it’s a structural shift that challenges traditional finance by demonstrating the market-driven sustainability of high-yield, low-risk on-chain money markets. At times, yields on major platforms like Morpho have reached 12-15% APY for USDC lending, significantly outpacing the 4-5% offered by U.S. Treasuries. This premium exists not from excess risk-taking or complex financial engineering, but from genuine market demand for stablecoin borrowing.

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Market dynamics driving yields

The rise of high-yield farming strategies, especially those involving Ethena’s synthetic dollar (sUSDe) product, has been a key driver behind elevated stablecoin lending rates. Over the past year, Ethena’s USDe and staked USDe (sUSDe) have delivered yields in the 20-30% APY range, fueling substantial demand for stablecoin borrowing. This demand comes from leveraged traders aiming to capture the spread created by these high yields.

What sets Ethena apart is its ability to capture funding fees traditionally claimed by centralized exchanges. By offering sUSDe, Ethena allows DeFi participants to tap into profits generated from traders paying high funding rates to go long on major assets like ETH, BTC and SOL. This process democratizes access to these profits, enabling DeFi participants to benefit simply by holding sUSDe.

The increasing demand for sUSDe drives more capital into the stablecoin economy, which, in turn, raises the base yield rates on platforms like Aave and Morpho. This dynamic not only benefits lenders but also strengthens the broader DeFi ecosystem by increasing yield and liquidity in the stablecoin lending market.

Risk-adjusted returns in perspective

While double-digit yields might raise eyebrows, the risk profile of these lending opportunities has matured significantly. Leading money market protocols have demonstrated resilience through multiple market cycles, with robust liquidation mechanisms and time-tested smart contracts. The primary risks — smart contract vulnerability and stablecoin depegging — are well understood and can be managed through portfolio diversification across protocols and stablecoin types.

Annual Yield Comparison – Traditional Fixed Income vs. DeFi Lending Returns

30-day average as of February 1, 2025

Source: Traditional markets data from Bloomberg Terminal, DeFi markets data from vaults.fyi

Implications for traditional finance

For wealth managers and financial advisors, these developments present both an opportunity and a challenge. The ability to access stable, transparent yields that significantly outperform traditional fixed-income products demands attention. As the infrastructure for institutional participation in DeFi continues to improve, these yields may become increasingly relevant for income-focused portfolios. While yields are highly responsive to market cycles, especially funding rate dynamics, fluctuations are still common. However, the efficiency and transparency of on-chain money markets suggest that meaningful yield premiums over traditional alternatives could be sustainable in the long term.

As DeFi infrastructure matures, these on-chain money markets may not only serve as a viable alternative to fixed-income products — they could become the new standard for transparent, risk-adjusted yields in the digital economy, leaving traditional finance to play catch-up.

Franklin Templeton has made the OnChain U.S. Government Money Market Fund (FOBXX), the third-largest tokenized money market fund, available on Solana in another signal of growing interest in the blockchain.

The fund is already available on Ethereum, Coinbase’s Base, Aptos and Avalanche, which were all added last year. The Stellar network functions as the primary blockchain. The asset manager announced the expansion on Wednesday.

Solana has emerged as the leading venue for new tokens (mostly memecoins) and decentralized trading. It now accounts for over 90% of all new tokens appearing on decentralized exchanges (DEX), according to a Pantera Capital report. That’s up from 1% in late 2023.

“Even when innovation doesn’t start on Solana, it eventually finds its way there,” Cosmo Jiang and Eric Wallach wrote in the report.

FOBXX, which started in 2021, has grown to a $594 million market capitalization, according to data by rwa.xyx. It lags behind Hashnote’s Short Duration Yield Coin (USYC) and BlackRock’s USD Institutional Digital Liquidity Fund (BUIDL).

Tokenization is one of the fastest-growing sectors in crypto adoption as institutions increasingly bring traditional financial assets like bonds, commodities and funds into the blockchain economy for more efficient operations and faster settlement. It’s a multitrillion dollar market opportunity, reports from BCG, McKinsey and Brevan Howard have forecast.

