In this article, I will be analysing EigenLayer who have pioneered the concept of restaking. This could be the next big thing in DeFi and has been gaining traction on crypto twitter. While this concept is fairly technical, I will try my best to break it down and explain it as simply as possible. Do not that restaking is different form staking and liquid staking. You can read up more on these concepts in my Introduction to Pendle article.
1. Introduction to Restaking
Any module that cannot be deployed on top of the Ethereum Virtual Machine (EVM) cannot have their processes validated by nodes with staked ETH. As such they cannot tap on the pooled trust of the Ethereum network. Such modules are not compatible with the EVM because they process inputs from outside Ethereum. Examples of such modules include sidechains based on new consensus protocols, data availability layers, new virtual machines, keeper networks, oracle networks, bridges and other crucial components that allow the crypto ecosystem to function.
Such modules require actively validated services (AVS) to validate their processes. These AVS are either secured by their own native token (Decentralized) or are permissioned in nature (Closed network where designated parties participate in consensus validation).
An example would be Chainlink. Chainlink regularly collects data from non-EVM blockchains and off-blockchain sources to perform its function as an oracle. Since it cannot make use of node operators in the Ethereum blockchain to validate it’s transactions, they have their own node operators who stake Link tokens instead and perform the validation role.
2. Overview of EigenLayer
EigenLayers allows modules to secure their AVS with restaked ETH rather than their own tokens. Users can deposit ETH and liquid staked tokens on EigenLayer. Users can then opt for this ETH to be delegated/staked with entities who run EigenLayer validator nodes. Users will be able to see the fees charge by each validator and their performance metrics.
Modules/Protocols will need to incentivize these validators to allocate restaked Eth to their module and validate their transactions. Incentivization can be in the form of the module’s native token. These modules also introduce a slashing fee on validator nodes who do not perform their role correctly. Validators will take a % cut of the rewards given by modules and the rest is given back to the ETH restakers. This allows LST holders to earn an additional yield (on top of yield earned by LSTs) while giving modules access to additional pooled security. Do note that ETH/LST delegated will be subject to a lock-up period which exposes delegators to illiquidity risk. The lock-up period has yet to be determined by the team as not all functions of EigenLayer are fully up and running.
3. Where EigenLayer comes in
High cost of capital
New protocols that need to develop a new AVS will have to bootstrap a new trust network in order to get security and this imposes a huge cost for the protocol. Take for example a new Protocol X. Protocol X can get validators to stake a certain amount of X tokens to be a validator and reward them with X tokens. Since the protocol is new, X tokens likely have low utility and trade with low volumes causing its price to be volatile. Validators will be taking a huge risk by staking X tokens and will demand a commensurate number of X tokens to validate their processes. A high amount of X tokens given out as rewards will cause the token to be inflationary. Consistent decrease in the token price will make it even easier for bad actors to secure enough nodes to corrupt the protocol.
Lower security
In order to prevent corrupt practices, protocols need to ensure that no one entity commands more than 51% of the validator nodes. This can only be done if the cost to run a node is high enough (Eg; 32 ETH to run an Ethereum node). However this is a high cost for a single validator to set aside to validate a new risky protocol.
Why the need for restaking
Tapping on the collective amounts of ETH restaked by many users lowers the capital risk for validators to perform a validation function for new protocols. Lowered risk for validators means that less rewards have to be emitted by protocols to compensate them, reducing inflationary pressures. EigenLayer also increases the cost of corruption as validator nodes are backed by the collective amount restaked on EigenLayer as compared to if the AVS where to be run by independent parties.
Other use cases
A huge market for EigenLayer are Layer 2s which has led to the launch of EigenDA. Sequencers on Layer 2s process transactions off-chain before sending them on-chain to be finalized. This is a crucial function of Layer 2s and currently most of these sequencers are centralized. Using EigenLayer, L2s can utilise the large validator set to decentralise and run their sequencers.
4. Traction
EigenLayer has raised $54.4 million in its Series A round from a large number of reputable investors such as Blockchain Capital, Polychain, Coinbase Ventures, Figment Capital, and etc. There are 12 early projects building on EigenLayer including prominent names such as Mantle and Celo.
EigenLayer has launched on Ethereum mainnet and has already achieved 226M TVL. However, the protocol is still in development and as such have placed a cap on the amount of ETH that can be restaked on their platform. Each time the staking cap was raised, it was filled in hours, highlighting strong interest in the crypto community.
5. Potential Risks
The key risk here is systematic risk which has been covered well by an article by Swissborg. If a large amount of ETH staked in the Ethereum network is used for restaking other protocols, a security breach in one of those protocols could potentially result in a significant amount of ETH being slashed. This will reduce the overall security of the Ethereum network.
Another interesting risk is that high yields may be unsustainable. Stakers on EigenLayer will delegate their restaked ETH to node operators who can offer the highest returns. This will incentivise node operators to seek protocols that offer higher returns. These high returns will either come from inflationary tokenomics or at the expense of protocol users who will be offered lower yields instead. Both cases are not sustainable for the protocol and could lead to its collapse affecting node operators and thus restakers on EigenLayer.
6. Roadmap ahead
EigenLayer currently supports rETH, stETH and cbETH and look to support more liquid staking tokens in the coming months. In addition, the operator testnet phase will begin in Q4 2023.
Users who have currently restaked with EigenLayer are assigned restaked points (amount of Eth restaked x time restaked). While such activity might be driven by an anticipation of an airdrop, the team has mentioned that they currently don’t have any plans to launch a native token.
7. Conclusion
Love the pain points EigenLayer is aiming to solve. EigenLayer encourages innovation while allowing for decentralization and greater security. EigenLayer can be seen as similar to VCs who help bootstrap early stage start-ups.
Moving forward it will be important to see the impact of the operator testnet launch as well as their ability to secure partnerships with big players in the space. An active community of restakers, operators and new protocols seeking validators is needed for EigenLayer to thrive. It will also be interesting to see if they eventually succumb and launch a native token.
Interesting articles that were the inspiration behind my own one and cover more technical details for those interested:
