Blockchain fragmentation challenges digital asset markets

Permissionless blockchains aim to reduce reliance on centralised intermediaries through decentralised infrastructure.

The Bulletin describes how consensus mechanisms in these blockchains balance decentralisation, security, and scalability, shaping validator participation, costs, and coordination.

These choices generate distinct equilibria across different layer 1 (L1) blockchains and drive the growth of layer 2 (L2) solutions that execute off-chain.

L1s are base networks that validate and process transactions directly, while L2s run on top of an L1 to enhance efficiency and scalability.

The paper assesses how this architecture fragments activity across and within chains, and how mitigation tools reduce frictions while introducing new trust, governance, and operational dependencies.

It concludes with implications for the potential role of permissionless blockchains as financial market infrastructures and for policy.

The diversity of L1 networks, each with distinct consensus mechanisms, separates users and liquidity across different, siloed networks.

While Ethereum remains dominant in decentralised finance (DeFi), new L1s have expanded horizontally.

Some networks have also shifted towards modular architectures, splitting functions vertically across specialised layers for execution, settlement, data availability, and sequencing.

This modularity, while raising efficiency, creates distinct execution environments with their own transaction ordering, pricing, and points of failure, adding vertical fragmentation.

Mitigation mechanisms like bridges and native multi-chain issuance aim to connect assets and liquidity across blockchains, but they reintroduce new dependencies on trust, governance, and operational resilience, shifting rather than eliminating risks.