Solana gathers steam

Smart-contract network Ethereum leads ecosystem for tokenization efforts with a 52% market share representing $3.8 billion worth of tokenized real-world assets. It is followed by Ethereum layer-2 ZKsync Era, rwa.xyz data shows. Solana, at $135 million, ranks seventh.

Franklin Templeton’s expansion to Solana is the latest sign of increasing interest in the network for tokenization efforts. Real-world asset platform Securitize expanded its offerings, including BUIDL, to the network in late January.

Anthony Scaramucci, the founder and managing partner of hedge fund SkyBridge, in a Tuesday interview touted Solana’s speed and efficiency, saying that it will “win the race” in the tokenization world.

Alexander Vinnik, the jailed former operator of once mighty bitcoin exchange BTC-e, is being released from U.S. custody as part of a prisoner exchange with Russia.

Vinnik, 44, is being swapped with jailed American teacher Marc Fogel, who returned to the U.S. last night after negotiators struck a surprise breakthrough with the Kremlin. It had not immediately been clear who was on the other side of the deal.

But BTC-e was one of the early exchanges that popularized the buying and selling of the world’s most popular digital asset. It had over 1 million customers and moved over $9 billion of transactions between 2011 and 2017.

Its popularity also fostered a thriving criminal underground who relied on it to move in and out of ill-gotten bitcoin proceeds, according to U.S. prosecutors. They accused Vinnik of operating BTC-e “with the intent to promote” drug dealers, money launders and other cybercriminals, and caused the loss of $121 million.

Vinnik was arrested in Greece in 2017 and ultimately extradited to the U.S. He pled guilty to money laundering conspiracy in 2024 and faced a maximum of 20 years in prison.

His lawyers had previously lobbied unsuccessfully for his inclusion in other high-profile U.S.-Russia prisoner exchanges, like last year’s deal over formerly jailed Wall Street Journal reporter Evan Gershkovich.

CoinDesk Indices presents its daily market update, highlighting the performance of leaders and laggards in the CoinDesk 20 Index.

The CoinDesk 20 is currently trading at 3136.62, down 0.6% (-20.46) since 4 p.m. ET on Tuesday.

Six of 20 assets are trading higher.

Leaders: APT (+1.8%) and DOT (+1.7%).

Laggards: LTC (-4.7%) and HBAR (-3.9%).

The CoinDesk 20 is a broad-based index traded on multiple platforms in several regions globally.

If you asked a cypherpunk in the 1990s about their worst-case scenario for the future of money, they probably would have described something very close to Central Bank Digital Currencies (CBDCs). The fight against financial surveillance was fundamental for Bitcoin’s early instigators, and CBDCs go against everything they stand for: privacy, decentralization and individual sovereignty.

In “The Cypherpunk Manifesto” (1993), Eric Hughes argued that cryptography should protect individual freedoms, not be a tool for centralized control. Bitcoin, born out of concerns over financial censorship and systemic instability, represents an alternative to traditional monetary systems. While central banks typically operate with a degree of independence from governments, CBDCs raise questions about financial privacy and the potential for increased state oversight over transactions. As such, CBDCs are the antithesis of Bitcoin.

CBDCs, which are being adopted and trialled throughout the world, have been marketed as a tool for financial inclusion. But, to most Bitcoiners, they are a Trojan horse for reinforcing state control rather than granting individuals true financial ownership. They represent the exact kind of Big Brother system that cypherpunks fought to prevent.

This is why Adam Back — one of the all-time most influential figures in Bitcoin, the inventor of HashCash, and the founder of Blockstream — has been vocal about the dangers of CBDCs and the role of the World Economic Forum’s (WEF) in promoting them. He sees this for what it is: a power-play by global elites, many of whom either misunderstand — or actively oppose — Bitcoin. If Bitcoin was designed to take control away from the state, CBDCs are designed to return it.

According to Back, a speaker at Consensus Hong Kong, CBDCs did not emerge as a natural evolution of money; they were a reactionary move by regulators — a panic response to the threat of private-sector digital currency. He pointed to Facebook’s Libra as the moment that freaked the central banks out, when we caught up for a chat on Google Meets.

