If Coinbase is making the market prices by leaving large limit orders at certain prices, and Coinbase limit runs out, then the price moves past their limit. It's as simple as that.
Nobody can place limit orders with money they don't have (I understand there is a "margin trading" option, but I don't have that enabled on my account and I'm uncertain how many accounts on GDAX do have that feature.)
If Bitcoin price goes up, that just means that the supply of Bitcoin at a lower price point has evaporated.
Coinbase is not buying and selling coins (let's assume, but also assume that if they are buying and selling, they play by the same rules as everyone else. No imaginary wallets.)
The exchange are just playing matchmaker so that Market Order X that crosses Limit Orders Y, Z, P, Q, R... that intersect, are all matched and executed together. Then, GDAX can collect a fee from the person who placed the Market order, and GDAX Limit orders are fee-free. Coinbase-proper is 100% market orders with a slightly larger fee, so they can clean up even more on each transaction there, because Coinbase still does not need to sell some of their own currency for each buy; they are just the matchmaker.
Coinbase and GDAX are the same company. If Coinbase needs some of GDAX's liquidity so that it can match Coinbase customers with GDAX's limit orders, they can do that opaquely. The customers do not need to know where their cryptocurrency came from exactly.
If all of the liquidity on GDAX dries up, then there will be a problem (but still, the problem/opportunity is not Coinbase's problem, it is the whole market that comes grinding to a halt until someone opens up some more liquidity at a particular price point.)
Things look different with margin trading though. Margin trading implicitly implies a loan from the exchange to the trader. If the market moves too much against the trader, exchanges typically automatically force their positions to be closed. The problem is that if the price moves too quickly, the proceeds from this transaction may not be enough to cover the loan to the trader. So then the trader can end up owing money to the exchange, and it may be difficult for the exchange to get that money. That can lead to solvency issues.
They obviously need to keep dollars on hand in order to cash everyone out. But what if Bitcoin goes up in price? If there is a run on the exchange later they may have to sell their bitcoins on the spot market to cash people out.
Banks reinvest money held into loans and other speculative investments. But what do you do when as an excuange / market maker you stand ready to buy and sell at any time?
Here is my concern: while it was just two guys meeting up to exchange $ for bitcoin, the $ kept circulating. But these exchanges may be locking up more and more USD just so they have enough to cash people out on demand. As a result, there is a real transfer of wealth to bitcoin and USD is getting frozen in exchanges.
If this continues for 5-10 years more, wouldn't bitcoin become millions of dollars and bitcoin holders would be able to buy up anything vs dollar holders? One bitcoin holder could buy half of NYC already, and who can stop them?