It is a Feature, Not a Bug: Why Blockchain’s Mechanics Reject Fractional Reserves
In my previous report (USD-Stablecoin Rates – The True Cost of Capital), I argued that the on-chain financial ecosystem is inherently non-fractional. For those who’ve been in the crypto trenches since the early days, this insight is hardly revolutionary. Bitcoin, after all, was conceived as a peer-to-peer value transfer system—an asset with a hard cap and a decentralized ledger that records every transaction immutably. Its architecture was never meant to replicate the leverage-driven scaffolding of traditional finance. It was built to replace it. This isn’t an oversight. It is, quite emphatically, a feature—not a bug.
(download the report here or just read it on LinkedIn)
The Implications: Capital, Friction, and Who’s Left Holding the Bag
The implications of this design philosophy are twofold.
First, blockchains are structured to operate on a fully funded basis. No credit, no rehypothecation, no overnight liquidity injections from a central bank. Every transaction must be backed by actual assets. As outlined in the Bitcoin whitepaper itself, the vision was clear: eliminate financial intermediaries and replace them with cryptographic trust. Peer-to-peer value exchange, disintermediated and uncensored. If the system’s only function were to enable trustless transfers between two parties, this setup would be elegant in its simplicity—and sufficient.
But the ecosystem didn’t stop there. Over the past decade, this raw infrastructure has been overlaid with increasingly sophisticated applications: exchanges, lending protocols, derivatives venues, payment layers, and consumer-facing commerce platforms. And herein lies the rub. A fully funded architecture, while elegant in theory, becomes economically demanding when scaled across an entire financial ecosystem.
Take commerce: when a user purchases a product using stablecoins, the merchant often still needs to convert those tokens back into fiat to pay suppliers, staff, or rent. That bridge between digital and traditional finance is neither instantaneous nor costless. In trading, the friction is even more acute—every position must be pre-funded, collateral must sit idle, and capital efficiency suffers.
This brings us to the second, and perhaps more structural, implication: the system demands vast amounts of capital to function. In the early days, that capital came overwhelmingly from retail investors—often funneled through offshore exchanges like Bitfinex, Kraken, or Bitstamp to name a few. Traditional financial institutions, preoccupied or dismissive, allowed these flows to happen under the radar.
As the capital inflows ballooned and regulatory scrutiny intensified, the gates began to close. Jurisdictions imposed controls. On-ramps were shuttered. And as the ecosystem weathered two to three boom-and-bust cycles, the capital composition shifted. What was once an 80/20 retail-to-institutional split has, by my estimate, flipped: today, perhaps 20% of the capital is retail, and the remaining 80% is controlled by a small cadre of early, active institutional players—trading firms like Jump, Cumberland, Galaxy, and the remains of the NFT class, many of whom saw their paper wealth vanish in the last drawdown.
This matters because today’s blockchain infrastructure still needs fresh capital to sustain and scale. On the retail side, the pipes are in place—but the appetite is gone. Retail has been burned too many times, and the shark tank is no longer alluring. On the institutional side, the interest is there—but the bridge is harder to cross. Regulation, compliance, operational risk, and reputation all pose real frictions.
Sentora is actively working to address this exact capital access challenge—building infrastructure that enables regulated and unregulated counterparties to participate in on-chain and off-chain markets alike. By focusing on stablecoin monetization and capital-efficient structures, Sentora plays a role in re-opening institutional bridges while preserving the ethos of permissionless systems.
I covered many of these institutional access barriers in my earlier report (USD-Stablecoin Rates - The True Cost of Capital). What’s clear is that the foundational design of blockchain—the non-fractional, fully-funded, peer-to-peer premise—remains intact. And it should. But the world we’re building atop that foundation now needs to reckon with the economic cost of purity.
From Fiat to Finality: Why On-Chain Capital Still Struggles to Compete
To grasp the difference between the traditional fiat-based financial system and the on-chain stablecoin economy, one must dissect the plumbing. On the surface, both promise seamless transactions and liquidity—but their inner mechanics could not be more different. The legacy world thrives on fractional reserves, institutional trust, and deeply integrated financial market infrastructure (FMI). The blockchain world, by contrast, operates on fully funded logic, cryptographic finality, and a persistent struggle for capital access.
Let’s examine this divergence through four lenses.