“Regulators saw that a company with a billion-plus users could launch corporate electronic cash, and they realized they might lose control. So they tried to get ahead of it with their own government electronic cash,” Back said. “But the problem is, it’s systemically impossible for them to create something that the average person would want to use because they have such control-oriented ideas.”

Adam Back is a speaker at Consensus Hong Kong. Come and experience the most influential event in Web3 and digital assets, Feb.18-20. Register today and save 15% with the code CoinDesk15.

Back isn’t just criticizing CBDCs in theory; he is actively building an alternative. In the past year, Blockstream has launched the Jade Plus hardware wallet — a Bitcoin-only hardware wallet designed for privacy-conscious users, offering an open-source alternative to Ledger and Trezor — and Greenlight, a non-custodial Lightning-as-a-Service platform that simplifies Bitcoin payments for developers.

Blockstream has also expanded Bitcoin’s financial infrastructure with new institutional-grade investment funds, offering regulated Bitcoin-based financial products for high-net-worth investors. They’re also advancing Layer 2 scaling solutions through the Liquid Network, a Bitcoin sidechain enabling faster and confidential transactions. These initiatives build on Blockstream’s long-standing satellite network, which allows Bitcoin transactions without internet access, and its mining operations, which strengthen decentralization.

Together, they reflect a clear vision: a Bitcoin-based financial system independent of traditional banks and centralized authorities.

Some might argue that state involvement in Bitcoin is a growing concern. With Bitcoin ETFs gaining traction, discussions around a U.S. Strategic Bitcoin Reserve, and institutions stockpiling the asset, isn’t there a risk that governments and large entities will gain centralized control over Bitcoin? Isn’t individual self-custody and self-sovereignty the whole point?

Back, a British cryptographer, aged 54, who speaks with a quiet humility that belies his influence, remains unbothered. Moisturized. Happy. In his lane. Focused. Flourishing.

“ETFs and other investment products built around Bitcoin just give people a simpler way to start,” he said, with the cool resolve of a man on a mission.

“Hopefully, they take some physical Bitcoin later and learn how to store it. What matters is that a good number of people hold Bitcoin in its bearer electronic cash format, so it doesn’t become overly concentrated in ETFs or institutions, and that’s still the case today — the majority of it is in individual ownership, some in cold storage, some in exchanges and things like that.”

While it’s hard to to predict exactly how the balance between self-custody and institutional holdings will shift over time, Back believes the broader trend is clear.

He’s been involved in Bitcoin long enough to see how adoption plays out. His well-documented email exchanges with Satoshi Nakamoto suggest he might understand Bitcoin’s trajectory better than anyone else. The way he sees it, Bitcoin’s top-of-the-funnel has widened. Sure, ETFs and institutional funds bring Bitcoin into the mainstream, but ultimately, this just means more people will be pulled into the Bitcoin network. At its core, Bitcoin remains opt-in, censorship-resistant, and free from government interference. CBDCs are the exact opposite.

Currently, 44 countries are at the CBDC pilot stage, according to a tracker from the Atlantic Council. Some claim to preserve privacy, but the reality is that these are poorly veiled efforts to maintain centralized power over money. For a while, the push for state-backed digital currencies seemed inevitable — until political opposition in the U.S. turned it into a battleground issue. Reflecting the sharp Republican turn against CBDCs in the last 18 months, Trump recently announced he would ban the development of CBDCs in the U.S.

Back points this out as a sign that the tide is shifting in favor of Bitcoin. “A number of people in the Trump cabinet are Bitcoin-enthusiasts with relevant experience, so perhaps we’ll see an improvement because it’s partly the participants to date that would probably have preferred that Bitcoin didn’t exist,” he said.

He referenced the former SEC Chair Gary Gensler, who, despite his background teaching blockchain at MIT, took an aggressive stance against the industry. “Hopefully there will be some more common sense and forward-looking regulations and recognition of individual rights to self-sovereignty,” Back said.

