Blockchain Fragmentation: Explained

One of the key value propositions of the Ethereum ecosystem is that it rallies around activity around a single asset, creating a significant network effect. 99% of the value comes from the execution layer, where the money is made.  Currently, over 516 million accounts are holding various amounts of digital assets, with 90% of them in stablecoins across Layer 2 (L2) networks, totaling an estimated $47 billion in total value locked (TVL) across more than a hundred active and upcoming networks.

However, L2s have a noisy neighbor problem. With the expansion of L2s, most blockchains today are fragmented by state and sequencing processes. The role of Web3 software creation has evolved significantly in recent years. According to Anu Atluru’s Working Theory Substack essay, we’ve entered the "era of the software creator." However, developers and users face major losses in building sustainable applications due to challenges in user acquisition, long wait times, gas fees, and optimizing crypto value long after a token airdrop or a covetable NFT is minted.

The Lifecycle of USDC 

To understand fragmentation, one must consider the journey of a token across different chain environments. The lifecycle of USDC is a good example of how fragmentation manifests in blockchain, affecting assets, wallets, users, and overall experience.

USDC is a centralized stablecoin issued and maintained by Circle’s ERC-20 contract on Ethereum, designed to be pegged to the US dollar 1:1 using a lock and mint model. This model exposes it to risks, especially with third-party involvement. Therefore to mitigate these risks, Circle created the Cross-Chain Transfer Protocol (CCTP).

 Here’s how it works:

1. Burning USDC on the Source Chain

1. A user initiates a transfer from one blockchain to another through a wallet or desktop app.

2. The user signs the transaction, approving the Token Messenger contract on the source chain, enabling a contract to withdraw USDC from the user’s wallet.

3. The app facilitates a burn of the specific amount of USDC on the source chain by executing the `depositForBurn` function, which sends USDC to the burning address.

2.  Fetching a Signed Attestation from Circle

3.  Minting USDC on the Destination Chain

USDC to Op Superchain 

Now picture this: 1000 USDC is sitting in a wallet and needs to be swapped for wrapped ETH on Optimism to purchase an NFT in niche marketplace. In a world of hundreds of L2s, the journey of the stablecoin should, in theory, remain straightforward. However, maintaining redemption risk across different chains makes Circle’s native USDC the main character to the fragmentation problem. Below, we will compare three of the largest bridges (Stargate, Celer, Across) and the amount of USDC a user gets for different-sized USDC bridge transactions from Ethereum to OP, 1,000/500/200/100 USDC. 

The below table shows the amount of output one would get if one were to use non-CCTP bridges, starting with USDC on Ethereum. Note that USDC is native USDC minted on OP, whereas USDC.e is a wrapped version of USDC.

How does native USDC and how does the CCTP fit into today’s fragmentation problem with the digital asset narrative?

With the introduction of CCTP, bridging fees that reduce the bottom line of the destination USDC are theoretically decreased. However, with over 31 million unique stablecoin users, it becomes challenging to track transactions in a world of hundreds of L2s. Generally, CCTP transactions cost less and result in the user receiving more USDC compared to traditional methods, as fewer contracts need to be executed on the destination chain. Additionally, for larger transaction sizes, CCTP is even more efficient because it eliminates the need for and costs associated with USDC liquidity providers. However, with over a third of cryptocurrency holders owning some form of stablecoin, not all digital assets will be processed through CCTP.

Unifying Assets to Simplify Blockchain Fragmentation

Network effect tokens like ETH and future infrastructure for swapping them must come together. Fundamentally, fragmentation in the blockchain is about assets. At its core, the crypto space involves tokens stored and transferred across protocols, smart contracts, and blockchain networks. Fragmentation in user experience stems from asset fragmentation. Unified assets with consistent trust assumptions would eliminate fragmented experiences such as switching RPC providers or viewing different wrapped versions of the same token.

If assets like USDC were identical across all blockchains, users wouldn't need to bridge tokens or manage fragmented balances. For instance, one USDC on Blast would equal one USDC on Optimism. However, this ideal is complicated by multiple native tokens across different L2s. Nonetheless, if the settlement asset like USDC remains consistent across chains, much of the complexity can be abstracted away, allowing seamless transactions across chains.

Wallets: Managing Fragmentation

Wallets play a crucial role in reducing fragmentation. A wallet that supports seamless RPC connections and bridges, leveraging solutions like CCTP, can significantly unify the user experience. For example, if USDC on Arbitrum is the same as USDC on Optimism, users should be able to transact seamlessly across chains.

Visa reports over 150 billion stablecoin volume (USDC and USDT combined) is traded, highlighting the growing need for trusted third-party verifications via zero knowledge or shared sequencers from optimistic rollups, further bending and stretching the fragmentation problem.

