Liquid Restaking Tokens: What Are They and Why Do They Matter?

As of February 29 2024, the total value locked (TVL) in EigenLayer, an LRT leader, amounts to $9.67 billion, while TVL in the liquid restaking category has reached more than $5 billion.

In distributed systems like blockchains, addressing the Cold Start Problem — gaining enough incentive and network effect for security — is crucial. Restaking offers a way forward. It repurposes staked ether to support external systems (e.g., rollups, oracles) with an economic security layer.

EigenLayer leads this effort to improve the efficiency of staked assets. However, careful, phased implementation is vital due to the heightened risks and responsibilities involved.

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The EigenLayer system consists of Actively Validated Services (AVSes), Operators that validate AVSes tasks and restakers that lock tokens used for the validation process.

So, starting from the first principles, let's delve into the arguments that underscore the importance of liquid restaking protocols and, by extension, liquid restaking tokens:

A safety buffer: Liquid Restaking Tokens (LRTs) act as a protective buffer for Ethereum Mainnet. By selectively choosing AVSes to validate, they ensure against the potential for the spiral of slashing, if there were widespread slashing events across non-blue chip AVSes. Since users can freely exchange their LRTs like eETH back to ETH, they don’t need to withdraw it from the Beacon Chain (the Ethereum PoS chain since the Merge in September 2022).

This mechanism lowers the chance of a liquidation cascade and positions withdrawals from Ethereum (the Beacon Chain to be precise), as a backup defense procedure. Moreover, reduced volatility in EigenLayer security enhances Ethereum's core security stability.

Another chance to strive for the vitality of Ethereum staking: Liquid restaking protocols give Ethereum a new opportunity to invigorate its staking ecosystem. As an advancement over traditional liquid staking, these protocols aim to engage in Ethereum's consensus process, thereby democratizing the staking landscape and challenging the hegemony of established liquid staking leaders. The traditional Liquid Staking Protocols put ETH deposited by users into securing the PoS chain, whereas the Liquid Restaking Protocols use funds to validate AVSes, which validates various systems, i.e. rollups, oracles, bridges, etc.

Liquid Staking vs Restaking Tokens (Source: RedStone’s LRT report)

Simplicity: Running a validator involves complex tasks like managing infrastructure, monitoring status, and addressing downtime, requiring technical expertise. Similarly, LRT protocols manage restaking complexities behind the scenes, simplifying the process for users.

Risk Management: LRT Protocols, add complexity to Ethereum's staking ecosystem. Unlike standard LSTs that solely validate consensus, LRTs can undertake various market-driven tasks, each carrying unique risk profiles and yields due to diverse restaking combinations. This variation necessitates a deeper understanding of each token's technical and financial risks, making the staking landscape significantly more intricate than traditional liquid staking methods.

Applying Modern Portfolio Theory to Ethereum Restaking

Source: Idan Levin

Appetite for higher ETH Yield: Given the steady, 120% yearly, increase of ETH staked in the post-Merge era, the yield from native staking is correspondingly decreasing, a trend showing no signs of abating. It makes sense, users who have ETH exposure can simply stake it for additional yield with relatively low slashing risk. Hence Liqueid Staked ETH is often referred to as the 'internet bond'. Aware of this, there's a substantial demand for enhanced yields. The LRT market is best positioned to capitalize on this growing demand, keeping risks within the reasonable spectrum.

Availability: The LSTs deposits into EigenLayer are capped and set by the EigenLayer team to ensure the system is not overheated. This restriction doesn't apply to native restaking.
Native restaking, essentially solo staking involving a 32 ETH deposit into the Beacon Chain, operating an Ethereum client node, and notably includes using EigenPods—a personalized contract designed for native restaking. LRT Protocols that utilize native restaking have the advantage of unlimited growth potential.

Gas Efficiency: Since restaking can be used to validate various services, rewards to AVS operators (so indirectly restakers) are set to distribute enhanced rewards in comparison to simple staking – not only in ETH but also in a variety of other tokens. This could turn into a highly gas-intensive task on the resource-limited Ethereum L1. In contrast, LRTs have the capability to batch-collect rewards for the entire pool collectively and then distribute them among protocol holders in various efficient ways, thereby conserving user resources.

Ethereum’s staking distribution

Source: Hildobby’s Ethereum Staking Dashboard

We can't conclude a discussion about EigenLayer without addressing some of the criticisms it faces, such as concerns about what occurs during a cascade liquidation event, or the potential risk of restaking overloading the Ethereum consensus. There are compelling points for and against these concerns, and the prevailing view is that only time and practical observation will reveal the true impact.

Want to learn more? Read the LRT Report.