Research on the Liquidity Fragmentation Issue in the Era of Layer 2

After Ethereum shifted to Layer 2-centric scaling solutions, combined with the rise of tools like RaaS, a large number of public chains have rapidly developed. Many entities wish to build their own chains to represent different interest appeals and seek higher valuations. However, the emergence of numerous public chains has made it difficult for the ecosystem to keep up, resulting in many projects experiencing a drop in value at the time of their Token Generation Event (TGE).

With the help of OP Stack, a trading platform has launched its own Base Layer 2, another trading platform has released Ink; leveraging ZK technology, a trading platform has introduced XLayer; Sony has launched Soneium, and LINE has released Kaia, among others. Nowadays, the funding and technical thresholds for building a chain have been greatly reduced, with the cost of operating a chain based on OP Stack being about $10,000 per month.

The future will undoubtedly be an era of multi-chain coexistence. Although these Layer 2 chains may choose EVM compatibility for interoperability, it is difficult for them to build applications and reach consensus on the same chain due to the large number of downstream applications backed by Web2 entities.

The current multi-chain ecosystem brings a new challenge: liquidity and state dispersion. Since the existence of multi-chain is inevitable, interoperability is a field that must be explored and solved. Currently, there are many liquidity solutions, such as chain abstraction, intent, Clearing Execution, Native CrossChain, ZKSharding, but their core essence is the same.

We use the industry-recognized Cake architecture to introduce the core components of cross-chain abstraction from top to bottom:

应用层(Application Layer)

This is the layer where users interact directly, and it is also the most abstract layer in liquidity solutions, as it completely shields the details of liquidity conversion. In the application layer, users interact with the front-end interface and may not fully understand the underlying liquidity conversion mechanisms.

Permission Layer (

Located below the application layer, users connect their wallets to dApps and request quotes to fulfill their trading intentions. Here, "intention" refers to the user's expected final trading outcome ), which is output (, rather than the specific execution path of the trade.

Account Management and Abstraction Layer ) Key Management and Account Abstraction (

Due to the existence of a multi-chain environment, there is a need for an account management and abstraction system that adapts to different chains to maintain the unique account structures of each chain. For example, SUI's object-centered account system is completely different from EVM. One Balance is a representative project in this field, building a trustworthy account system that does not require inter-chain consensus, only the trustworthy commitments between existing account systems. Near Account achieves abstract management by generating multi-chain account wallets for users, greatly optimizing the user experience and reducing the fragmentation of UX. However, in terms of liquidity, it mainly integrates existing public chains.

Solve Layer )Solver Layer(

This layer is responsible for receiving and implementing the user's trading intentions. The Solver role competes here to provide a better user experience, including faster transaction times and execution speeds. On this basis, intention-based projects such as Anoma have built various intention-driven solutions. Derivatives of such intentions, such as the Predicate component, can realize user intentions under specific rules.

Settlement Layer )Settlement Layer (

This is the middleware layer used to achieve user intent in the solution layer. Core components of liquidity and state decentralization solutions include:

• 预言机)Oracle(: Used to obtain state information from other chains.
• Cross-Chain Bridge ) Bridges (: Responsible for the transmission of information and liquidity across chains.
• Pre-Confirmation ): Shorten cross-chain confirmation time.
• Data Availability ( DA ): Provides accessibility to data.

In addition, factors such as inter-chain liquidity, finality (, Layer 2 proof mechanisms, etc., need to be considered to ensure the efficient operation of the entire multi-chain system.

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Solution

Currently, there are various solutions on the market to address liquidity fragmentation. After reviewing a large number of solutions, we found that there are mainly a few methods:

1. Centered on RaaS: Similar to Rollup solutions like OP Stack, it assists in building Rollup shared liquidity and state on OP Stack by adding specific shared sequencers and cross-chain bridges. This aims to address the decentralization of liquidity and state at a higher-level direction. A more refined aspect here is the separate design of shared sequencers, which is more targeted at Layer 2 and lacks universality, such as Astria, Espresso, and Flashbots.

2. Account-Centric: Similar to NEAR, build a full-chain account wallet that supports signing and executing transactions across multiple blockchain protocols through a technology called "chain signature." The core component is the MPC network, which replaces users in signing for multi-chain transactions. This solution, while greatly addressing the issue of UX fragmentation, involves complex backend implementation for developers and does not fundamentally solve liquidity and state dispersion.

3. Centered on the off-chain intent network: that is, the Solver Network in our "Introduction" cake architecture diagram, the core is that users send intents to the Solver network, and the Solver role competes for quotes, providing the optimal completion time and transaction price. These Solvers can be AI Agents, CEX, Market Makers, or even integrated protocols like Liquorice, etc. Projects in this area include Anoma, Khalani, Enso, aori, and Valantis. Although intents can theoretically achieve arbitrarily complex cross-chain operations, sufficient liquidity Solvers are required to assist in implementation, and when encountering some off-chain demands, there is a possibility of fraud with Solvers. If fraud proofs and other methods are introduced, the implementation difficulty of the Solver Network will increase, and the threshold for running Solvers will also become higher.

