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

Introduction

With Ethereum transitioning to Layer 2-centric scaling solutions and the rise of various tools, a large number of public chains are developing rapidly. Many entities wish to build their own chains to represent different interest claims and seek higher valuations. However, the emergence of numerous public chains has made it difficult for the ecosystem's development to keep pace with these public chains, leading many projects to face difficulties early on.

With the help of new technologies, several well-known platforms have launched their own Layer 2 or independent chains. Today, the capital and technical thresholds for building a chain have significantly decreased, with the monthly cost of operating a chain based on a specific tech stack being around $10,000.

The future will undoubtedly be an era of coexistence of multiple chains. 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 behind them.

The current multi-chain ecosystem has brought a new challenge: liquidity and state dispersion. As the existence of multiple chains is inevitable, interoperability is a field that must be explored and solved. There are currently many liquidity solutions, but their core essence is the same.

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

Application Layer

This is the layer directly interacted with by users, 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 necessarily understand the underlying liquidity conversion mechanism.

Permission Layer

Located beneath the application layer, users connect their wallets to dApps and request quotes to fulfill their trading intentions. Here, "intent" refers to the user's expected final trading outcome, rather than the specific execution path of the trade.

Account Management and Layer 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. Some projects achieve abstract management by building a trustworthy account system or generating multi-chain account wallets for users, greatly optimizing the user experience and reducing fragmentation.

Solution Layer

This layer is responsible for receiving and executing the user's trading intentions, with the role of solvers competing here to provide a better user experience, including faster transaction times and execution speeds. Some projects have built various intent-driven solutions.

Settlement Layer

This is the middleware layer used to solve the layer for achieving user intent. Core components of liquidity and state-distributed solutions include oracles, cross-chain bridges, pre-confirmation schemes, and data availability, among others. Additionally, factors such as inter-chain liquidity, finality, and Layer 2 proof mechanisms must also be considered to ensure the efficient operation of the entire multi-chain system.

Solution

Currently, there are various solutions on the market to address liquidity fragmentation, mainly including the following methods:

1. Centered around a specific tech stack: The system built by adding specific shared orderers and cross-chain bridges assists in sharing liquidity and state.

2. Account-Centric: Build a full-chain account wallet that supports signing and executing transactions across multiple blockchain protocols through specific technologies.

3. Centered around the off-chain intention network: Users send intentions to the solver network, where solvers compete with bids to provide the optimal completion time and transaction price.

4. Centered on the on-chain liquidity network: Build a liquidity layer on which applications are built to share liquidity across the entire chain.

5. Centered on on-chain applications: Build high liquidity applications by integrating large market makers or third-party applications.

Solving liquidity issues is a very important proposition; in the financial world, liquidity often represents everything. If a liquidity integration platform can be built, especially one that consolidates fragmented liquidity across the entire chain, it will have tremendous potential.

Typical Project Case

INFINIT

INFINIT has built a service in the DeFi space that provides the necessary components for directly constructing DeFi protocols, such as oracles, pool types, assets, etc., and also offers components like instantly enabled leveraged trading and yield strategies.

Khalani Network

Khalani has built three core components: the intention compatibility layer, validity, and the general settlement layer. External applications or the intention layer can publish intentions to Khalani, and then Khalani's intention compatibility layer can convert external intentions into a format that protocol solvers can recognize.

Liquorice

Liquorice is a decentralized application that enables auction-based price discovery and unilateral liquidity pools. Its main mission is to provide professional trading firms with efficient inventory management tools and to easily connect to core DeFi protocols when settling trades based on usage intent.

Xion

Xion is an upgrade from the Burnt brand, focusing on solving the significant fragmentation issues present in on-chain interactions. The cross-chain communication used by Xion is based on specific protocols, making it more native and secure than other cross-chain bridges.

=nil; Foundation

nil is a developer of Ethereum's ZK computing power market, ZK co-processors, and Layer 2. It proposed the zkSharding solution, which uses ZK technology to horizontally scale the Ethereum mainnet, execute sharded parallel processing of transactions, and generate ZKP.

ERC-7683

This is an Ethereum standard under development, aimed at establishing a universal standard for cross-chain operations across L2 and sidechains, standardizing order and settlement interfaces to achieve seamless cross-chain execution. At its core is a payment agent role.

OP Stack

OP Stack is one of the solutions within Ethereum addressing the fragmentation of liquidity among Layer 2s. By designing a complete multi Layer 2 solution, it aims to solve the issues of information transmission and the decentralization of sequencers all at once.

Summary

Solving the issue of cross-chain liquidity is a very complex area with many solutions available. The future will undoubtedly be multi-chain, and addressing the challenge of fragmented liquidity is a necessary task for the industry. There is vast growth potential in the integration of on-chain liquidity, which could build important infrastructure for the Web3 era.