The Fragmented DeFI: What Are the Downsides of Current Fragmentation? Part 1

The Fragmented DeFI: What Are the Downsides of Current Fragmentation? Part 1

Every day, more independent and scaling blockchains are being added to the Web3 landscape by diligent innovative developers. Each blockchain brings its own unique features and capabilities: some blockchains have low gas prices, some offer better development tools, some offer security and privacy, while others promise better decentralization.

Whatever attracts developers to this or that blockchain, we have to admit the current Web3 world is extremely fragmented.

 

The Downsides of Fragmentation

There are many DeFi protocols, DAOs, NFT projects, games, etc. strewn across multiple chains, using multiple coins and tokens. While each of these projects benefits from the unique set of features it has adopted, we have defined several downsides to this scenario:

 

#1. Users Need to Learn a Lot – Again

Every new blockchain increases the users’ barriers to the blockchain world entry. New paradigms, consensus algorithms, reconciliation mechanisms, staking schemes… All of a sudden, every user who just wants to get a decent APY on his tokens, has to become a Ph.D. in cryptography and at the same time a blockchain expert.

 

#2. Access Mechanisms Are Different

Each blockchain has its own wallet and way of representing value. The user now must have a myriad of wallets, one for each chain, and keep private keys and account addresses in proper order. Not all software wallets support hardware wallets (i.e., Ledger), this way contributing to more potential security failures.

 

#3. Different Chains Mean Different Coins

Except for different wallets,  various blockchains use different coins. This means a user needs to fragment their available liquidity across different assets, keeping track of their value. Rebalancing quickly becomes an issue.


#4. Multiple Accounts Create Liquidity Islands

Being unable to assess the total sum of their assets, a user is forced to track multiple accounts, in multiple applications and multiple levels of liquidity. This is called liquidity islands. Bizarre, manually updated Excel sheets appear only to disappear again when the user gives up and loses track of their assets.

While some tokens may seem like they’re the same across blockchains (i.e., there’s a Wrapped ETH (WETH) and a USDC on almost every chain), the reality is poor: these are just representations of those tokens from another chain – meaning you now have to trust a 3rd party wrapper.


#5. This Way or Another, You Have to Go Back to CeFi

To enjoy the benefits of protocols across multiple blockchains, users have to rely on CeFi (centralized exchanges to obtain L1 coins). Then, they need to transfer those into specialized wallets. They can then use AMM (Automatic Market Makers) on the target blockchain to convert the coin into a native token that will allow them to participate in their favorite DeFi protocol.

This process is cumbersome, expensive (just look at how well exchanges like Coinbase and FTX are doing now from the fees extracted from users who are craving blockchain access), repetitive, and limited.

Some exchanges list certain coins and not others, forcing every user to maintain several accounts with different exchanges. Add to that country and state laws that prevent certain exchanges’ access, and you end up mired in an uncertain landscape where people in a certain state (ahem New York) cannot obtain certain coins/tokens, and therefore have to resort to creative solutions or give up.

 

In part 2, we’ll talk about current fragmentation solutions, mostly bridges and their pros&cons.


Diversifi develops an open protocol that enables blockchain developers to build chain-agnostic, user-friendly, and secure Web3 applications.

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