Original Title: Restaking: Everything Old is New Again

Original Author: David Han

Original Compilation: Ladyfinger, Blockbeats

Editor's Note: The Ethereum Restaking protocol and LRT are becoming hot topics in the cryptocurrency space. With the PoS consensus mechanism and an economic security fund of nearly $112 billion, the largest security fund in the crypto world, the concept of restaking offers a new way to contribute to network security while earning additional rewards. The successful launch of Eigen Layer and its rapid rise to become the second-largest DeFi protocol further demonstrate the potential and appeal of the restaking concept and technology. Restaking protocols allow validators to restake their already staked Ether to secure new Active Validator Services (AVS), providing not only an additional revenue stream for validators but also bringing new security and financial incentives to the entire Ethereum ecosystem. However, as LRT evolves and the complexity of the restaking mechanism increases, new risks emerge. These risks involve not only security and financial stability but also potential impacts on the future stability of the Ethereum consensus protocol.

Introduction

The PoS consensus mechanism has the largest economic security fund in cryptocurrency, totaling nearly $112 billion. However, the validators protecting the network are not limited to earning basic rewards solely on locked ETH. For a long time, Liquid Staking Tokens (LST) have been a way for participants to bring their ETH and consensus layer earnings into the DeFi space—either for trading or as collateral for other transactions. Now, the emergence of restaking introduces another layer in the form of liquid restaking tokens.

Ethereum's relatively mature staking infrastructure and excessive security budget have allowed Eigen Layer to grow into the second-largest DeFi protocol in the ecosystem with a Total Value Locked (TVL) of $12.4 billion. Eigen Layer enables validators to earn additional rewards by reusing their held ETH to provide Active Validator Services (AVS). As a result, intermediaries in the form of liquid restaking protocols have also become more common, driving the spread of light rails.

That said, from a security and financial perspective, restaking and light rails may introduce additional risks compared to existing staking products. As the number of AVS increases and light rails differentiate their operator strategies, these risks may become increasingly opaque. Nevertheless, restaking rewards are laying the groundwork for a new class of DeFi protocols. If such proposals are implemented, separate discussions about reducing staking issuance to a Minimum Viable Issuance (MVI) could further enhance the relative importance of long-term restaking yields. Therefore, the heightened focus on regaining opportunities is becoming one of the biggest themes in crypto this year.

Ethereum Restaking Foundation

Eigen Layer's restaking protocol launched on the Ethereum mainnet in June 2023, with AVSs set to launch in the next phase of its multi-stage rollout (2Q24). In practice, the restaking concept of Eigen Layer establishes a method for validators to protect new functionalities in Ethereum, such as data availability layers, rollups, bridges, oracles, and cross-chain messaging, which may earn additional rewards in the process. This represents a new revenue stream for validators in the form of "security as a service." Why has this become such a hot topic?

As the largest PoS cryptocurrency, ETH currently has a massive economic foundation to protect its network from hostile majority attacks. However, at the same time, the relentless growth of validators and staked ETH can be said to have exceeded the necessary conditions for network protection. At the time of the Merge (September 15, 2022), approximately 13.7 million ETH were staked, which was enough to protect the then $22.1 million TVL of the network. As we began to release, there are now about 31.3 million ETH staked, which has tripled in ETH terms, but Ethereum's TVL in ETH terms today (compared to the end of 2022) is actually lower, at 14.9 million ETH (see Figure 1).

The excessive staked ETH, along with the security, liquidity, and reliability of the underlying assets, places it in a unique position to help facilitate the security of other decentralized services. In other words, we believe that rethinking as a concept is largely inevitable, as an extension of ETH's inherent value. However, there is no free lunch. To ensure the correctness of these services, restaking is used for behavioral verification and may be subject to slashing or penalty, similar to traditional staking. (That is, when the first group of AVSs is released in 2Q24, slashing will not be enabled.) Similarly, like staking, restaking operators will also earn additional ETH (or AVS tokens) for their services.

Ethereum LRT

So far, the growth of Eigen Layer's TVL has been astonishing, second only to Lido (Ethereum's leading liquid staking protocol). Eigen Layer achieved this while retaining most of the deposit cap of the process and completing it before launching any live AVS. That said, it is difficult to decouple the ongoing supply demand from users' interest in short-term points and airdrop farming. While the number of restaked ETH may continue to grow in the long term as the protocol matures, we believe that TVL may see a short-term decline when point farming ends or if early AVS rewards fall below expectations.

