Restaking ETH via EigenLayer
Key Takeaways:
- This strategy fits the profile of an investor who is willing to take risk in exchange for a greater reward for entering a brand new ETH primitive.
- The strategy makes use of EigenLayer, a new protocol built on Ethereum that introduces restaking, a new primitive in cryptoeconomic security. This primitive enables the reuse of ETH on the consensus layer (project continuity risk).
- The strategy is fairly simple: staked ETH (e.g. stETH) are restaked into EigenLayer and used to provide security to other protocols.
- The Yield (APY) is composed of - Staking ETH (secure the Ethereum PoS consensus mechanism), Stage 1 - Restaking ETH (reuse the staked ETH to provide security to other protocols), Stage 2 (happening in Q1 2024).
- Because of the number of protocols involved smart contract risk is not to be ignored: exploit in one of the protocols would impact the entire strategy (tech risk).
- A lockup period of 270 days is present and rewards are paid out at the end of the period (ETH liquidity risk). For this reason, investors will not be able to quickly adjust to any changes of market conditions.
- Staking and restaking subject to very specific risks, namely slashing. On the restaking side during the process, ETH tokens are subject to slashing conditions imposed by the other protocol, as well as Ethereum.
- Risk Checklist: in our view the predominant risks for this strategy are - Tech risk - Project continuity risk - Complexity risk - ETH liquidity risk - Staking and restaking risks
1. Strategy Explained
What is staking and what is restaking?
Staking is the process of validators confirming transactions in a proof-of-stake consensus blockchains. Restaking is EigenLayer’s revolutionary idea that allows these validators to opt-in to transaction mining for other applications / middleware (e.g. oracles and bridges). To put it simply, restaking allows users to stake the same ETH on both Ethereum and on other protocols, securing all of these networks simultaneously. Hence, restaking allows for leverage of existing trust networks.
In simpler words: what the protocol does could be seen as the equivalent of rehypothecation in traditional finance: re-using previously pledged collateral as the collateral for a new loan.
When restaking, investors take on a new set of slashing conditions (i.e. risk). In exchange, ETH restakers can receive additional rewards to supplement their traditional staking yields.
What is EigenLayer
EigenLayer is a middleware that is built on the Ethereum network, which lets protocols that integrate with it leverage Ethereum’s highly secure trust network without needing to establish its own validator set.
This means that protocols can integrate EigenLayer to leverage Ethereum's underlying security by ‘renting’ it. This is achieved by allowing ETH stakers to restake their ETH to secure these protocols.
The goal of EigenLayer is to create a much more robust blockchain ecosystem, with the bulk of protocols being highly secure.
Why does this matter?
Stakers provide security to the protocol. Before EigenLayer, providing proper security was one of the biggest hurdles to overcome for new blockchains. Even if successful, the security is only as strong as the number of validators.
EigenLayer is presents itself as a win-win protocol for Ethereum ecosystem:
- On one hand, you have stakers who can now earn extra rewards on their ETH
- On the other, you have projects who can now rent Ethereum’s security at a fraction of the cost
How will the strategy work?
With this first vault, ETH will be deployed on to the EigenLayer smart contract. In the first phase ETH will be held on the EigenLayer deposit address. The ETH will be turned into stETH and will earn Lido rewards. This would represent a floor to the strategy APY.
Once Stage 2 (expected in Q1 2024) is initiated, the staked ETH will be effectively restaked in order to provide security to other protocols/chains. From that moment, the restaking rewards will start..
Lockup period: 270 days.
2. Risks and Rewards
Protocol Risks
Trust Score
Developed by EigenLabs, EigenLayer is led by University of Washington professor Sreeram Kannan, with team members from AWS, Compound, ConsenSys, Facebook, Microsoft and Protocol Labs.
EigenLabs has raised ~$65 million from investors including Blockchain Capital, Polychain Capital, Ethereal Ventures, Electric Capital, Figment Capital, Coinbase Ventures and more.
SwissBorg trust score for Lido is ‘green’, i.e. the protocol is trustable.
Tech risk is set to 3/10.
Project Continuity Risk
Project continuity risk is medium.
EigenLayer app mainnet launch happened on June 14, 2023. That is, just a couple of weeks ago. This followed a successful completion of the Stage 1 Testnet for restaking functionality.
The stETH, rETH and cbETH pools have been filled within minutes and a total of over 14,000ETH is restaked in the protocols’ smart contracts.