Financial surveillance

For Back, he doesn’t just want Bitcoin to win, he wants CBDCs to die. And he believes CBDCs aren’t just a monetary issue — they’re part of a broader agenda of financial surveillance, social credit systems, and state control. “The social media interference in elections in the U.S. and expression of interest in CBDCs in Europe where they’re clearly envious of Chinese social credit scores and things like that which are very dystopian, some of the things the WEF has been coming out with.. They really do not sound good.”

The WEF, in particular, has been leading the charge on CBDCs and other centralized control mechanisms. “I mean, they’ve generally been in favor of all kinds of illiberal things like CBDCs and loss of individual men in power. I mean, they will come out with trial balloons that just sound horrendous and then delete their own tweets.”

He’s not wrong. The WEF has a history of floating controversial ideas, and scrubbing them when the backlash hits. As just one example, in 2021, they tweeted that the pandemic was “quietly improving cities” by reducing air pollution. The suggestion that the lockdowns were a net positive for the environment was met with outrage, so WEF deleted the tweet.

Blockstream is betting that high-net-worth individuals and institutions won’t want their assets trapped in a WEF-endorsed CBDC system controlled by centralized entities. That’s why they’ve launched a suite of institutional-grade Bitcoin funds designed for those looking to preserve their wealth in a system that cannot be arbitrarily manipulated. Recent events have only reinforced why this matters so much. The collapse of FTX, Celsius, and other crypto companies in 2022, has further eroded trust in centralized institutions, whether in traditional finance or crypto.

Back, however, is nothing like Sam Bankman-Fried, the disgraced FTX founder who cared little for individual privacy and was proudly anti-decentralization. He is also nothing like Alex Mashinsky, the Celsius CEO who recklessly gambled with user funds. Back is a cypherpunk continuing to execute on the master plan to ensure that Bitcoin is rolled out exactly as Satoshi intended: as a decentralized, trustless, and censorship-resistant monetary network.

For him, this is more than just a battle between Bitcoin and CBDCs. It’s about freedom. “It’s a renaissance for cypherpunk thinking,” Back told me, explaining that once people are drawn into Bitcoin, they start to grasp its deeper implications, and they see what it means for privacy, sovereignty, and control. He added that when the original Cypherpunk Manifesto was written in the 1990s, its authors may not have fully anticipated how deeply digital technology would eventually permeate every aspect of our lives.

“So in a way, the [Manifesto’s] concerns are even more pressing now because everything is online,” he said, laser eyes twinkling.

The fourth quarter was a good one for crypto and Wall Street analysts expect leading U.S. exchange Coinbase (COIN) to have posted a big jump in earnings from the prior three months.

Revenue for the fourth quarter is expected to have been $1.8 billion, according to FactSet, up from $1.26 billion in the third quarter. Earnings-per-share are estimated to have risen to $1.99 from $0.41.

Maybe more importantly, thanks to the major rally across crypto following Donald Trump’s presidential election victory, analysts expect exchange volume to have risen to $195.9 billion in the year’s final three months from $185.3 billion in the third quarter. That $195.9 billion figure would be the strongest quarterly result since the fourth quarter of 2021.

“We maintain our bullish thesis on COIN, seeing the company well positioned to benefit as crypto begins a potential transition into a new era,” analysts at Citi bank wrote in a note.

The bank has a buy rating on the stock and this week increased its price target to $350 from $275. Shares on Tuesday are trading at $270, ahead nearly 90% from the year-ago level. The Citi team, however, does expect Coinbase to report fourth quarter revenue of $1.7 billion, missing the $1.8 billion consensus estimate.

The November election was a “monumental catalyst for the crypto ecosystem,” wrote JPMorgan’s Ken Worthington, who nevertheless remains neutral on the shares. He sees fourth quarter revenue at $1.77 billion, also a miss from the $1.8 billion estimate.

Outlook on 2025

While the final months of 2024 had many catalysts for crypto and thus Coinbase, 2025 is hard to predict as policy changes typically take some time to go into effect, say some Wall Street analysts.

