The limited scalability of blockchains has fragmented the crypto universe, as
newer blockchains that cut corners on security have entered the fray. The Terra
blockchain is just the most prominent of a horde of new entrants (Graph 2.B). Even
as recently as the beginning of 2021, Ethereum accounted for almost all of the total
assets locked. By early May 2022, this share had already dropped to 50%. The
widening wedge (in red) accounted for by the failed Terra blockchain is particularly
striking. Terra’s collapse highlights the tendency of the crypto universe to fragment
through its vulnerability to new entrants that prioritise market share and capacity at
the expense of decentralisation and security.
A system of competing blockchains that are not interoperable but sustained by
speculation introduces new risks of hacking and theft. Interoperability refers here
to the ability of protocols and validators to access and share information, as well as
validate transactions,
across different blockchains. Interoperability of the underlying
settlement layers is not achievable in practice, as each blockchain is a separate
record of settlements. Nevertheless, “cross-chain bridges” have emerged to permit
users to transfer coins across blockchains.13 Yet most bridges rely on only a small
number of validators, whom – in the absence of regulation and legal accountability
– users need to trust to not engage in illicit behaviour. But, as the number of
bridges has risen (Graph 4.A), bridges have featured prominently in several highprofile hacks (Graph 4.B). These attacks highlight the vulnerabilities to security
breaches that stem from weakness in governance.
The striking fragmentation of the crypto universe stands in stark contrast to
the network effects that take root in traditional payment networks.
Traditional
payment networks are characterised by a “winner takes all” property, whereby more
users flocking to a particular platform beget even more users. Such network effects
stand at the heart of the virtuous circle of lower costs and enhanced trust in
traditional platforms. In contrast, crypto’s tendency toward fragmentation and high
fees is a fundamental structural flaw that disqualifies it as the foundation for the
future monetary system.14
Despite fragmentation, speculation can induce high price correlations across
different cryptocurrencies and blockchains. Attracted by high returns and the
expectation of further price increases (Box B), the influx of new users can push up
prices even more. As many cryptocurrencies share a similar user base and are tied
to similar protocols, there is strong price co-movement.