The interest of the community is definitely there. The ‘restaking’ primitive is a breakthrough innovation in the crypto industry and EigenLayer has all the credentials to become a top player in this game.
The ‘restaking’ functionality is however not live. And won’t be active until Q4 2024.
For this reason we take a conservative stance stance and set the protocol continuity risk to medium.
Protocol continuity risk is 7/10.
Counterparty Risk
Counterparty risk is deemed low.
EigenLayer brings the advantages of the Proof-of-stake consensus mechanism to a next level by allowing staked tokens to be staked again to provide security to other networks/protocols.
The protocol is fully decentralised and its operations are all regulated by smart contracts.
With Proof-of-stake, participants referred to as “validators” lock up set amounts of cryptocurrency or crypto tokens—their stake, as it were—in a smart contract on the blockchain. In exchange, they get a chance to validate new transactions and earn a reward
Those validators, with the assets and rewards they hold, are fully transparent and always verifiable "on-chain".
With staking (and restaking), there is no counterparty but the network(s) itself. Validators are rewarded by operations automatically through preset ‘block reward’ rules, as well as through a share of transaction fees. In principle. there should be no risk of default or bank runs.
Counterparty risk is 1/10.
Liquidity Risk
Liquidity risk is deemed low.
Although a lockup period is present (see in the next section) once the unstaking of the restaked assets is initiated, tokens will be readily available and no liquidity constraints represent a foreseeable risk.
Liquidity risk is 2/10.
Strategy Risks
Complexity
Complexity of strategy is medium to high.
The strategy employs one chain (Ethereum), 2 main protocols and a not yet clear number of protocols (and services) whose security is guaranteed via staking ETH.
Restaking is not yet live so we conservatively set the complexity risk to medium/high.
Complexity of the strategy is 7/10.
Scalability
Scalability risk of strategy is low.
Staking is a highly scalable practice. Indeed, the more stakers (and restakers) are participating, the higher the safety of the blockchains/protocols involved.
Scalability risk of the strategy is 1/10.
Sustainability
Sustainability risk of strategy is medium.
The strategy generates yield via ETH staking in Lido (i.e. taking part in the Ethereum network Proof-of-Stake algorithm) and by restaking ETH.
APY from Lido staking is ‘real’.
As for the restaknig APY, it could also depend on protocol’s incentives employed to attract validators. This could create a trade-off between restakers and existing protocol participants (see the sections below): If too many rewards are given to restaking participants, it will impact the protocol’s tokenomics, causing existing participants to leave. Conversely, if rewards are too low, restaking participation may decrease - and so its security. Thus, each protocol needs to carefully consider how to distribute token rewards before introducing EigenLayer.
Sustainability risk of the strategy is set to 5/10.
Yield Risk
Yield risk of strategy is medium.
The strategy yield is at the time of writing unknown. This is because restaking has not started yet and we are thus not in a position to comment on the APY evolution.
Obviously the APY is floored at the Lido staking APY.
Yield risk of the strategy is conservatively set to 5/10.
Staking and restaking Risks
Risks associated with ETH restaking are to be considered high.
The Ethereum blockchain was initially built relying on a Proof-of-Work consensus mechanism, very similar to that of Bitcoin. It has switched on its Proof-of-Stake (PoS) mechanism in 2022 because it is more secure, less energy-intensive, and better for implementing new scaling solutions.
Ethereum PoS enables crypto investors to stake ETH in order to contribute to network security and decentralisation and earn an attractive yield for their staked tokens.
An important risk to be aware when staking ETH of is the possibility of losing your staked assets due to slashing. Slashing is a penalty enforced at the protocol level associated with a network or validator failure.
The main risk of restaking is obviously related to slashing for the staked (Lido) and restaked tokens. For Lido staking risks please refer to the ETH Lido strategy risk report.
During the restaking process, ETH tokens are subject to slashing conditions imposed by the other protocol, as well as Ethereum.
If a validator participating in the restaking process loses their staked ETH tokens due to the slashing conditions of another protocol, they will still lose their staked ETH tokens even if they have followed the Ethereum network’s rules.
Currently, if a validator on the Ethereum network engages in malicious behaviour, they may lose up to half of their staked 32 ETH tokens, up to a maximum of 16 ETH through slashing. EigenLayer allows slashing the remaining half.
Participating in restaking doubles the risk, but it also increases the total reward by receiving not only Ethereum block rewards but also rewards from other protocols.