Gas Fees, Cross Bridge Flat Fees and How Tokens Flow on L2s

Maintaining gas and bridging fees across a hundred different blockchain networks involves several key strategies and tools designed to manage and optimize gas fees efficiently. Optimistic Rollups, for example, power L2s as a scaling solution. Currently the top 5 L2s are responsible for executing billions of dollars in transactions.  The relationship between stablecoins and rollups involves locking up tokens to enhance efficiency and reduce transaction costs.   Per the Cross Chain Transfer Protocol Standard from Circle, bridging tokens must be “locked”  or  burnLockedUSDC in a smart contract and burned when they move from one chain to another.  For instance, transferring USDC from Ethereum to Arbitrum involves locking USDC on Ethereum and minting an equivalent amount on Arbitrum. However, market volatility can affect the final transfer value. The function getExchangeRate() is used to fetch the current exchange rate of a currency to ensure accurate minting and burning across different chains, especially with non-CCTP interactions, because not all applications require stablecoin. Sometimes, it’s just about the memes and trendy NFTs. 

Bridging Tokens with CCTP on L2s

Typically, bridging tokens across chains can involve a significant delay, such as a seven-day withdrawal period. However, with CCTP as an L2 solution, this process could be streamlined by leveraging EIP-4844, which introduces a groundbreaking data structure known as "blobs," marking a significant advancement in blockspace. These blobs, which can handle up to 125 KB of opaque byte strings, are part of a new transaction type. This innovation addresses the high costs that rollups like Base or Optimism face when posting proof data in smart contract CALLDATA, which is entirely on-chain. By integrating this specific use case of CALLDATA into a more fundamental function of Ethereum, gas fees are anticipated to decrease. For CCTP on L2s, the key requirement is that the L2 should publish data on the Ethereum mainnet using Ethereum blobs for data availability. 

This approach eliminates the need for the typical withdrawal period, which is usually necessary when withdrawing an asset to a canonical bridge contract. As a result, CCTP significantly reduces the time and complexity involved in bridging tokens like USDC between chains.  The below graph shows the gas fee savings of L2s dropping 97% after the Dencun Upgrade.  

Fragmented Users: Unlocking Ethereum’s Execution on L2 Through Solana

By nature, Web3 is wrought with herd mentality, so it’s not a surprise there’s a distinct divide over whether to build on Solana or mirror an Ethereum stack. This division stems from the apparent developmental timelines and goals of each blockchain. Ethereum was launched seven years before Solana and was ideologically driven toward creating a censorship-resistant settlement layer. On the flip side, Solana focuses more on practicality and scalability to meet current crypto demands and trends. 

One protocol aiming to reimagine the benefits of Solana's and Ethereum is Eclipse. For settlement, Eclipse taps Ethereum, which involves a canonical bridge contract similar to most L2s. However, for execution, instead of the EVM, Eclipse will use the Solana Virtual Machine (SVM). This approach promises all the benefits of the SVM, such as parallelization and isolated fee markets. Additionally, Eclipse as an L2 aims to incorporate RISC-0 for zero-knowledge (ZK) fraud proofs and Celestia for data availability, instead of Blobs. 

According to Solana maxis, the reason for this optimization is clear when builders examine most L2s today, where execution remains significantly constrained and riddled in fees.  They typically have a transaction per second (TPS) rate of 10, 20, or 30. Even after Base updated their gas per block target, the TPS remains relatively low. 

The Trickle-Down Effect to Fragmented Applications

In a world where end users want to purchase blue-chip NFTs with native USDC and gaming tokens, the fragmentation of Web3 applications poses further challenges for onboarding and maintaining a thriving ecosystem. It’s no secret that Web3 communities are partisan over various L2 solutions, but the key takeaway is the need for an integrated developer stack. For developers, the pressing question becomes: where should they build? Applications should not be confined to a single chain; their assets should be bridgeable and purchasable to users across different chains to add value to the end user.

Today, the trend seems to be that popular apps are now moving towards having their own dedicated chains, such as Friend.tech moving away from Base, and DeFi chains like Aevo and Lyra becoming more common. These shifts add a layer of complexity for new users, who now have to navigate bridging, onboarding, and switching RPC steps when new application experiences rise to the top charts.

Simplifying the User Experience 

To streamline this process, universal wallet profiles and smart wallets are becoming popular when developing onchain applications, in efforts to evolve the complex process down to three clicks or less. These workflows aim to provide a more seamless and user-friendly experience by consolidating multiple RPCs and simplifying cross-chain interactions with minimal fees absorbed by the end user. Some wallets, like MetaMask, have pre-set lists of L2s and can identify which chain to use based on the application. However, with the growing list of L2s and even more L3s, the responsibility and fees will inevitably fall on the user. 

If developers had the freedom to customize their applications fully, the concept of appchains would become more widespread, but in reality, there needs to be an integrated stack. Moreover, projects like Friends.Tech and DEGEN Chain exemplify this desire for customization and value accrual within their specific communities. This customization allows for tailored user experiences and potentially higher value for communities investing in these platforms.  Subsequently, piggybacking L3s into the discussion.  However, hot take: Users don't need to think about whether they're using a Solana app or an Ethereum app; they just want to use the app with the token and see their gains in their wallet of choice. 

Key Takeaways

• Fragmentation in the blockchain ecosystem is driven primarily by asset fragmentation.

• Unified assets across chains would significantly enhance the user experience, reducing the need for bridging tokens and managing fragmented balances.

•  Wallets play a crucial role in mitigating fragmentation by supporting seamless RPC connections and bridges.

•  Despite the complexities, the continued evolution of blockchain infrastructure and wallet technology aims to provide a more unified and user-friendly experience for Web3 users.

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