The Rise of Liquid Restaking Tokens

Introduction to Restaking

Blockchains face a significant challenge known as the cold start problem—the difficulty of gaining initial momentum for a new network. This is particularly crucial in a distributed system where security and efficiency depend on widespread participation. Attracting users and securing the network can be an uphill battle without an initial base of validators and users.

Enter restaking, an innovative approach that involves taking assets already staked to secure a blockchain network and repurposing them to secure additional external systems. This efficient use of resources improves the security of multiple platforms without requiring users to invest additional capital.

The Concept of Liquid Restaking

Restaking is an approach to securing a blockchain network by allowing users to use their assets to protect external services. This method leverages existing staked assets, such as Ether (ETH), Liquid Staking Tokens (LSTs), or other tokens, and repurposes them to secure additional networks or services.

Distinction between LST and LRT

Liquid Staking Tokens (LSTs): LSTs represent staked assets in iquid form. These tokens are created when users stake their crypto assets (e.g., ETH) on a network and receive a token that represents their staked position. This allows them to continue participating in DeFi activities while still earning staking rewards. For example, staking ETH on a platform and receiving stETH, a token that represents the staked ETH, is an example of liquid staking.

Liquid Restaking Tokens (LRTs): LRTs are a subset of LSTs used specifically in the context of restaking. Restaking involves taking these already-staked assets and using them to secure additional external services or networks. Essentially, LRTs are LSTs that have an extra layer of utility, as they not only represent staked assets but also the additional security provided to other platforms through restaking.

Since LRTs originate from liquid staking tokens and add an extra layer of functionality, every LRT starts as an LST. While all LRTs are liquid staking tokens, not every LST is used for restaking. LSTs may only provide liquidity and staking rewards, without the additional security role that LRTs fulfill.

Restaking Process

Staking Assets: Initially, users stake or lock their crypto assets (e.g., ETH) in a primary blockchain network like Ethereum to help secure and validate the network. This process earns them rewards.
Restaking: Users can then restake these already staked assets on platforms like EigenLayer. Their staked assets now also secure other external services, such as rollups, oracles, and bridges.
Receiving LRTs: In return for restaking their assets, users receive LRTs, which represent their stake and can be used within various decentralized finance (DeFi) applications.

Types of Restaking

Native Restaking: This process involves setting an Ethereum validator’s withdrawal credentials to EigenLayer’s smart contracts, or EigenPod. To participate in native restaking, users must operate an Ethereum Validator node.
Liquid Restaking: In this method, users deposit liquid staking tokens (LSTs) and EIGEN tokens into EigenLayer smart contracts. Unlike native restaking, this doesn’t require operating a validator node.

The Role of EigenLayer

EigenLayer is at the forefront of improving the efficiency of staked assets in the blockchain ecosystem. The primary goal of EigenLayer is to enhance the utility and security of staked Ether (ETH) by allowing it to support multiple systems simultaneously, not just the Ethereum network. This approach maximizes the economic value and security provided by staked assets.

As of July 14, 2024, EigenLayer has secured over $15 billion in total value locked (TVL), making it a leader in the liquid restaking token (LRT) space. The broader liquid restaking category now includes over 20 different protocols, highlighting the growing adoption and importance of restaking mechanisms in the cryptocurrency landscape. New entrants like Renzo, Puffer Finance, and Kelp are contributing to the ongoing evolution and expansion of the liquid restaking ecosystem.

EigenLayer contracts feature a 7-day withdrawal delay for LST tokens and native restaking to enhance the security of their ecosystem. The withdrawal window for the EIGEN token is 24 days to support future planned functionality unique to the token. By utilizing these restaking processes, users can maximize the utility and security of their staked assets, contributing to a more robust and secure blockchain ecosystem.

Key Components of EigenLayer

Actively Validated Services (AVS): AVS are external systems or applications that require their own distributed validation semantics for verification and rely on the security provided by staked assets. These services can include rollups, oracles, bridges, and other blockchain-based applications. EigenLayer extends the security benefits of staked ETH by integrating with AVS to these external services, thereby increasing their reliability and robustness.
Operators: Operators are entities or individuals who run the AVS software and are responsible for validating the tasks and processes within it. They register in EigenLayer and allow ETH stakers to delegate their staked assets to them in the form of native ETH or LSTs, then opt in to provide various services (AVSs), enhancing the overall security and functionality of their networks.