1. General Settlements in Commerce: Only as Efficient as the Edges
In the early days of crypto evangelism, it was fashionable to proclaim that “the blockchain will make payments cheaper and more efficient.” That mantra still echoes today, especially amid a wave of renewed regulatory focus on stablecoins.
But I’ve long added a crucial caveat: efficiency only exists if both legs of the transaction remain on-chain. The moment one party needs fiat—whether it’s a merchant cashing out or a supplier demanding dollars—friction reappears. Stablecoins may be instantaneous on the blockchain, but the moment they exit the digital realm, they meet the age-old bottlenecks of conversion, compliance, and correspondent banking.
As Anthony DeMartino, my CEO, recently explored in his piece “The Future of Stablecoins: Liquidity — To Centralize or Not to Centralize”, the question of how and where liquidity concentrates—and whether stablecoins will evolve into a systemic piece of infrastructure or remain a bridge asset—sits at the heart of this friction.
2. Trading and Settlement: Fully Funded, Fully Frictioned
Crypto trading venues function in a world where every trade must be pre-funded. Assets and cash must reside on-chain, often in wallets controlled by the venue. Even when using leverage, the assets being shorted must be either owned or borrowed—and already under the venue’s control. This model may protect users from the kinds of balance sheet alchemy that brought down FTX, but it creates structural capital inefficiencies.
For a trading firm, it’s a tough equation: funds must be deployed across multiple venues, incurring fragmentation and opportunity cost. There is no central clearing, no netting, no overnight credit lines. What you see is what you trade—with your own capital.
And so one might ask: if everything is already on-chain, where is the promised efficiency? The answer, again, lies in architecture. The blockchain ecosystem rejects the core tenet of traditional banking: credit creation. It demands that value be real, present, and provable—on every leg of the transaction.
3. TradFi’s Brick Layer of Trust and Capital Access
Not everything that has emerged from the past 50 years of traditional finance is broken. The fiat system, with all its intermediaries, has unparalleled access to global liquidity. Fiat is accepted nearly everywhere, with no conversion required. It is regulated, embedded in commerce, and institutionally supported. Stablecoins, by contrast, still sit outside the regulatory perimeter, which means they are not treated as cash equivalents by banks or regulators.
This creates a cascade of complications. Your bank does not consider your USDC holdings to be the same as your dollar balance. It treats them as assets with issuer risk, whereas fiat deposits are backed—at least in perception—by the full faith and credit of the bank. Most users overlook the fact that their fiat is also a liability on a bank’s balance sheet. But regulators don’t.
Meanwhile, the TradFi world is upheld by a fortress of FMIs: banks, brokers, central banks, CSDs, CCPs, SWIFT, Fedwire, and a host of national infrastructures. These players enable fractional reserves, maturity transformation, and netting—tools that supercharge capital availability and velocity. This is where most of the world’s capital resides.
By contrast, the blockchain world is still largely isolated from this pot of institutional capital. It lives by principles of decentralization, permissionlessness, and disintermediation—noble values that, so far, come at a cost.
Bridging the gap between these two financial worlds is a challenge Sentora is directly tackling—creating lending and liquidity solutions that interoperate with both crypto-native infrastructure and traditional financial capital. Rather than reinventing every component, Sentora focuses on integrating what works—stablecoins, on-chain collateral, and structured credit—with the reach and regulatory readiness of institutional capital demands.
Other projects like ClearToken* and Ubyx# also aim to close that gap—though from different architectural and philosophical angles.
* ClearToken (from the whitepaper) is building a regulated central counterparty (CCP) and settlement infrastructure tailored for the digital asset ecosystem. Its platform aims to reduce bilateral counterparty risk by providing centralised clearing, margining, and net settlement—integrated with 24/7 DvP capabilities across digital assets and fiat rails. The infrastructure bridges the gap between traditional financial market infrastructure and crypto markets by introducing legal finality, capital efficiency, and multi-custodial integration for institutional participants. The system is designed to comply with IOSCO principles and seeks regulatory recognition to operate as trusted financial market infrastructure.
The way I see it, the whitepaper frames the issue through the lens of post-trade infrastructure. It draws a compelling parallel between today’s blockchain settlement inefficiencies and historic failures in TradFi, such as the Herstatt collapse or the settlement backlog of the 1980s. It argues that prefunded, unsynchronised settlement creates capital drag and systemic risk—particularly when assets move across venues or chains. Its proposed solution: a regulated digital Central Securities Depository (CSD) that introduces legal finality, risk netting, and synchronisation—bringing familiar TradFi safeguards into the digital realm without undermining decentralisation entirely. In short, they are building institutional-grade post-trade infrastructure for crypto.