We are aware of some operators that are likely to be involved in restaking with EigenLayer. Before restaking is enabled there will still be the option to opt out from the staking process (Stage 2) if the designated operators do not pass our due diligence criteria.
Under the non-restaknig scenarios tokens will remain locked and Lido staking rewards will nonetheless be received.
There are in principle several additional concerns about the use of EigenLayer.
- Users may be less motivated to use the native tokens of the protocols utilising EigenLayer. This is because users can participate in EigenLayer’s security and receive rewards by restaking ETH without needing the native tokens of other protocols. As a result, the tokenomics of the protocols using EigenLayer could be greatly affected.
- There is a concern regarding security incidents. If a significant portion of the ETH staked in the Ethereum network is employed for restaking in other protocols, a security breach in one of those protocols could potentially result in a significant amount of ETH being slashed. This could then cause a decrease in the security of the Ethereum network. To prevent this, a conservative approach should be taken when investigating and selecting protocols for restaking. Moreover, the conditions for slashing should not be overly severe. Preventive measures could include insurance pools or the implementation of delays before slashing, coupled with going through governance processes.
- There are greater centralization risks as ETH stakers redirect their withdrawal credentials to EigenLayer, which creates a systemic risk for the Ethereum network.
- The system's security design success relies heavily on a rebalancing algorithm that accurately accounts for validators and their security capacity and usage. If this mechanism fails, EigenLayer could expose itself to various attack vectors, replicating the vulnerabilities it sought to solve.
- The distribution of token rewards of the protocols using EigenLayer should be considered. When introducing EigenLayer, a protocol must distribute its native tokens as an incentive to both existing participants and restaking participants. If too many rewards are given to restaking participants, it will impact the protocol’s tokenomics, causing existing participants to leave. Conversely, if rewards are too low, restaking participation may decrease - and so its security. Thus, the protocol needs to carefully consider how to distribute token rewards before introducing EigenLayer.
- There are various concerns such as the risks associated with the unstaking period of restaking and the management of Ethereum staking in a restaked state. Therefore, it is necessary to observe how EigenLayer can address these issues.
- Last, there are several concerns, including the risks associated with the unbonding period for restaking and the management of stakes in Ethereum during the restaking process. Thus, it is crucial to monitor how EigenLayer can tackle these challenges.
Risks associated with restaking are set to 8/10.
Liquidity Risks of restaking
Liquidity Risk on staking ETH is high.
Restaking ETH in EigenLayer requires the investor to lock-up their ETH tokens for a period of 270 days. Regardless of the direction the market chooses during this time, your assets will be out of reach. This aspect needs to be carefully considered when entering this strategy.
Liquidity risk is therefore set to 8/10.
Worst-case scenarios
To help the investors assess the risks of this strategy we’ve tried to identify the negative scenarios that the strategy could face:
- Restaked ETHs experience a slashing event due to bad behaviour of a node operator or due to too strict slashing conditions on the staking protocols.
Part (or all) staked tokens are lost.
- The designated operators do not pass our due diligence criteria. As Stage 2 (restaking begins) approaches, we choose not to opt in (too risky). Tokens will remain locked and Lido staking rewards will nonetheless accrue.
- Stakers on EigenLayer opt into the highest yielding protocols to maximise their returns. This leads to a race to the top between protocols offering ever higher yields to attract capital. Such high yields are unsustainable and also create friction with protocol users (who get lower yields). Eventually this situation leads to the collapse of the protocols secured by EigenLayer, and eventually of EigeinLayer itself.
- For more ETH blockchain related issues please refer to the ‘Staking and staking risks’ section above.
3. Conclusions/Recommendations
EigenLayer represents an evolution of the concept of staking.
What the protocol does could be seen as the equivalent of rehypothecation in traditional finance: re-using previously pledged collateral as the collateral for a new loan.
When restaking, investors take on a new set of slashing conditions (i.e. risk). In exchange, ETH restakers can receive additional rewards to supplement their traditional staking yields.
The EigenLaye strategy in ETH comes with risks. The investment strategy is fairly simple but yet it requires some deep understanding of how staking works.
It does involve a 270-day locking period and rewards are paid out at the end of the period.
The SwissBorg Risk Team ranks ETH on EigenLayer as a Satellite investment, one for an investor with a very good understanding of staking and restaking, who is willing to take on extra risk in exchange for a very attractive reward on ETH.