4. Centered on the on-chain Liquidity network: This direction is specifically focused on optimizing cross-chain liquidity issues, but it does not address the problem of on-chain state dispersion. Its core is to build a liquidity layer, on which applications are built to share liquidity across the entire chain. Some projects include: Raye Network, INFINIT, Everclear, Elixir, etc.

5. Centered on on-chain applications: These applications build high liquidity applications by integrating large MM or third-party applications, such as Liquorice, Socket, Radiant Capital, a trading platform, Hedgemony, etc. These projects require management of complex cross-chain processes, which places high demands on developers, making them highly susceptible to hacking incidents.

Solving liquidity issues is a very important proposition. In the financial world, liquidity often represents everything. If a platform that integrates liquidity can be constructed, especially one that consolidates fragmented on-chain liquidity, it will have great potential. We have also looked at many different solutions.

In the above two classifications, we can see that based on the structure of the cake, the Settlement Layer is the most atomic level solution. Above these atomic solutions such as cross-chain, oracle, and Pre-Confirmation solutions, a more abstract layer is built, which includes the Solver Layer, Permission Layer, and Application Layer. The various solutions we listed above, constructed in different directions for abstraction or liquidity, correspond to different levels of this system, which can be understood as upstream and downstream relationships. However, these solutions are still not atomic-level solutions, and the entire liquidity fragmentation issue has led to the emergence of many complex derivative problems. Therefore, a wide variety of solutions have emerged targeting interoperability. But essentially, it still relies on these components. Next, we will discuss several typical projects related to chain abstraction concepts to see how each addresses the issue of liquidity fragmentation from its own starting point.

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) INFINIT

INFINIT has built a RaaS service in the DeFi space, which can provide the necessary components for DeFi protocols, such as Oracle, Pool Type, IRM, Asset, etc. It can also offer immediately usable components like Leverage Trading and Yield Strategy. This is similar to other application construction ends, but the final liquidity is placed in Infinit's Liquidity layer. However, the underlying working mechanism has not been disclosed yet. Currently, INFINIT has raised $6 million in seed funding from Robot Ventures, Electric Capital, and Maelstrom Capital.

( Khalani Network

Khalani has built three core components: the Intent compatibility layer, Validity, and the universal settlement layer.

External applications or the intent layer can publish intents to Khalani, and then Khalani's Intent compatibility layer can convert external intents into a format that the protocol Solver can recognize, using the standardized format of Validity language. The Khalani node is responsible for submitting the final results to the universal settlement layer through cross-chain bridges, rapid settlement technologies, etc. This project is still in the construction phase and has not disclosed more work details. In August, it obtained $2.2 million in seed round financing from Ethereal Ventures, Nascent, Maelstrom Capital, and others.

) Liquorice

Liquorice is a decentralized application that enables auction-based price discovery and unilateral liquidity pools. The main mission of Liquorice is to provide professional trading firms with efficient inventory management tools and to easily connect to certain DEX and other core DeFi protocols when settling trades with intent. Meanwhile, Liquorice has created a lending market for its lending transactions. This application focuses more on trading itself. It is still in the development stage and announced in July that it has secured $1.2 million in a Pre-seed round of funding led by GreenField.

Xion

Xion is an upgrade from the Burnt brand. In the past, Burnt focused on consumer application software, but the team discovered a significant fragmentation issue with on-chain interactions, leading to the development of Xion to address this problem. Xion is built on the Comet BFT consensus protocol. Its cross-chain communication is based on Cosmos IBC, making it more native and secure than other cross-chain bridges. It has undergone four rounds of financing, with investors including Animoca, Multicoin, Alliance DAO, Mechanism, and others.

=nil; Foundation

nil is the ZK computing power market, ZK co-processor, and Layer 2 developer of Ethereum. The team has a solid foundation in ZK technology. They proposed the zkSharding solution, which uses ZK technology to horizontally scale the Ethereum mainnet, executing sharding to process transactions in parallel and generate ZKP, while the main shard verifies data, communicates with Ethereum, and synchronizes the network state among all validators. The main shard also manages the distribution of validators and accounts in the execution shards. The consensus protocol used by the validation committee is also Hotstuff, which is common in the latest parallel execution projects. =nil; L2 has embedded cross-shard communication into the protocol from the very beginning. Cross-shard messages are validated as transactions by the validator committees of each shard.

The basic idea is to construct an embedded cross-shard communication architecture similar to IBC through a sharded Layer 2 architecture, which can solve the problems of liquidity and state dispersion. However, the core idea is not reasonable, because the problem of liquidity dispersion is a multi-chain issue, and what is being built is a single Layer 2. This means that to solve it, all chains need to become a shard of ZK-sharding, which is difficult to achieve.

ERC-7683

Ethereum is also working to address the cross-chain liquidity issue. Currently, certain Layer 2, certain Layer 2, and a certain DEX are the first to publicly support the ERC7683 standard, which is based on an Intent-based cross-chain approach. The core goal is to establish a universal standard for cross-chain operations between L2 and sidechains, standardizing order and settlement interfaces to achieve seamless cross-chain execution. The main core is a Filler, which can also be described as the Solver role in chain abstraction for payment on behalf. This proposal is jointly constructed by a certain DEX and Across and is currently under review by the Cake working group.

OP Stack

OP Stack, ERC-7683, and zkSharding are all solutions within Ethereum for the liquidity fragmentation among Layer 2.