Becoming an operator in the EigenLayer ecosystem does not require a specific amount of delegated, restaked TVL. Any Ethereum address can serve as an operator. An address can function as both a restaker, engaging in either liquid or native restaking, and an operator simultaneously. An operator can participate in the EigenLayer network without having any restaked tokens.
Restakers: Restakers are users who restake native ETH or Liquid Staking Tokens (LSTs) to the EigenLayer protocol. By doing so, they enhance the security and efficiency of multiple systems while earning rewards.

Benefits of Liquid Restaking Tokens (LRTs)

Restaking allows Ethereum validators to join branched consensus networks of various applications. By shifting the responsibility of securing these applications to AVS operators, who are more secure both technically and organizationally, the risk of attacks is reduced, thus enhancing overall security. Without such architecture, decentralized platforms often rely on vulnerable third-party solutions like cross-chain bridges or oracles, which have been frequent targets in DeFi hacks and exploits.

To become an AVS operator, an entity must first be an Ethereum validator, requiring a deposit of 32 ETH and specific technical expertise and equipment, which limits participation opportunities. EigenLayer mitigates this problem by allowing users to deposit assets into a pool while operators handle the technical work, similar to how Liquid Staking Derivatives (LSD) protocols function. LRT protocols further add liquid tokens to the chain, enabling greater capital utilization in DeFi operations. This encourages more restakers to join and more AVS operators to emerge, making these services more accessible.

Enhancing Ethereum Staking

Liquid restaking protocols present a new opportunity to invigorate Ethereum’s staking ecosystem. Unlike traditional liquid staking protocols, which use user-deposited ETH solely for securing the proof-of-stake chain, liquid restaking protocols utilize funds to validate various AVSes, extending the security benefits of staked ETH to a broader range of blockchain applications. This democratizes the staking landscape and challenges the dominance of established liquid staking leaders.

Simplifying the Staking Process

Running a validator node involves complex tasks such as managing infrastructure, monitoring status, and addressing downtime, requiring technical expertise. Liquid restaking protocols simplify this process by managing these complexities behind the scenes. This makes it easier for individuals to participate in staking and benefit from the rewards without needing extensive technical knowledge.

Demand for a Higher ETH Yield

There is substantial demand for enhanced yields, and the LRT market is well-positioned to capitalize on this growing demand. By providing higher returns through diversified staking opportunities, LRTs attract users seeking better rewards within a reasonable risk spectrum.

Gas Efficiency

Restaking can validate various services, distributing enhanced rewards to AVS operators and indirectly to restakers. These rewards include ETH and other tokens. However, this process can become highly gas-intensive on the resource-limited Ethereum Layer 1. In contrast, LRTs can batch-collect rewards for the entire pool and distribute them efficiently among protocol holders, conserving user resources. This gas-efficient approach ensures that users receive maximum benefits with minimal transaction costs, making the system more sustainable and user-friendly.

Risk Management and Complexity

Despite their benefits, LRTs are not without risks. Here are some key concerns:

Systemic Risks

Any flaws in restaking mechanisms or underlying protocols could jeopardize Ethereum’s security and stability. Vulnerabilities in restaking processes can undermine the network’s integrity, causing potential downtimes or security breaches that affect the entire DeFi ecosystem reliant on Ethereum’s stability.

Impact on Ethereum Consensus

The creation of financial primitives like LRTs may affect Ethereum validators. Issues such as slashing nodes from third-party projects and expanding the validator set due to higher rewards could impact the Ethereum transaction finalization process.

Decoupling Risks

LRTs are susceptible to decoupling from the underlying value of staked assets, causing mispricing, liquidity challenges, and potential losses for LRT holders. Inaccurate valuation of LRTs can introduce additional risks when used as collateral in DeFi protocols, potentially triggering liquidations or compromising platform stability.

Demand and Sustainability

The long-term success of LRTs hinges on the actual demand for AVS operator services. If demand is insufficient, liquid restaking providers may struggle to integrate into the current blockchain infrastructure and create a sustainable economic model.

Economic Implications

The increasing appeal of passive income via LRT protocols could lead to a supply shock for native ETH, potentially causing a liquidity crisis. If the current trend continues, a sudden shift in supply dynamics could push investors away and destabilize the market.

Conclusion

Liquid Restaking Tokens (LRTs) offer a promising solution for enhancing blockchain security and efficiency. They provide significant benefits by maximizing the utility of staked assets and democratizing the staking process. However, the associated risks—ranging from systemic vulnerabilities to economic implications—must be carefully managed. As the LRT ecosystem evolves, the sustainability and security of these protocols will depend on the actual demand for AVS operator services and the robustness of the underlying infrastructure. By understanding and addressing these risks, the potential of LRTs can be fully realized, contributing to a more secure and efficient blockchain environment.

The original article was published on LinkedIn.