Every chain is an island, and cryptocurrencies are facing liquidity crisis

Author: Jin Kwon, Co-founder and Chief Strategy Officer of Saga, CoinTelegraph

Translated by: Baishui, Golden Finance

Crypto has made great progress in improving transaction throughput. The new Layer 1 (L1) and side networks offer faster and cheaper transactions than ever before. However, a core challenge has become the focus: liquidity fragmentation—capital and users are scattered in a growing blockchain maze.

Vitalik Buterin highlighted in a recent blog post how scaling success leads to unpredictable coordination challenges. With so many chains and so much value scattered in it, participants are faced with the trouble of bridging, exchange and wallet switching every day.

These problems affect not only Ethereum, but also almost all ecosystems. No matter how advanced the new blockchain is, it may become a liquidity "island" that is difficult to connect with each other.

The real cost of fragmentation

Liquidity diversification means that there is no single asset "pool" that traders, investors or decentralized finance (DeFi) applications that can leverage. Instead, each blockchain or side network has its own fixed liquidity. This isolation can cause multiple troubles for users who want to buy tokens or access a specific lending platform.

Switching the network, opening a dedicated wallet and paying multiple transaction fees is far from seamless, especially for those who don’t know much about technology. Liquidity in each isolated pool is also weak, resulting in increased price differences and trading slippage.

Many users use bridges to transfer funds between chains, but these bridges are often targeted by attacks, causing fear and distrust. If liquidity transfer is too cumbersome or the risk is too high, DeFi will not be able to gain mainstream development momentum. At the same time, projects are scrambling to deploy on multiple networks, otherwise there is a risk of being eliminated.

Some observers worry that fragmentation may force people to return to a handful of dominant blockchains or centralized exchanges, thus undermining the decentralized philosophy that drives the rise of blockchain.

Familiar fixes, there are still gaps

Solutions to this puzzle have emerged. Bridges and packaging assets achieve basic interoperability, but the user experience is still troublesome. Cross-chain aggregators can route tokens through a series of exchanges, but they usually do not merge the underlying liquidity. They only help users navigate.

Meanwhile, ecosystems such as Cosmos and Polkadot enable interoperability within their frameworks, although they are different in the wider cryptosphere.

The problem is fundamental: each chain thinks it is different. Any new chain or subnet must be "inserted" at the bottom to truly unify liquidity. Otherwise, it will add another area of ​​liquidity that users must discover and bridge. This challenge becomes more complicated as blockchains, bridges and aggregators see each other as competitors, resulting in intentional isolation and fragmentation becoming more obvious.

Integrate liquidity at the base layer

The integration of the base layer solves the problem of liquidity fragmentation by embedding bridging and routing functions directly into the core infrastructure of the chain. This approach occurs in certain layer 1 protocols and dedicated frameworks, where interoperability is considered as a base element rather than an optional add-on.

Verifier nodes automatically handle cross-chain connections, so new chain or side networks can be launched immediately and access the liquidity of the wider ecosystem. This reduces reliance on third-party bridges that often pose security risks and user friction.

The challenges faced by Ethereum in its own heterogeneous layer 2 (L2) solutions underscore the importance of integration. Different participants—Ethereum as the settlement layer, L2 focusing on execution, and various bridging services—have their own motivations, resulting in a dispersed liquidity.

Vitalik's reference to this issue emphasizes the need for a more cohesive design. The integrated base layer model integrates these components at release, ensuring that funds can flow freely without forcing users to browse multiple wallets, bridging solutions or aggregates.

The integrated routing mechanism also integrates asset transfers, simulating a unified liquidity pool behind the scenes. By capturing a small portion of the overall liquidity traffic rather than charging users on each transaction, such protocols reduce friction and encourage capital flows throughout the network. Developers deploying new blockchains can immediately access the shared liquidity base, while end users can avoid using multiple tools or encounter unexpected expenses.

This emphasis on integration helps keep the experience seamless, even if more networks are available online.

Not just Ethereum's problem

While Buterin's blog post focuses on aggregation of Ethereum, fragmentation has nothing to do with the ecosystem. Whether the project is built on a chain compatible with Ethereum virtual machines, a WebAssembly-based platform, or other platforms, if liquidity is quarantined, fragmentation traps will occur.

As more and more protocols explore fundamental layer solutions—embedding automatic interoperability into their chain design—one hopes that future networks will not further split capital, but will help unify capital.

A clear principle emerges: without connectivity, throughput is meaningless.

Users do not need to consider L1, L2 or side chains. They just want seamless access to decentralized applications (DApps), games and financial services. If stepping on a new chain feels the same as operating on a familiar network, then it will be adopted.

Moving towards a unified and fluid future

The crypto community’s focus on transaction throughput reveals an unexpected paradox: the more chains we create to speed up, the more fragmented the advantages of our ecosystem, and this advantage lies in its shared liquidity. Each new chain designed to increase capacity creates another isolated capital pool.

Building interoperability directly into blockchain infrastructure provides a clear path to addressing this challenge. When the protocol automatically handles cross-chain connections and effectively routes assets, developers can scale without dispersing their user base or capital. The success of this model comes from measuring and improving the smoothness of value flowing throughout the ecosystem.

The technical basis for this method is currently there. We must implement these measures seriously and pay attention to security and user experience.