BIS Warns Blockchain Fragmentation Undermines Liquidity, Challenges Scalable Settlement Vision

Permissionless blockchains were built on a promise: reduce reliance on central intermediaries through open participation and shared verification. But a new paper from the Bank for International Settlements (BIS) argues that the industry’s growth has moved in the opposite direction—toward fragmentation that dilutes ‘liquidity’ and weakens network effects rather than converging on a single scalable settlement layer.

In BIS Bulletin No. 126 published on July 6 (UTC), the authors describe an “economics of splitting” embedded in blockchain design. Activity on distributed ledger technology (DLT) has expanded far beyond early use cases—spanning payments, decentralized finance (DeFi), and digital asset issuance—yet the ecosystem has splintered across many networks. The BIS frames this outcome not as a historical accident or purely technical choice, but as the product of economic trade-offs inherent to consensus.

At the center of the report is a simple proposition: consensus is best understood as a ‘token incentive equilibrium.’ Blockchains are append-only ledgers maintained by validators who do not necessarily know or trust one another. In a permissionless setting, where anyone may attempt to propose or validate blocks, the system must align a validator’s private payoff with the public good of a consistent ledger.

That alignment is costly. The BIS notes that validators must be compensated not only for direct operating expenses—such as energy or hardware—but also for ‘coordination risk,’ the uncertainty born from depending on other validators to behave honestly and remain engaged. In Proof-of-Work (PoW), Bitcoin (BTC) miners incur energy and capital costs in exchange for block rewards. In Proof-of-Stake (PoS), Ethereum (ETH) validators lock native tokens and accept the risk of ‘slashing’—loss of stake—if they break protocol rules. Too many validators can make coordination expensive; too few can increase the risk of control, manipulation, or disruption. From this economic lens, “consensus” is not a single technical standard but a spectrum of equilibria supported by token incentives.

The report places these dynamics within the well-known ‘blockchain trilemma’: decentralization, security, and scalability—where systems typically optimize for two at the expense of the third. When many independent validators participate in block production and finality, decentralization and security tend to improve, but communication and verification overhead rises, limiting throughput and increasing latency. PoW and many PoS systems fit this category. Conversely, designs that reduce validator counts or raise hardware requirements can deliver higher performance, but they narrow participation and weaken decentralization. The BIS points to delegated Proof-of-Stake models such as Tron (TRX) and Proof-of-Staked-Authority designs such as BNB Chain (BNB) as examples of the scalability-first end of the spectrum.

Security requirements tighten the trade-off further. As the value secured by a chain grows, the ‘cost of attack’ must rise to deter malicious behavior. In permissionless systems, the BIS argues, users ultimately bear these costs through fees, congestion rents, and token dilution. Higher security, in practice, often implies tighter capacity constraints—meaning the price of safety is frequently paid in lower throughput or higher transaction costs.

These constraints help explain why the layer-1 (L1) landscape has not converged. Early networks such as Bitcoin (BTC) and Ethereum (ETH) prioritized broad validator participation and robust security guarantees, accepting limited scalability as the trade-off. As demand for scarce block space rises, congestion increases and fees spike, pushing out price-sensitive users. Newer L1s, by contrast, have often pursued higher throughput through more centralized validator sets or demanding infrastructure requirements—choosing a different point on the trilemma rather than overcoming it.

Fragmentation, the BIS argues, plays out along two axes. The first is ‘horizontal’ proliferation: multiple L1s competing for users and liquidity. Even as Ethereum (ETH) has maintained a leading position in DeFi, adjacent ecosystems expanded rapidly in the past cycle, with some later collapsing or fading in relevance—Terra’s 2022 boom-and-bust serving as a prominent example, and other networks seeing sustained declines in activity.

The second axis is ‘vertical’ modularization, in which execution, settlement, data availability, and sequencing are separated into specialized layers. Layer-2 (L2) systems, for example, process transactions offchain and post results back to an L1 for settlement and data availability. The BIS stresses that modularity does not eliminate trade-offs; it redistributes them across layers and introduces new governance and interoperability challenges—often shifting risk and decision-making into fewer critical components.

As fragmentation has deepened, demand has surged for tools that reconnect assets, applications, and users across chains. But the BIS warns that many of these “fixes” reintroduce intermediaries and new dependencies rather than restoring a unified environment.

Bridges, for instance, typically lock assets on one chain and mint representations on another. While convenient, they concentrate risk in key management, message validation, and smart contract security. The BIS highlights the $625 million Ronin network exploit in March 2022 as emblematic of how bridge failure can produce outsized losses.

Another approach is native multi-chain issuance, in which major issuers—often stablecoin operators—deploy similarly named tokens on multiple networks. The BIS notes that even when tokens share branding, they may not be transferable across chains, may rely on different wallet standards and addresses, and trade in separate liquidity pools. The result can be deeper fragmentation, with price alignment increasingly dependent on cross-chain arbitrage activity.

The report also discusses ‘shared layers’ that provide common services across multiple rollups—such as shared security through pooled staking, shared data availability for verification, or shared sequencers that order transactions across L2s. While these can improve efficiency and reduce rent-seeking, the BIS cautions that they concentrate governance and operational risk into fewer modules that can become systemically important within the ecosystem.

Finally, interoperability protocols aim to connect chains through verified messages and proofs rather than moving assets directly. By keeping assets on their home chains, such designs can reduce duplicated liquidity and inconsistent token representations, but they still require new trust assumptions that must be minimized through onchain verification. The BIS notes that usage of these interoperability protocols has risen sharply, underscoring the market’s attempt to cope with fragmentation.

On the question of whether permissionless blockchains can organically mature into general-purpose financial market infrastructure (FMI), the BIS offers a cautious conclusion. While these systems aspire to broad financial functionality, the report argues that binding economic constraints tend to push them toward specialization and fragmentation. The very mechanisms built to reconnect the ecosystem often reintroduce intermediaries, governance bottlenecks, and operational dependencies—limiting the extent to which permissionless networks can evolve into FMI without additional governance and oversight frameworks.

The BIS outlines three policy considerations. First is operational and cyber resilience: diverse consensus models, incentive schemes, and governance structures complicate risk assessment, incident response, and recovery planning. Even when shared middleware reduces fragmentation, it can create single points of failure if common services become dominant. Second is supervisory perimeter: shared sequencers, data availability layers, and cross-chain messaging increasingly perform functions similar to traditional market infrastructure, and may warrant FMI-like resilience standards and oversight as they scale. Third is the balance between competition and standardization: open, interoperable standards can reduce fragmentation while preserving innovation, but cross-border coordination may be necessary to limit regulatory arbitrage and operational risk in a multi-jurisdictional environment.

The BIS ultimately argues that the case for decentralization is strongest where trust is scarce and reliance on centralized intermediaries is costly or impractical. But sustaining robust consensus equilibria at scale, the authors contend, will still require careful incentive design, transparent governance, and effective operational controls—particularly for shared components that could become systemically important.

The report’s themes also carry implications for markets considering domestic stablecoin frameworks. If a future Korean won stablecoin were issued natively on multiple chains, the BIS’s concerns could reappear in local form—tokens sharing a name but not being transferable, liquidity split across isolated pools, and market efficiency increasingly reliant on cross-chain arbitrage. That dynamic would make early decisions around issuance strategy and interoperability architecture more consequential, especially as regulators weigh rules for tokenized securities and stablecoins.

The BIS bulletin was co-authored by Sang Hyuk Lim, and references related research by BIS Economic Adviser Hyun Song Shin. The bulletin reflects the authors’ views and does not represent an official position of the BIS or its member central banks.