Ethereum’s DeFi scene has been buzzing again this year, with the emergence of a new kind of asset called “liquid restaking tokens” or LRTs promising to maximize investor’s yields like never before.
In the last year, billions of dollars of vale have flowed into liquid restaking protocols like Kelp DAO, Ether.Fi, Swell and Puffer Finance, and those platforms are locked in a turf war, vying to become the protocol of choice for adventurous DeFi investors.
The liquid restaking trend arose thanks to EigenLayer, itself a fairly recent protocol, which last year launched a novel “restaking” platform on Ethereum. EigenLayer has come up with a powerful mechanism for Web3 applications to inherit the strong security of Ethereum, which is backed by billions of dollars’ worth of “staked” capital. All told, EigenLayer has amassed more than $12.9 billion in capital, accounting for just over 1.5% of all ETH tokens in the world.
EigenLayer’s proposed restaking system provides a way for blockchain protocols to inherit the security of Ethereum’s proof-of-stake network, by enabling staked ETH deposits to be reused, or “restaked”. As such, dApps that utilize this mechanism won’t have to fight Ethereum itself for investor’s capital.
The idea has caught on like wildfire, and ETH has poured into EigenLayer because it offers better yields than traditional staking. However, investors also have the option to deposit funds in EigenLayer indirectly by going through third-party liquid restaking protocols, enabling them to use those tokens yet again elsewhere in the DeFi landscape.
The likes of Kelp DAO, Ether.Fi, Swell and Puffer Finance aim to simplify the process of restaking on EigenLayer and provide strong incentives to boost their appeal. When DeFi investors go through them, they can receive what’s known as a “liquid restaking token” or LRTs for their EigenLayer deposits, thereby maintaining liquidity. So they can continue trading with their LRTs even after they have restaked their Ethereum derivatives.
Another key draw of EigenLayer is the concept of “points”, which are given to users by EigenLayer in return for their deposits. These rewards are currently of little value, though its believed and hoped that in future they may entitle holders to token airdrops later on down the line. With the arrival of points, the DeFi industry has given birth to yet more platforms, like Pendle Finance and Kelp, which enable investors to leverage those assets further.
The Rise Of Restaking
The restaking industry emerged as a result of Ethereum’s switch to a proof-of-stake consensus mechanism a couple of years ago. With that move, Ethereum attracted billions of dollars in funds from more than 900,000 validators, and countless more delegates who back them. These people participate in the Ethereum network by locking up ETH in a smart contract as a deposit to ensure they act honestly as they help to maintain the security of the network.
With billions of dollars in ETH sitting idle, it wasn’t long before the ever-innovative DeFi world came up with a use for those locked-up tokens. Restaking services like Lido act as a kind of middleman, staking ETH tokens on behalf of users and giving them back a kind of receipt token, called stETH in the case of Lido. Those derivative tokens earn interest the same as regular staked ETH does, and they can also be reused in various DeFi protocols, enabling investors to effectively double their yields
Lido has become incredibly successful, with more than $23.7 billion in TVL at the time of writing. Its stETH token often achieves trading volumes that exceed those of the original ETH on some of the biggest decentralized exchanges, borrowing and lending platforms.
Liquid Restaking Is Born
With liquid restaking, the same thing is happening again. With EigenLayer, investors can reinvent their deposits for a third time, once again increasing their rewards potential. EigenLayer is building a system that will enable other protocols to bootstrap using Ethereum’s security. When users stake their stETH tokens on EigenLayer, those assets are used to provide security for “actively validated services”, or AVSs built on EigenLayer.
While none of those AVSs are up and running yet, they will eventually include the Layer-1 blockchain Celo, a bridge infrastructure project called Omni, and EigenDA, which is EigenLayer’s very own data availability layer.
Because none of EigenLayer’s AVSs are up and running yet, depositors cannot yet earn interest for securing them. So what EigenLayer does instead is reward them with points, which are likely to represent some kind of reward in future – probably through some kind of token airdrop.
The liquid restaking protocols add in an extra incentive, giving users LRT tokens that can be deposited elsewhere, so restakers in effect can maintain their liquidity while earning those EigenLayer points.
As an example, Kelp DAO provides depositors with its native rsETH tokens, which can be redeemed at any time. Puffer Finance gives users pufETH tokens, while Ether.Fi distributes ETHFI to its investors.
Some liquid restaking protocols go even further. For instance, Pendle Finance splits liquid staking tokens into two separate tokens and gives them both to investors. It offers yield tokens and principal tokens, unlocking leveraged trading opportunities.
Meanwhile, Kelp DAO has come up with another clever incentive in the shape of its KEP tokens, which are minted and given to depositors in lieu of the EigenLayer points they would normally earn if they restaked directly.
KEP provides users with a way to trade those EigenLayer points and leverage them in borrowing and lending protocols, adding up to a fourth incentive. Investors can earn ETH yield, restaking yield and liquid restaking yield and then take their KEP elsewhere to earn even more rewards through another DeFi protocol.
Reasons To Be Wary
From the sounds of it, the ability to earn four separate yields on a single investment sounds insane, and there are many who believe that the entire liquid restaking movement is incredibly risky and speculative, and there are good reasons why they think that way.
EigenLayer’s main offering hasn’t even gone live yet, and there is a danger that its AVSs might not pay out the kinds of rewards investors are hoping for. If that happens, it’s likely that many will flee EigenLayer’s ecosystem in favor of more alluring protocols.
There’s also the risk that the EigenLayer points might ultimately flop. The planned airdrops have not yet been confirmed, and there is a danger that they might never happen. Alternatively, the airdropped tokens could well be flops – if that happens, the points would rapidly lose whatever speculative value they currently have. What’s even more dangerous is that EigenLayer’s points system lacks transparency as it’s not based on the blockchain, so there’s no way for anyone to track how many points are in circulation.
Some say the speculation around liquid restaking is similar to the yield farming boom that occurred during the last DeFi summer in 2021. At that time, billions of dollars of tokens flooded into protocols like Terra and Olympus, which promised incredible yields to investors, but ultimately fell flat on their faces.
A Game-Changer For DeFi?
Despite these very real concerns, proponents of liquid restaking believe that the current boom is built on more stable foundations, as EigenLayer has the potential to support an entirely new generation of blockchain networks and dApps with far greater security.
By enhancing liquidity, improving capital efficiency and unlocking new opportunities for investors, liquid restaking promises to be a powerful mechanism that will reinforce the value of the overall DeFi ecosystem.
The entire industry will be watching the progress of EigenLayer very closely, and if its proposed system works as it should, we might see an explosion of interest in liquid restaking that’s far bigger than what has occurred so far.