Eigen Layer builds on the existing staking ecosystem by allowing the staking of diversified underlying LSTs or native staked ETH (through Eigen Pods). Programmatically, validators point their exit addresses to Eigen Pods to earn Eigen Points, which will be redeemed for protocol rewards in the future. The LST locked in Eigen Layer (1.5 million ETH) accounts for about 15% of all LSTs, while the total ETH locked in Eigen Layer accounts for nearly 10% of all ETH used in investments (3M of 31.3 million ETH). (LSTs themselves account for 43% of all ETH used in the ecosystem.) In fact, we believe that after the staking demand stabilizes post-October 2023, the restaking has been a recent reason for the renewed interest in onboarding new validators. In February 2024, an increase of over 2 million ETH staked coincided with the suspension of Eigen Layer's deposit cap. In fact, some LST providers are increasing their target APY as a way to attract new users to their own platforms by leveraging the interest in reinvestment.

Learning from the popularity of LSTs, a rich LRT ecosystem has developed, with over six protocols offering liquid restaking token versions with various points and airdrop schemes. Of the 3M ETH protected in Eigen Layer, approximately 2.1M (62%) is wrapped in secondary protocols. We have seen similar patterns in the liquid staking market before and believe that as the industry grows, diversification of alternatives will be important.

In the long run, if native staking issuance declines due to increased staking participation (as more validators join, yields will decrease), then restaking could become an increasingly important avenue for ETH yields. Separate discussions about reducing native staking ETH emissions could further enhance the relevance of restaking yields (though this is still in the early discussion phase).

That said, the yield of AVSs is expected to be relatively low after launch, which may pose challenges for LRT in the short term. For example, the largest LRT, Ether.fi, charges a 2% annual platform fee on its TVL for "vault management." However, not all light rails have the same fee structure, leaving room for competition in this regard. However, if we use this 2% fee as a title for calculating breakeven costs, AVS would need to generate approximately $200 million in annualized fees (restaking $1.24 billion) to break even—this is more than the fees charged by Aave or Maker in the past year. This raises the question of how much business AVS needs to generate to improve the overall yield for ETH stakeholders.

Emergence of Validation Services

As of today, no AVS has been launched on the mainnet. The first AVS to be released (in early 2Q24) will be EigenDA, a data availability layer that can serve a role similar to blob storage with Celestia or Ethereum. After the successful Dencun upgrade reduced L2 fees by over 90%, we believe EigenDA will become another tool for cheaper L2 transactions in the modular toolkit. However, building or migrating L2s to leverage EigenDA is a slow process that may take months to generate meaningful revenue for the protocol.

To estimate the initial yield of EigenDA, we can compare it to the costs of Ethereum blob storage. Currently, about 10 ETH per day is used for blob transactions across many major L2s, including Arbitrum, Optimism, Base, zkSync, and StarkNet (see Figure 5). If EigenDA sees similar usage levels, based on our conservative estimates, the annualized rate of restaking rewards would be approximately 3.5k ETH, equivalent to about 0.1% of additional rewards. The fees in the first few months may even be lower than this estimate, although the addition of multiple AVSs could quickly increase yields.

Other AVSs built within the Eigen Layer ecosystem include interoperability networks, fast finality layers, proof of location mechanisms, Cosmos chain security bootstrappers, and more. The opportunity space for AVSs is vast and continually growing. Restakers can choose which AVS they wish to secure with ETH collateral, although this process becomes increasingly complex with each new AVS.

Challenges and Strategies of LRT

This raises the question of how different LRTs will handle (1) AVS selection, (2) potential slashing, and (3) eventual token financialization. In traditional staking, the one-to-one mapping between validator responsibilities and income is clear, making LSTs a relatively straightforward matter when considering all factors. However, with restaking, the many-to-one structure introduces some non-trivial complexities in how rewards (and losses) are accumulated and distributed (as well as the diversity of LRT issuers). LRTs not only pay basic ETH staking rewards but also pay rewards for acquiring a set of AVSs. This also means that the potential rewards paid by different LRT issuers will vary.

Currently, many LRT models have not been fully clarified. However, if each project has only one LRT, all token holders in a given protocol may be subject to unified AVS incentives and slashing conditions. The design of these mechanisms may vary by LRT provider.

