Table of Contents
Researcher
This article was written on Sep 26th and has been recently edited to fit the Snapshot template.
Key Takeaways
Not long after the introduction of the concept of restaking by EigenLayer, Liquid Restaked Token (LRT) protocols aim to unlock the liquidity of restaked ETH.
Stader Labs, Restake Finance, Inception LST, and Astrid Finance are notable examples of LRT protocols.
Given the tokenomics of LRT protocols, one might imagine an LRT War similar to the Curve War. However, due to the uncertain popularity of LRT protocols, the demand for AVSs’ security establishment, and the unpredictability of which LRT protocol will take the lead, LRT War might not significantly occur.
The inherent risk associated with LRT protocols is mainly the depegging risk due to additional slashing conditions. However, this risk wouldn't be as significant as the community might perceive.
1. What Happened?
EigenLayer is introducing a groundbreaking concept known as restaking to the Ethereum ecosystem, creating a new wave in the staking market. However, from a user experience perspective, EigenLayer has a drawback. In the case of restaking, ETH staked on the Ethereum network is liquified once and then staked elsewhere. So, while ETH is staked in two places, it ultimately gets locked. Just as liquid staking protocols emerged to unlock the liquidity of staked ETH, Liquid Restaked Token (LRT) protocols are emerging to unlock the liquidity of ETH that has been restaked on EigenLayer. This article will delve into LRT protocols' overview, examples, and risks.
2. Backgrounds
2.1 Liquid Staking Protocol: The Most Successful DeFi Primitivies
Source: DefiLlama
So far, various types of DeFi protocols, such as DEX, Lending, Derivatives, Synthetics, and CDP, have been launched. However, among them, the Liquid Staking Protocol is the most standout DeFi protocol in terms of TVL. Liquid Staking Protocol is a protocol that liquifies tokens staked for the security of PoS networks. Users can stake their tokens in the network and, at the same time, utilize the LST (Liquid Staking Token) in other DeFi protocols, allowing them to earn more rewards.
As of September 2023, across all networks, the DeFi protocol with the highest TVL is Lido, with a TVL of $14.1 billion. This is about three times higher than the second place, MakerDAO, which has a TVL of $4.9 billion. Lido's LST, known as stETH, ranks 7th in terms of market cap among all tokens, which is higher than DOGE, ADA, SOL, and MATIC. In the market, not only is there Lido, but there are also various Liquid Staking services, both decentralized like Rocket Pool's rETH and Frax's frxETH and centralized ones like Coinbase's cbETH and Binance's BETH.
Souce: @21co
From the launch of Ethereum's Beacon Chain in December 2020 until the Shapella upgrade, it was impossible to withdraw staked ETH. However, with the Shapella upgrade in April 2023, withdrawals of ETH were enabled, associated risks were mitigated, and liquid staking of ETH has been active ever since. Only about 22% of the total ETH supply has been staked so far, which is significantly lower than other PoS networks. Therefore, ETH staking through liquid staking protocols is expected to continue to rise.
2.2 EigenLayer
EigenLayer is a restaking protocol that offers a step ahead of liquid staking protocols. While liquid staking protocols enabled users to utilize their staked tokens in other DeFi protocols, EigenLayer allows the staked ETH on the Ethereum network to be restaked in other protocols that require security. Protocols that use EigenLayer's restaked ETH for security are called AVS (Actively Validated Services). Here, ETH is staked on both 1) the Ethereum network and 2) AVS, subject to two different slashing conditions, but can earn rewards from both types of staking.
How is it possible to stake ETH simultaneously on the Ethereum network and other AVS protocols? Ethereum validators set withdrawal credentials to allow ETH withdrawals, and these can be set to EigenLayer's smart contract. This means that Ethereum validators that want to participate in validating other AVSs through EigenLayer restaking only need to run the client required for AVS validation and set the withdrawal credentials to EigenLayer's smart contract. If a specific validator meets the slashing conditions of AVS, EigenLayer has the authority to slash that validator's ETH, so restaked ETH can be subjected to both slashing conditions.
AVS utilizing EigenLayer's restaked ETH offers various advantages:
Security Bootstrapping: For new AVS, it's challenging to establish a set of validators for security. Utilizing EigenLayer allows them to leverage Ethereum network validators and its robust security.
Capital Efficiency: There's no need to use native tokens to establish security directly, and already staked ETH can secure both the Ethereum network and AVS, leading to higher capital efficiency.
In summary, if a protocol wants to establish decentralized security with added slashing conditions but finds it challenging to build on its own and wants to benefit from Ethereum's security, it can become one of EigenLayer's AVS. Several renowned projects, like AltLayer, Celo, Espresso, EigenDA, Hyperlane, Mantle, Polyhedra, etc., are planning to participate as early AVS in EigenLayer.
