Revisiting and re-pledging How does EigenLayer initiate the profit flywheel?

Revisiting the Profit Flywheel How EigenLayer Initiates the Cycle of Success

Author: Siddharth Rao, IOSG Ventures

“Re-Staking” Section

Introduction to EigenLayer

About a year ago, EigenLayer embarked on a new journey to help the cybersecurity understanding of a new paradigm. The concept of “re-staking” was born. In a nutshell, ETH validators can now secure multiple networks, including foundational layers like DA layer, computational networks, as well as middleware like shared sequencers. Essentially, any network needs some form of consensus without the need for a security deposit. These networks are called Actively Validated Services (AVS) on EigenLayer.

Without EigenLayer, any operator wanting to run a system like DA would need to invest in hardware and initial stakes. This forces projects requiring a validator set to issue tokens at very high (sometimes unreasonable) valuations to incentivize high inflation rewards. This can lead to massive speculation and be detrimental to validator operators.

Admittedly, there is a risk of leveraged liquidation for single operators, but there are always well-performing validators looking to gain some extra earnings.

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EigenLayer allows for local re-staking of Ethereum by creating EigenPods or using liquid staking tokens (LSTs) such as stETH, rETH, and cbETH, to secure the AVS network. Anyone holding LSTs effectively becomes a contributor to Ethereum’s security and decentralization and earns rewards from the Ethereum network. Further staking of LSTs provides security to AVS networks in exchange for AVS rewards. Therefore, LST re-stakers are eligible for network rewards (operational fees deducted).

If staking and re-staking are beneficial, why is it liquid?

If you believe in liquid staking for Ethereum, then you also appreciate liquid re-staking. Ethereum’s liquid staking involves two parties: Lido and retail participants. Retail participants may say, “I don’t have enough ETH, hardware, or even time to operate a validator, but I want to maximize my ETH earnings.” Staking companies would respond, “I can help you with that; I will take a portion of the rewards as operational fees, and we’ll do it in a fully transparent manner.”

This eliminates five expenses for the public: hardware costs, hardware maintenance, time, energy, and mental space.

For EigenLayer, in addition to the aforementioned costs, there are additional delegating expenses. In Ethereum, each node operated by an operator is “interchangeable,” meaning the network treats each node as the same whether it runs on bare-metal infrastructure, the cloud, or elsewhere.

For EigenLayer, there is a network that secures other networks, and each operator in the network can choose which other networks it wants to validate. This essentially means that there are no two identical operators. Therefore, experienced teams or associations wisely choose operators with good strategies to address retail participants’ concerns.

“Liquidity” Section

There are opportunities throughout the year to earn ETH returns higher than any staking protocol on Ethereum.

If you’re focused solely on returns, there are approximately 1748 ways to earn higher returns on your ETH.

The real value lies in the nearly “risk-free” yield, which means the lowest-risk ways to earn ETH. For liquid tokens, the lower the risk, the greater the likelihood of LST being listed on other protocols, the stronger the composition, and the greater the demand for LST. It all starts with trust, which is the lowest risk.

For LST, risk assessment isn’t so difficult. You have operator risk (operator shutting down validators, operator quality, hardware quality, etc.) and network risk (smart contract risk). The consensus mechanism for all risks is the same, and the minimum hardware requirements are the same for all operators.

In re-staking, there are more factors to consider, including hardware requirements (if expansion is needed), AVS security audit, real-world testing of the new consensus mechanism, AVS’s own economic model, and the types of supporters (investors, partners, etc.) that AVS has, among other minor factors, such as the types of supporters AVS has (investors, partners, etc.). There are 32,767 possible strategies from just the 15 AVS running on EigenLayer. We can’t expect retail investors to make educated decisions.

Retail participants won’t do this, and if they simply mimic any operator’s strategy and get slashed, trust will be lost, which will affect network liquidity. If operators launch their own LST, it will result in excessive fragmentation or excessive staking concentration in the early stages. Even if multiple operators use the same strategy, but with different Liquid “re-staking” tokens (LRTs), it will lead to unnecessary fragmentation. A unified strategy and decentralized operators with a common LRT are critical to EigenLayer’s success.

This ensures a “lowest-risk” positive feedback loop, which can be seen as:

Best Risk Management → More Liquidity → More Whitelisting → More Usage → More Liquidity → More Popular → Lowest Risk

The reason it’s the lowest risk is because losing 1 ETH from being slashed from 100,000 validators is much less risky than losing 1 ETH from 1 validator. That’s why people still choose to stake with Lido. Lido recently experienced a slashing event where over 20 validators were slashed about 1.1 ETH each (approximately 20 ETH in total). While their infrastructure partner took on the losses, it’s negligible compared to Lido’s 8.83 million staked ETH. This demonstrates the importance of having trusted partners.

How does Liquid Re-staking work?

Users send their LSTs/ETH to the funding pool contract of the Liquid Re-staking platform. Re-stakers will receive an equivalent amount of LRT (Liquid Re-staking Tokens). The contract then distributes these tokens to the strategy management contracts within the EigenLayer protocol. The strategy management contracts delegate these tokens to node operators and ensure they adhere to the strategy. The governance of LRT can choose specific strategies. The operators validate the underlying AVS and retain a portion of the rewards. The rest is then transferred to the LRT protocol, which extracts a portion and ultimately distributes the remaining rewards to the re-stakers. This is clearly more extractive than LST (Liquid Staking Tokens), but it requires more resources in terms of work and maintenance.