One suggestion is to take a tiered approach, allowing LRT issuers to adopt a range of "high" and "low" risk AVSs, although this would require establishing risk standards that have not yet been defined. Additionally, depending on the architectural design, the final rewards for token holders may still be paid across all AVSs, which we believe contradicts the purpose of a risk-tiered framework. Alternatively, decentralized autonomous organizations (DAOs) could decide which AVSs to choose, but this raises questions about who the key decision-makers are within these DAOs. Otherwise, LRT providers could act as interfaces for Eigen Layer and allow users to retain decision-making power over AVS adoption.

Upcoming Risks

However, at launch, the restaking process should be relatively straightforward for operators, as Eigen DA will be the only AVS that can be secured. However, one characteristic of Eigen Layer is that ETH is committed to one AVS and can then be further directed to other AVSs. While this can increase yields, it also increases risks. The hierarchy of slashing and claim conditions between services presents challenges when submitting the same restaked ETH to multiple AVSs. Each service creates its own custom slashing conditions, so there may be a situation where one AVS slashes the restaked ETH due to misconduct, while another AVS wishes to reclaim the same restaked ETH as compensation for harmed participants. This could lead to eventual slashing conflicts, although, as mentioned earlier, Eigen DA will not have slashing conditions at the initial launch.

Complicating this setup is Eigen Layer's "collective security" model—where AVSs utilize a common staked ETH pool to secure their services—can be further customized through "attributable security." That is, individual AVSs have the potential to receive (additional) reused ETH, which is only used to secure their specific services—this is a form of insurance or safety net for paying premiums for AVSs. Therefore, as more AVSs are launched, the role of operators becomes technically more complex, and slashing rules become more difficult to follow. In addition to this reordering complexity, the expansion of LRT extracts many fundamental strategies and risks from token holders.

This is a concern because ultimately, we believe people will go where the highest rewards are offered by these LRT providers. Therefore, LRTs may be incentivized to maximize yields to gain market share, but these may come at a higher (albeit hidden) risk. In other words, we believe it is important to focus on risk-adjusted rewards rather than absolute rewards, but it may be difficult to maintain transparency on this. This could lead to additional risks as LRT DAOs are incentivized to re-stake multiple times to remain competitive.

Moreover, if LRT payments are entirely made in ETH, LRTs may also exert downward selling pressure on non-ETH AVS rewards. That is, if LRT needs to convert native AVS tokens into ETH (or equivalents) to redistribute rewards to LRT token holders, the accrued value of the repurchase may be limited by recurring selling pressure.

Additionally, LRT carries non-negligible valuation risks. For example, if an extended staking withdrawal queue emerges (after Ethereum's Dencun Fork, validator outflow limits were reduced from 14 to 8), LRT may temporarily misalign from its underlying value. If LRT becomes a widely accepted form of collateral in DeFi (e.g., in borrowing and lending protocols), this could inadvertently exacerbate liquidations, especially in low liquidity markets.

This assumes that these DeFi protocols can first correctly assess the incidental value of LRT. In practice, LRT represents a diversified portfolio of holdings, the risk profile of which may change over time. New components can be added or removed, or the AVSs themselves may change their yield or repayment risk. Hypothetically, we could see a scenario where a market downturn simultaneously affects several AVSs, thereby destabilizing light rails and amplifying the risks of forced liquidations and market volatility. Recursive lending would only magnify these losses. On the other hand, protocols that can decompose LRT into its principal and yield components can help mitigate this risk, as tokenized principal can serve as original collateral, while tokenized yields can be used for interest rate swaps.

Finally, as Ethereum co-founder Vitalik Buterin emphasized, in some cases, significant failures in the reconstruction mechanism could threaten the fundamental consensus protocol of Ethereum. If the amount of restaked ETH is sufficiently large relative to all held ETH, there may be economic incentives to execute erroneous decisions that could lead to network instability.

Conclusion

Eigen Layer's restaking protocol is poised to become a cornerstone for various new services and middleware on Ethereum, which in turn could provide meaningful sources of ETH rewards for validators in the future. From Eigen DA to Lagrange's AVS, it can also greatly enrich the Ethereum ecosystem itself.

That said, the opaque risks of resetting strategies around the underlying protocol may lead to hidden risks or temporary dislocations with the underlying protocol. How different issuers choose which AVSs to adopt and how to allocate risks and rewards to LRT holders remains an open question. Additionally, the initial yields of AVSs may not meet the extremely high expectations set by the market, although we expect this situation to change over time as AVS adoption increases. Nevertheless, we believe that restaking supports open innovation in Ethereum and will become a core part of the ecosystem's infrastructure.