3. Zoom in: Liquid Restaked Token (LRT)
3.1 Overview
From the end user's perspective, there are several inconveniences in using EigenLayer directly:
Node operator selection: Operators on EigenLayer participate in validating for different AVS. It's challenging for end users to select a node operator considering both risks and rewards.
Interest compounding: To get compound interest from rewards in EigenLayer, users must compound it manually, and the gas fees for this process are expensive.
Illiquidity: ETH restaked on EigenLayer is illiquid and cannot be further utilized elsewhere.
The LRT protocol unlocks the liquidity of ETH restaked on EigenLayer, addressing the above issues. The LRT protocol restakes the deposited ETH across various operators in EigenLayer to standardize reward and risk profiles. Additionally, it provides users with tokenized representations of their restaked ETH and rewards, allowing them to further leverage these tokens in other DeFi protocols for additional benefits. The basic rewards users receive include 1) ETH staking rewards, 2) AVS restaking rewards, and 3) additional LRT utilization rewards. Moreover, one can also anticipate rewards in native tokens issued from EigenLayer and the LRT protocol.
3.2 LRT Protocols
3.2.1 Stader Labs
Stader Labs is a multi-chain liquid staking protocol that supports Ethereum, Polygon, Hedera, BNB, Fantom, Near, and Terra 2.0 networks. Following its liquid staking services, it announced the launch of its LRT protocol in August 2023. Users can restake stETH or rETH to receive rsETH, which can then be leveraged in other DeFi protocols for additional rewards. The price of Stader Labs' LRT token is determined by the underlying ETH and accumulated rewards. Currently, their testnet service is in operation.
Restaked ETH is allocated to validators and services chosen by the LRT DAO. Through governance, the LRT DAO can attract new validators and AVS and plans to adopt a permissionless system in the future where anyone can participate. The tokenomics of the native token of LRT DAO will play a crucial role in determining how the restaked ETH is allocated across various AVS (it's not yet confirmed if this token is SD).
Source: Stader Labs
The main modules underlying rsETH are 1) deposit pool, 2) node delegator, 3) reward market, and 4) withdrawal manager contracts. The deposit pool is a simple vault where ETH restakers deposit liquid tokens and receive rsETH. The deposit pool delegates the deposited ETH to EigenLayer's operators associated with the LRT DAO through the node delegator. The reward market oversees everything related to rewards and offers various strategies to provide the best possible rewards for restakers. The withdrawal manager contracts allow users to redeem their rsETH for ETH and various rewards.
3.2.2 Restake Finance
Restake Finance is also an LRT protocol, with some distinctions from Stader Labs. First, liquid restakers can choose the AVS directly for staking. Secondly, it only supports stETH, and its LRT, known as rstETH, is a rebase token hard pegged at 1:1 with stETH. This means that the rewards corresponding to staking on the Ethereum network are provided through a rebase mechanism, so the amount of rstETH in the holder's wallet automatically increases. For additional rewards provided by EigenLayer, users can claim through a claim function. Regarding tokenomics, by staking Restake Finance's governance token, ReFi, one can receive a yield boost and a share of the protocol's profits. Currently, their testnet is live.
3.2.3 Inception LST
Source: Inception LST
Users can deposit stETH, rETH, and cbETH to receive inETH at Inception LST. According to Inception LST, it is a layer-2 restaking platform, allowing users to receive L2 rewards while having their liquid tokens in a liquid state. From the perspective of L2 networks, they can expand their Total Value Locked (TVL). Specific details haven't been disclosed yet, so how it is associated with the LRT protocol and L2 remains to be seen.
Inception LST has a native governance token called ING. Holders can vote on EigenLayer's node operators through delegate voting and boost interest rates. Token distribution is allocated as follows: seed round 5%, private round 10%, initial contributors 20%, user incentives 55%, and DAO treasury 10%.
3.2.4 Astrid Finance
Source: Astrid Finance
At Astrid Finance, users can restake stETH and rETH, receiving rstETH and rrETH, respectively. The restaked ETH is delegated to various EigenLayer operators chosen through votes by Astrid DAO. Rewards are auto-compounded, and the reward distribution method uses the rebase mechanism, similar to Restake Finance. In Astrid Finance, the number of delegators and the allocation of ETH are determined by governance. 10% of the revenue generated by the protocol goes to the Astrid DAO treasury.
3.3 Will LRT War Happen?
Apart from Restake Finance, the other three LRT protocols share a commonality. Specifically, the LRT protocol autonomously delegates the deposited ETH to EigenLayer's node operators on behalf of users. Furthermore, token governance is used to determine the amount of ETH delegated to each node operator. This means that if AVS wants to secure more ETH through the LRT protocol, they need to secure and stake the governance tokens of that LRT protocol.
