Liquid Restaking
TL;DR:
EigenLayer's introduction of a new cryptoeconomic primitive, restaking, is set to significantly impact Ethereum’s DeFi landscape.
Restaking enables the repurposing of native staked ETH and ETH LSTs to validate transactions from EigenLayer modules while rewarding users for their pledges.
Despite looking attractive, whenever a user restakes it increases its investment risk profile which may end up in impermanent loss.
Restaking in DeFi: Maximizing Yield on Your Ethereum Assets
EigenLayer's introduction of a new cryptoeconomic primitive, restaking, is set to significantly impact Ethereum’s DeFi landscape. With Ethereum's shift from Proof-of-Work (PoW) to Proof-of-Stake (PoS), staking has emerged as a leading investment strategy in the ecosystem, favored for its simplicity and associated rewards.
In case the reader is unaware of what it is, in a nutshell, Staking is the act of locking up a certain amount of coins with network validators to support blockchain operations and security. One can think of it as a term deposit that accrues interest for the deposited amount and time time-locked. In this case, the interest is paid in the form of additional coins.
A notable niche within the staking sector is liquid staking tokens (LSTs). This sector currently represents almost half of the chain’s total value locked (TVL). Unlike traditional staking, liquid staking protocols allow users to mint a wrapped token that represents both the yield generated and the underlying asset value, thus its attractiveness compared to the original model.
Ethereum Liquid Staking Protocols TVL. Source: DefiLlama
Now, looking at restaking, EigenLayer proposes a new model that allows for the repurposing of native staked ETH and ETH LSTs. This means that users can stake their tokens a second time (restake), with a second tier of validators, and accrue an additional layer of yield.
Even though EigenLayer doesn’t offer any liquid solution, protocols like GenesisLRT and InceptionLRT are already preparing a liquid restaking solutions for their users. This will enable users to remain capital efficient by minting a wrapped token that includes staking and restaking rewards, as well as the underlying asset.
As with traditional and liquid staking solutions, the opportunity to earn a second layer of yield for the same asset is likely to attract more investors, seeking to expand their returns.
Restaking Possibilities in EigenLayer. Source
The Promising Outlook for Restaking
EigenLayer goal when introducing restaking, is to establish a decentralized trust marketplace based on Ethereum’s network. The core idea behind this initiative is to tackle Ethereum’s (and other blockchains) limitation to read off-chain data, while simultaneously reducing innovation barriers by mitigating the need to create unique validation networks for each protocol.
While blockchains excel at managing and connecting data generated on-chain, they face substantial limitations when interacting with off-chain data. Currently, to fetch off-chain data, the network is completely reliant on third-party applications and their validators network. Looking at the overall oracle panorama, it’s noticeable that this sector is highly dependent on the infrastructure created by Chainlink, which became a leading player since it was the first of its class and established its presence early on.
Total Value Secured on all Oracles. Source
This dependency poses a huge threat to the blockchain since it is highly reliant on not-so-secure validator networks. Furthermore, these same third-party validator networks are quite capital and time-intensive, which represents a barrier to permissionless innovation.
Addressing these limitations, EigenLayer proposed the restaking primitive. Restaking will secure a new set of data availability modules (actively validated services, or AVSs) that will close this gap and perform all the connections with off-chain information.
Doing so, not only increases the network security but also diminishes a huge barrier to the permissionless innovation concept since protocols will be able to leverage the restaking validator network to build their off-chain platforms.
The possibilities of these AVSs are quite vast, such as fast finality layers, data availability layers, virtual machines, keeper networks, oracle networks, bridges, threshold cryptography systems, AI inference/training mechanisms, and committees for trusted execution environments.
EigenLayer Restaking Framework. Source
The Inherited Restaking Risks
Given the vast variety of use cases and the encompassed distribution of dividends to participants in the ecosystem, it's only natural that we look at restaking as a very promising sector.
However, it’s also important that we note the risks of it. As in everything related to finances, the higher the reward, the higher the risk. In this case, to understand the restaking risk profile it’s important to not overlook how EigenLayer will control its validators.
Similar to Ethereum, EigenLayer requires its validators to consent to the potential loss (slashing) of their pledged assets if they engage in any malicious activities against the network or considerably underperform when executing its tasks. This means that if the operator the user delegated his restaking underperforms or tries any malicious behavior toward the network, users may lose their tokens.
Furthermore, it’s also noteworthy to consider the risk inherited by LST DeFi baskets. In a nutshell, a “financial basket” represents the aggregation of different financial products over the same index. In this case, each LST represents the underlying asset (ETH) and the corresponding staking rewards, thus an LST DeFi basket would encompass several LSTs altogether.
While this basket may seem a safe and secure option, it also encompasses risks. As wrapped tokens, LSTs always pose the risk of depegging, which could bias the whole basket value. Additionally, it’s also worth considering that any of the LSTs in the basket can be slashed for any validator underperformance, which once again could encompass a risk for the whole basket index.
Concluding our thoughts, even though restaking presents a very promising opportunity for investors, it’s also important to consider that when restaking, investors are indeed getting exposed to more layers of risk.
Despite finding the whole EigenLayer framework very promising, we urge everyone interested in participating in it to carefully do their research on the different validators and operators. When leveraging your assets, there’s always the inherited risk of being liquidated, so we urge you to mitigate that risk with a strong due diligence process.