# Ubyx (from the whitepaper) is building an on-chain settlement infrastructure designed to enable capital-efficient and risk-isolated transactions in the crypto ecosystem. By requiring full prefunding and leveraging a multi-tranche architecture, Ubyx ensures that all obligations can be settled atomically and without counterparty risk — a critical feature in the absence of fractional reserve or netting mechanisms on-chain. The protocol wraps this settlement logic into structured vaults that allocate yield from underlying DeFi strategies using traditional credit-style tranching, offering tailored risk-return exposure for institutional and sophisticated investors.
This project attacks the problem at the level of collateral and credit. Its protocol design introduces a model for dynamic risk pricing, where capital can flow more freely within a structured framework that offers lenders transparency, security, and yield. By facilitating non-custodial, programmatic credit markets that mimic some of TradFi’s liquidity layers (while preserving composability and self-custody), The protocol attempts to reconstruct the missing credit rails in the on-chain world—without surrendering to the full intermediary stack of traditional finance. My short description is: risk-isolated on-chain settlement infrastructure.
Both projects acknowledge that integration with institutional-grade capital is necessary. Both try to make on-chain capital more efficient. And both suggest that isolation is no longer an option. The future of digital finance may not be TradFi 2.0—but it may well require selective importation of TradFi’s hard-earned lessons.
4. The Elephant in the Room: On-Chain Settlement Needs Prefunding
And here lies the heart of the matter: on-chain settlement requires prefunding. And prefunding requires capital—real capital, sitting idle, waiting to be used.
This requirement creates systemic friction. It limits leverage, constrains liquidity, and demands constant capital allocation just to enable the pipes to function. In TradFi, these frictions are abstracted away through a combination of credit, netting, and clearing. On-chain, they are faced head-on.
Until this capital constraint is addressed—whether through novel infrastructure, regulatory integration, or clever economic incentives—the blockchain financial system will remain more principled than practical, more complete than competitive.
Bridges, Not Portals: LayerZero, OFT, and the Messaging Layer of the Multi-Chain Economy
While much attention is rightfully given to the capital inefficiencies at the TradFi–DeFi boundary—particularly the regulatory, liquidity, and operational barriers between stablecoins and fiat—the blockchain ecosystem itself is not immune to internal fragmentation. The proliferation of Layer 1s, rollups, and token standards has created intra-DeFi frictions that mirror the very inefficiencies the space aims to solve. Assets often become siloed on specific chains, liquidity is fragmented, and cross-chain transfers remain dependent on wrapped assets and brittle bridges. In this sense, LayerZero’s OFT model doesn't just bridge chains—it addresses the capital inefficiency within DeFi itself, creating infrastructure that treats blockchain liquidity as a unified, composable whole.
For all the innovation in DeFi and blockchain-based infrastructure, one thing remains surprisingly analog: the transfer of value across chains. Despite smart contracts, rollups, and zero-knowledge proofs, the act of moving assets between chains often still feels like sending a fax—slow, clunky, and prone to failure.
LayerZero aims to change that. And in doing so, it’s quietly building what may become the SWIFT of the blockchain era—a messaging layer for value that is not bound to a single chain, protocol, or architecture.
At the heart of this vision lies the Omnichain Fungible Token (OFT) standard—a framework that allows tokens to move between blockchains natively, without relying on wrapped assets or intermediary bridges. Instead of duplicating or mirroring assets, LayerZero treats each token as part of a unified, cross-chain supply, tracked and enforced by its messaging infrastructure.
How It Works: Messaging, Not Mirroring
Think of it like this: traditional bridges often work like currency exchanges at airports—you give up one version of an asset and receive a placeholder on the other side, hoping it redeems later. OFT, on the other hand, is like sending a SWIFT message between banks—no cash physically moves, but the ledgers on both sides update with finality once all conditions are met.
This is achieved through a clever interplay of burn-and-mint (or lock-and-unlock) mechanisms and a decentralized message validation architecture. Tokens are either:
Burned on the source chain and minted on the destination (for native OFTs),
Or locked in an adapter contract and unlocked upon arrival (for OFTAdapter use cases).