“For [2025], we assume static crypto prices and factor more normalized volumes resulting in 6% YoY transaction revenue growth vs. consensus of 3% growth,” Citi said.

“Not unlike in the past, we expect the stock to remain as a ‘risk-on’ play throughout 2025 and will likely remain volatile around macro developments and swings in market sentiment,” Citi continued. “That being said, we expect the next 1-2 years to be highly formative for Coinbase’s business model/competitive strategy, as well as for the greater digital asset space.”

One of Coinbase’s main priorities over the past year has been to diversify its revenue stream, 50% of which still comes from trading fees. Retail traders, which pay the highest trading fee, still have not returned to the same levels seen in 2021, according to research firm Kaiko. The share of volume coming from that clientele shrank to just 18%, down from 40% in 2021, which continues to weigh on transaction revenue, Kaiko said.

According to Citi, Coinbase could solve this issue in 2025 by leaning further into the tokenization of assets, embedded smart contract applications and Web3, the potential efficiencies in cross-border and remittance, as well as using the blockchain as an AI governance tool, among others.

“In our view, the next evolution for Coinbase’s growth trajectory will rely on utility… an area with many proofs-of-concepts, but perhaps waiting to be unlocked with clearer rules,” the bank’s analysts wrote.

Bitcoin Twitter (or Bitcoin X) is having a moment after a 13F filing by Goldman Sachs (GS) disclosed higher stakes in a handful of spot bitcoin exchange-traded funds (ETFs), but the facts are less than meets the eye.

First and foremost, ownership of the ETFs isn’t exactly a bet by the Goldman trading floor on the price of bitcoin (BTC). The stakes are almost surely held by the bank’s asset management arm, Goldman Sachs Asset Management, for its clientele.

Secondly, while the filing — which is a snapshot of ownership as of Dec. 31, 2024 — shows a $288 million stake in the Fidelity Bitcoin ETF (FBTC) and a $1.3 billion stake in BlackRock’s Bitcoin ETF (IBIT), it also shows put option positions with nominal value of more than $600 million (along with a small call option position).

An put option gives the holder the right, but not the obligation, to sell that asset at a predetermined price. It can be seen as protection against price drop, representing a bearish stance.

“This position by Goldman Sachs, similar to many other banks and hedge funds, is not a net long position,” said CoinDesk Senior Analyst James Van Straten. “This is a strategy that reflects the basis trade, also known as the cash and carry trade, balancing potential profits and risks for bitcoin price fluctuations. The ETFs recently had options approved on them so this is most likely directional hedging.”

With the deadline for the fourth-quarter 13F disclosures fast approaching, similar filings — along with misleading headlines — are surely on the way for JPMorgan, Morgan Stanley and other large wealth-management operations.

The Ethereum community has been in turmoil over the past few weeks, with members raising the alarm that the chain will lose its competitive edge if it doesn’t address some core design issues.

A key focus of the outrage has been layer-2 fragmentation. In recent years, Ethereum has embraced a layer-2 scaling roadmap—a plan that encouraged the development of third-party auxiliary networks called “layer-2 rollups”—to help scale the base Ethereum ecosystem. Offloading activity to these upstart networks has helped bring down fees and improve speeds for end-users, but it has led to a massive, deeply fragmented ecosystem of layer 2s.

While layer-2 networks all post data back down to Ethereum, they often struggle to communicate directly with one another, meaning passing assets and data between them can become expensive and cumbersome. There’s also the risk of centralized sequencers: reliance on company-controlled black boxes to pass transaction data between blockchain layers.

As layer-2 chains continue to proliferate, some Ethereum developers are pushing rollup tech that takes a new approach to security and interoperability: “based rollups.”

Based rollups

Based rollups differ from most existing rollups because they shift execution duties—such as processing transactions—back to Ethereum’s layer-1 rather than handling them on a separate layer-2 network.

When someone transacts on a layer-2 rollup, their transaction is processed through a component called a “sequencer.” The sequencer batches multiple transactions and submits them to Ethereum for settlement. In most rollups today, this sequencer is centralized, meaning a single entity (usually the company that built the rollup) controls the ordering and posting of transactions.