How attractive is the yield?

We do not know how the AVS (Active Verification Services) incentive will be allocated, nor do we have a clear understanding of how each consensus mechanism will operate. However, based on some basic mathematical calculations, here are several scenarios that provide a reference for calculating EigenLayer’s yield.

In considering the case of FDV (Fully Diluted Valuation), using the last known FDV data of reference projects, project tokens may launch at higher valuations, making the yield significantly more attractive. As a conservative estimate, we assume that the FDV values of all partners announced on the EigenLayer ecosystem page are the valuations of their last funding round. As of October 19th, Eigen Layer’s TVL (Total Value Locked) is approximately 172k ETH, and Lido’s base yield is around 3%. According to our calculations, there is approximately $62 million in emissions (both affected by TGE price and emissions, which are conservative figures, i.e., 2.5% of token supply and FDV), roughly equivalent to an average enhanced APY yield of 9%, potentially totaling 12%.

In a more aggressive scenario, Boosted’s yield APY could reach 15%. Of course, these are based on assumptions and if you want a more in-depth calculation, you can DM me on Twitter (@Rao_Sidd).

The LRT Ecosystem

• Ion Protocol: A lending protocol that allows borrowing assets using LSTs and LRTs;
• Renzo: A platform dedicated to liquid re-staking. It accepts all EL LSTs (EigenLayer Liquid Staking Tokens) and ETH in exchange for their LRT ezETH (Liquid Restaking Token ezETH);
• Rio: A platform dedicated to liquid re-staking. It accepts all EL LSTs and ETH in exchange for the platform’s LRT reETH;
• Puffer Finance: An LRT protocol based on DVT;
• Inception LRT: A focus on ensuring L2s’ security with their LRT protocol;
• Swell: An LST protocol that is also creating its own LRT. Swell’s LSTs are also listed as candidates for the EigenLayer re-staking JokerAce competition;
• Stader Labs: Stader Labs also has its own LST ETHx and is creating its own LRT;
• Genesis LRT: Provides customized LRTs that allow each client to create their own LRT based on their desired risk configuration, mainly targeting large clients and institutions entering this field;
• Astrid Finance: Uses the rebase model, where users receive rstETH, rrETH, or rcbETH based on what they have staked in the funding pool and their balance. As rewards accumulate, the user’s balance adjusts automatically;
• KelpDAO: Similar model to Renzo and Rio;
• Ether.Fi: Allows users to deposit only ETH into the funding pool in exchange for the platform’s LRT eETH.

How might the future space evolve?

In this space, to become a true winner, it all starts with establishing the highest level of trust. LRTs will also follow the same positive feedback loop as LST. Risk management is the most important factor in attracting re-stakers, liquidity providers, and partners.

At some point in the future (timeline uncertain), the returns may be slightly higher than those of ETH, but this will depend on the design and utilization of the underlying AVS economic model. The use of AVS, or the lowest-risk return option for users on Ethereum, is a combination of Ethereum’s consensus rewards and AVS yield.

Mantle recently staked 40,000 ETH from BitDAO funds to Lido, which means they will receive a significant amount of stETH in the foreseeable future, potentially listing it on Mantle and re-staking some on EigenLayer (when the supply cap for LST increases). For example, if Mantle chooses to use EigenDA as the DA layer, they will heavily lean towards the lowest-risk strategy, as these AVS support Mantle’s overall strategy and goals while safeguarding the treasury.

Mantle can also incentivize the use of their platform’s LST: mntETH and create corresponding LRTs (liquidity re-staking tokens). This will help Mantle effectively utilize its funds while ensuring the safety of their committed DA layer. The fees earned can be given back to their users as gas rewards.

Due to the competitive environment, power law will play a role (market competition tends to favor a “winner takes all” pattern), and the top 1-2 protocols may eventually control 80-90% of the market. I believe only protocols fully focused on developing this market have a chance to come out on top since it requires highly concentrated investment. There is also a possibility that some large LST protocols may integrate upward into the supply chain, similar to Swell, but currently, there are no further signs of this.

The availability of LRT protocols on the first day of the market is also crucial. Retail market trust primarily comes from TVL (Total Value Locked). Projects that can attract substantial TVL on the first or second day of EigenLayer’s launch may become leaders in the foreseeable future.

There will always be people pursuing high returns, especially high-risk investors. With wider adoption of LRT protocols, there will be more DeFi integrations, unlocking many strategies exponentially, or creating a positive flywheel effect.

We believe that over time, all operators will choose to use more similar strategies and obtain the lowest returns. This will primarily depend on the new and old designs of the underlying AVS and its economic model. To avoid too much control by LST whales and liquidity staking protocols over EigenLayer, there is control at the protocol level. If re-staking returns become less risky, liquidity staking protocols will become power centers within the Ethereum ecosystem. This can be mitigated by early adoption of a version of “Governance Proof” from Jon Charbonneau’s concept.

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