Critically, LayerZero does not assume a single source of truth. It uses a dual-verification model, where both an oracle and a relayer must independently validate the same transaction. If both agree, the destination chain processes the message. This design ensures non-custodial, trust-minimized delivery—essential in a world of increasingly sophisticated bridge attacks.
Capital Efficiency and Use Case Proliferation
The implications are not trivial. OFT enables use cases that were previously difficult or impossible to execute cleanly. From cross-chain collateralization to unified liquidity provisioning, over 100 blockchains and protocols are already leveraging OFT to escape siloed liquidity models. In one prominent example, Lido’s wstETH now moves across chains natively—no wrapped assets, no synthetic derivatives, just capital moving as it should.
This is where the SWIFT analogy becomes more than metaphor. Just as SWIFT provides the infrastructure for interbank transfers without dictating how banks hold assets, LayerZero provides the infrastructure for cross-chain messaging without dictating token economics or custody. It's a modular, trust-aware protocol layer that developers can tailor to their own risk and performance needs.
A Competitive Landscape: CCIP and the Battle for Bridges
Of course, LayerZero isn’t alone. Chainlink’s Cross-Chain Interoperability Protocol (CCIP) offers a competing architecture, prioritizing enterprise-grade security and integration with traditional players—including actual collaboration with SWIFT itself.
While CCIP relies on Chainlink’s Decentralized Oracle Networks and active risk management modules, LayerZero focuses on performance, flexibility, and developer modularity. The former is often preferred for high-value or institutional use cases; the latter excels in DeFi-native environments that require composability and speed.
If LayerZero is building a permissionless version of SWIFT, CCIP may be building a compliant, enterprise gateway for tokenized assets. The coexistence of these systems reflects a deeper truth: interoperability will not be won by one bridge, but enabled by many competing messaging layers tailored to context, capital, and compliance.
Why It Matters
As this report has argued throughout, the future of finance is not binary. It will be stitched together by layers of trust, verification, and programmability—some regulated, others not. If value is to move freely across the multi-chain world, it needs messaging rails that are as secure and scalable as the assets they carry.
In this respect, LayerZero’s OFT standard may prove to be one of the most important pieces of crypto’s hidden infrastructure—a neutral courier in a world of fragmented sovereignty.
Grey Zones and Bridges: Rethinking the Architecture of the Future
The ideological divide between on-chain and off-chain systems is often framed in binary terms: trustless versus trusted, decentralized versus centralized, open-source code versus regulated institutions. But as with most things in finance, reality tends to resist such clean binaries. It is worth asking: must the future of finance be black or white—or is there space for something in between?
The current on-chain infrastructure is elegant, resilient, and transparent—but it is also capital inefficient, economically demanding, and isolated from the broader financial system. The TradFi architecture, for all its complexity and baggage, provides the liquidity, credit, and scale that most of the world still relies on. Instead of forcing a winner-takes-all outcome, a more useful lens might be to explore hybrid architectures that blend the strengths of both worlds.
Hybrid Systems: Not Either-Or, but Both-And
A hybrid model doesn’t need to dilute the core principles of decentralisation. Instead, it could involve modular layers—on-chain settlement rails complemented by off-chain credit underwriting, or tokenised representations of real-world assets (RWAs) backed by regulated custodians and integrated via smart contracts into DeFi protocols.
Imagine a system where:
Capital remains in traditional custody (e.g. bank treasuries or regulated custodians),
But trades are settled on-chain with programmable constraints and auditability,
And lenders can earn yield by selectively underwriting credit exposures or liquidity provisioning through a risk-priced protocol layer.
Sentora already operates with this hybrid philosophy—supporting institutional-grade trading and lending products that leverage the best of both worlds: on-chain transparency and settlement with off-chain capital relationships and credit evaluation. This kind of modular approach can serve as a model for how complex market participants interact with on-chain protocols without abandoning regulatory and operational rigor.
This is not theoretical. We already see glimpses of such ideas in projects,which aim to recreate a credit layer in DeFi without fully surrendering to off-chain intermediaries. Others try a different approach—building a central counterparty (CCP) that can offer DvP settlement and risk mutualisation while interfacing with on-chain venues—suggests a future where clearing is centralised but asset custody and transaction logic remain programmable and decentralised.