Centralized sequencers are currently a topic of debate in the Ethereum community. While sequencers provide efficiency and generate revenue for rollup operators by strategically ordering transactions, they also introduce a single point of failure. A malfunctioning or malicious sequencer can delay or manipulate transactions, raising concerns about censorship and reliability.

Based rollups avoid this vulnerability by using Ethereum’s built-in sequencing—its massive community of validators—rather than a single centralized sequencer.

The layer-2 roadmap evolution

In 2022, Ethereum co-founder Vitalik Buterin laid out his vision for a rollup-centric roadmap. The plan proposed using layer-2 rollups to side-step the base chain’s high fees and slow transaction speeds.

Different rollups employ different strategies for keeping down costs and boosting speeds, but they are all designed to uphold decentralization and security—meaning (in theory) the networks shouldn’t be centrally run, and the transactions they shepherd to Ethereum are free from tampering.

Rollups like Optimism, Arbitrum, Base, zkSync, and Blast have quickly grown to support larger transaction volumes than Ethereum itself. According to L2Beat, there are currently 140 live layer-2 networks, but the experience of operating between them—passing assets and other data between networks—has become clunky. As Ethereum becomes bigger and layer-2 networks become more integral to its functioning, improving communication between layer-2s—in other words, improving “composability”—has become more important than ever.

Because based rollups share the sequencer from the layer-1 chain (sometimes referred to as the layer-1 “proposer”), they can call on smart contracts on other based rollups within seconds, making it easier to access and exchange data across layer-2s.

“They effectively share a sequencer with each other and also with the layer-1 and that allows the sequencer now to coordinate messages passing between different based rollups, whereas normally message passing happens in an asynchronous fashion,” said Ben Fisch, the CEO of Espresso Systems, in an interview with CoinDesk.

Since based rollups all use Ethereum’s built-in sequencing, they can interact with one another instantly, in blockchain terms—all within the same Ethereum block.1

“You could have, in the span of one Ethereum block, a based rollup withdraw assets, do something in the layer-1, deposit the assets back, do something in the layer-2 and withdraw assets again,” Fisch told CoinDesk.

Some drawbacks

A few projects are looking to use based technology, but only one based rollup, Taiko, is currently live.

While rollups like Taiko present clear benefits, they will need to overcome some technical hurdles before they can be more widely adopted.

One major challenge is proof generation. When a based rollup submits transaction data to Ethereum, it must generate and publish proofs every 12 seconds—matching Ethereum’s block time. Currently, layer-2 rollups use two types of proof systems: zero-knowledge (ZK) proofs, which finalize in minutes, and optimistic proofs, which take up to seven days to suss out potential fraud.

For based rollups to function efficiently, proof generation speeds would need to align with Ethereum’s block time—a significant technical leap. However, Fisch says a breakthrough on this front could be “imminent. “

The other pitfall is Ethereum’s block producers, or “layer-1 proposers.” In based rollups, these proposers take over the role of sequencing transactions. But their primary motivation isn’t necessarily fairness—it’s profit

“Layer-1 proposers are not trusted entities that are working in the interest of the layer-2, they are economically motivated to make as much money as they can,” Fisch said. “So they may confirm some transactions for end users, and then see an MEV opportunity, which causes them to publish something totally different.”

MEV, or maximal extractable value, refers to the practice of reordering transactions to maximize profit, often at the expense of regular users. If proposers manipulate transactions, it could create instability in based rollups. To address this, developers are working on solutions like based pre-confirmations, which aim to add economic incentives for proposers to act in the interest of rollups.

So while based rollups may present a promising way to reduce fragmentation between layer-2s, they’re not a miracle fix. “My personal opinion is that based rollups are one part of the solution, they are not the only solution, and not all layer-2s necessarily should or will be based,” Fisch said.

Read more: ‘Sequencers’ Are Blockchain’s Air Traffic Control. Here’s Why They’re Misunderstood