Like the past Curve War, where various protocols secured CRV tokens (or CVX) to secure more liquidity, AVS pursuing a higher security level might accumulate LRT protocol governance tokens. However, there are several considerations about whether a massive event like the Curve War would occur once the LRT protocols launch.
Firstly, can the influence of the LRT protocol reach the level of Curve Finance? Curve Finance pioneered stable swap AMMs, allowing for trading two assets of the same value with minimal slippage. It's an essential protocol in the DeFi ecosystem, wielding significant influence. However, for an LRT protocol to achieve such influence, the volume of ETH restaked through EigenLayer must be substantial.
Secondly, is there a genuine demand for security construction from the perspective of AVS? In the Curve War, multiple protocols sought to expand the influence of their stablecoins. Providing deep liquidity to users was almost essential, which presented a clear incentive to amass large quantities of CRV tokens. Applying this to the LRT protocol, one must assess the willingness of AVSs to secure restaked ETH. From the user's viewpoint, while the deep liquidity of Curve Finance certainly improves UX, the security level of AVS doesn't necessarily. Most users don't concern themselves with protocol security levels. However, the economic security level of a protocol is fundamental, so there might be a high demand for AVSs to improve security, making it an important consideration.
Lastly, which LRT protocol could become dominant should be considered. Curve Finance and Lido each became pioneering protocols in stable swaps and liquid staking, respectively, achieving leading positions and becoming landmark protocols. However, with several LRT protocols on the horizon, it remains to be seen which will emerge as the leader. If multiple LRT protocols are in close competition, AVS might find it challenging to choose which LRT governance token to invest in.
3.4 Risk Analysis
3.4.1 Depegging
Before, the stETH/ETH price experienced a depeg, causing significant disruption in the DeFi market. Will the LRT protocol, which further unlocks the liquidity of restaked ETH, have similar risks?
First, it's essential to note that the past stETH/ETH depegging incident occurred because withdrawals of ETH were impossible before the Shapella upgrade. Many users noticed that stETH and ETH prices were somewhat similar. They deposited stETH into lending protocols, borrowed ETH, converted it back to stETH, and then deposited stETH again, effectively leveraging their investments. However, when market conditions deteriorated, several protocols and institutions, such as Terra, FTX, 3AC, and Celsius, went bankrupt. Their only option was to sell stETH for ETH, leading to the depegging of stETH/ETH and causing significant market confusion.
After the Shapella upgrade, it is now possible to withdraw staked ETH from the Ethereum network, making the extreme situations mentioned above less likely. If one wants to sell, they can simply withdraw stETH as ETH, which doesn't result in a depeg of stETH/ETH. This is also the case for the LRT protocol. If the LRT protocol and EigenLayer support native withdrawals in a short time frame, the price depegging risk between ETH, liquid staked ETH, and liquid restaked ETH will be minimal. Currently, Lido sets a withdrawal waiting period of 1-5 days, depending on the Ethereum network's situation, while EigenLayer, being a newer service, conservatively has a 7-day waiting period. This waiting period for EigenLayer is expected to decrease over time. (Of course, the current 7-day period is long, so there's a possibility of depegging).
3.4.2 Slashing
The additional risks introduced by liquid staking and LRT protocols are technical ones, like smart contract risks, oracle risks, and initial shallow liquidity leading to market risks. One more, the fundamental risk is slashing risk. If staked tokens are slashed, the circulating liquid tokens will not be fully backed, leading to depegging. If ETH and liquid token prices depeg, it can cause cascading collapses in various DeFi protocols and lower the price of ETH. Restaked ETH has one more slashing condition compared to staked ETH. LRT protocol carries a higher slashing risk than existing liquid staking protocols.
Specifically, EigenLayer manages various AVS slashing conditions, creating a risk of unintended slashing. To mitigate this, EigenLayer has introduced a veto slashing feature. If unintended slashing occurs in a specific AVS, EigenLayer's governance committee can oppose (veto) the slashing through multisig. The governance committee will be selected based on reputation. This feature is a precautionary measure for early unintended risks and is expected to be phased out once EigenLayer is thoroughly battle-tested.
4. Zoom out
Although the concept of restaking, using staked ETH for validating in other protocols, is relatively new, numerous projects are already attempting to unlock it again. While it does introduce an additional leverage effect, the core added risk comes from the new slashing conditions leading to depegging. This risk is not as complicated or as dangerous as the community might perceive. If LRT protocols become more active, ETH, despite its vast market capitalization, can generate significant value, and we can anticipate even more vitality in the Ethereum DeFi ecosystem.
Thanks to Kate for designing the graphics for this article.