These hybrid solutions don’t eliminate trust—they reassign and contain it, ideally to the points where it is most needed and can be transparently audited or regulated.
Incentivising the Invisible: Solving the Capital Cost Problem
The second architectural consideration concerns the cost of capital—specifically, how to economically reward the capital required to prefund an on-chain system. If we accept that some level of prefunding is inherent to the blockchain model (especially in the absence of credit creation), then the question becomes: who provides this capital, and why?
Here are a few potential design responses:
Yield-bearing collateral: Incentivise capital to sit in settlement buffers or margin accounts by allowing it to earn yield through integrated DeFi protocols or staking mechanisms.
Credit insurance markets: Allow underwriters to absorb counterparty risk in exchange for premium-like returns—essentially importing elements of credit insurance and default swap logic into DeFi.
Capital auctions or time-bound incentives: Borrow design ideas from Ethereum’s MEV auction logic—capital provision for settlement or liquidity buffers could be competitively priced based on demand volatility.
Dynamic pricing of finality: Give users the option to choose different settlement speeds or finality levels, each priced based on the liquidity and capital required—slow and cheap versus fast and costly.
These are just sketches. But they point toward a future where capital efficiency isn’t hacked around—it’s consciously priced and built into the system’s architecture.
Signals from the Ground: What Must Change for the Future to Take Hold
Speculating on future architectures is an exercise in intellectual freedom. But the real world, unfortunately, is bound by constraint—legal, economic, and human. Whether we evolve toward a hybrid financial infrastructure, or regress into the silos of parallel systems, will depend on how these constraints are handled in the years ahead.
Three categories of hurdles stand out as most critical to watch:
1. Legal and Regulatory Hurdles: Clarity or Containment?
The biggest question looming over the digital asset space is regulatory posture. Will governments regulate to integrate, or regulate to contain?
At present, the answer varies wildly by jurisdiction. In the U.S., regulatory ambiguity continues to slow institutional adoption and stifle innovation, with agencies often disagreeing on whether a given asset is a commodity, security, or neither. In contrast, jurisdictions like the EU (via MiCA) or Singapore are moving more decisively toward integrated frameworks—suggesting that regulatory clarity, not necessarily leniency, is the key unlock.
Projects like ClearToken recognize this directly, proposing regulated post-trade infrastructure that aligns on-chain settlement with existing legal frameworks for finality, custody, and netting. Without such alignment, most institutions simply cannot participate, regardless of appetite or opportunity.
The challenge is not to make digital assets compliant in a traditional sense—but to craft regulatory scaffolding that recognises and supports their unique properties.
2. Economic Hurdles: Making the Math Work
No matter how elegant the code or how principled the design, a financial system must be economically viable. The blockchain ecosystem today still suffers from high capital costs, fragmented liquidity, and low yield on idle assets. Until these issues are resolved—or at least priced in more efficiently—capital will not flow freely, especially not from the large pools controlled by traditional players.
Solving this requires more than just better UX or lower gas fees. It demands:
Clear value propositions for capital providers (e.g., real yield, risk-adjusted returns),
New roles for liquidity providers, market makers, and underwriters in a non-fractional world,
And potentially, new metrics for measuring efficiency—not just in throughput or TPS, but in capital efficiency per unit of transaction.
Some protocols offer early examples of how to rethink incentive design, using risk-based pricing models to attract capital into credit markets without reintroducing the opacity of TradFi.
3. Acceptance and Adoption: Culture Still Matters
The final hurdle is human: will people trust it, use it, and build on it?
Retail users, once the driving force behind crypto growth, have been burned too many times. Institutions, though increasingly curious, remain wary. And even among developers, ideological camps remain divided—between purists who reject any TradFi bridges, and pragmatists who see integration as the only path forward.
Mass adoption will require:
Better abstractions (so users don’t need to understand every technical nuance),
Trusted bridges (so institutions can engage without compromising their mandates),
And most importantly, time—to build track records, stress-test systems, and earn credibility.
Culture, after all, doesn’t shift on whitepapers. It shifts on experience and outcomes.
In Closing: The Road Ahead Is Not Binary
The future of finance isn’t pre-written in code or regulation. It will be shaped by capital flows, human behaviour, regulatory clarity, and the willingness to experiment—intelligently. Whether the result is on-chain, off-chain, or somewhere in between, one thing is clear: the cost of purity must be measured against the value of progress.