Written by: Bai Ding & Jomosis, Geekweb3
Editor: Faust
Introduction: Restaking and Layer2 are important narratives of the Ethereum ecosystem in this cycle. Both aim to solve existing problems of Ethereum, but the specific paths are different. Compared with ZK, fraud proof and other technical means with extremely complex underlying details, Restaking is more about empowering downstream projects in terms of economic security. It seems to just ask people to pledge assets and get rewards, but its principle is by no means as simple as imagined.
It can be said that Restaking is like a double-edged sword. While empowering the Ethereum ecosystem, it also brings huge hidden dangers. Currently, people have different opinions on Restaking. Some say that it has brought innovation and liquidity to Ethereum, while others say that it is too utilitarian and is accelerating the collapse of the crypto market.
There is no doubt that to determine whether Restaking is a panacea or a poison to quench thirst, only by figuring out what it is doing, why it is doing it, and how it is doing it can we draw an objective and clear conclusion, which is also of great reference significance for determining the value of its token.
When it comes to Restaking, Eigenlayer is an inevitable case. If you understand what Eigenlayer is doing, you will understand what Restaking is doing. This article will take Eigenlayer as an example, introduce Eigenlayer's business logic and technical implementation in the clearest and most understandable language, and analyze the impact of Restaking on the Ethereum ecosystem in terms of technology and economy, as well as its significance to the entire Web3.
Restaking and related terms explained
As we all know, Restaking means "re-staking". It was first rooted in the Ethereum ecosystem and became popular after Ethereum transformed into POS in 2022. What is "re-staking"? Let's first introduce the background of Restaking, namely PoS, LSD, and Restaking, so that we can have a clearer positioning of Restaking.
1. POS (Proof of Stake)
Proof of Stake, also known as "proof of equity", is a mechanism that probabilistically distributes bookkeeping rights according to the amount of assets pledged. Unlike POW, which distributes bookkeeping rights according to the computing power of network participants, it is generally believed that POW is more decentralized and closer to Permissionless than POS.
The Paris upgrade was launched on September 15, 2022, and Ethereum officially transitioned from POW to POS, completing the merger of the mainnet and beacon chain. The Shanghai upgrade in April 2023 allowed POS stakers to redeem their assets, confirming the maturity of the Staking model.
2. LSD (Liquidity Staking Derivatives Protocol)
As we all know, the interest rate of Ethereum PoS staking mining is quite attractive, but it is difficult for retail investors to obtain this part of the income. In addition to the requirements for hardware equipment, there are two reasons:
First, the Validator’s staked assets must be 32 ETH or multiples thereof. This huge amount of assets is beyond the reach of retail investors.
Second, before the Shanghai upgrade in April 2023, users’ pledged assets could not be withdrawn, and the efficiency of fund utilization was too low.
In response to these two problems, Lido was born. The staking model it adopts is joint staking, that is, "group staking, profit sharing", where users deposit their ETH on the Lido platform, which aggregates it as the asset to be staked when running Ethereum Validator, thus solving the pain point of insufficient funds for retail investors.
Secondly, when users pledge their ETH on Lido, they will exchange it for stETH tokens anchored to ETH at a 1:1 ratio. Not only can stETH be exchanged for ETH at any time, but it can also be used as a token equivalent to ETH, and participate in various financial activities as a derivative token of ETH on mainstream DeFi platforms such as Uniswap and Compound, which solves the pain point of low capital utilization of POS Ethereum.
Since POS uses highly liquid assets as collateral for mining, products such as Lido are called "Liquid Staking Derivatives", or "LSD". For example, stETH mentioned above is called a Liquid Stake Token, or "LST".
It is not difficult to find that the ETH pledged to the PoS protocol is the real native asset, which is real money, while LST such as stETH is generated out of thin air, which is equivalent to stETH borrowing the value of ETH to directly print one more copy of money, and one copy becomes two copies, which can be understood as the so-called "fiscal leverage" in economics. The role of fiscal leverage in the entire economic ecology is not simply good or bad, and it must be analyzed in combination with the cycle and environment. What needs to be remembered here is that LSD adds the first layer of leverage to the ETH ecology.
3. Restaking
Restaking, as the name suggests, is to use LST tokens as pledged assets to participate in more staking activities of POS networks/public chains to obtain returns, while helping more POS networks improve security.
After staking LST assets, a 1:1 staking certificate will be obtained for circulation, which is called LRT (Liquid Restaking Token). For example, if you pledge stETH, you can get rstETH, which can also be used to participate in DeFi and other on-chain activities.
In other words, the LST tokens such as stETH generated out of thin air in LSD are pledged once again, and a new asset is generated out of thin air, namely the LRT asset that appears after Restaking, adding a second layer of leverage to the ETH ecosystem.
The above is the background of the Restaking track. After reading this, there will definitely be a question: the more leverage, the more unstable the economic system. The LSD layer is understandable, which solves the problem that retail investors cannot participate in POS and improves the efficiency of capital utilization. But what is the necessity of the Restaking layer of leverage? Why do we need to pledge the LST that was generated out of thin air again?
This involves both technical and economic aspects. To address this issue, the following article will briefly review the technical structure of Eigenlayer, analyze the economic impact of the Restaking track, and finally conduct a comprehensive evaluation of it from both technical and economic aspects.
(As of now, many English abbreviations have appeared in this article, among which LSD, LST, and LRT are core concepts and will be mentioned many times later. We can once again strengthen our memory: ETH staked by Ethereum POS is the native asset, stETH anchored to the staked ETH is LST, and rstETH obtained by re-staking stETH on the Restaking platform is LRT)
Eigenlayer Product Features
We must first clarify the core problem that EigenLayer wants to solve in terms of product functions: providing economic security from Ethereum for some underlying security POS-based platforms.
Ethereum has extremely high security due to its considerable asset pledge. However, if some services are executed off-chain, such as Rollup's sorter or Rollup's verification service, the parts executed off-chain are not controlled by Ethereum and cannot directly obtain Ethereum's security.
If they want to obtain sufficient security, they must build their own AVS (Actively Validated Services). AVS is a "middleware" that provides data or verification services for terminal products such as Defi, games, and wallets. Typical examples include "oracles" that provide data quotation services and "data availability layers" that can provide users with the latest data status in a stable manner.
But building a new AVS is quite difficult because:
1. The construction of a new AVS is very expensive and takes a long time.
2. The staking of new AVS often uses the project’s own native token, and the consensus of this type of token is far inferior to that of ETH.
3. Participating in the staking of the new network AVS will cause the stakers to miss out on the stable income of staking on the Ethereum chain, which will consume opportunity costs.
4. The security of the new AVS is much lower than that of the Ethereum network, and the economic cost of attack is very low.
The above problems can be solved if there is a platform that allows startup projects to directly rent economic security from Ethereum.
Eigenlayer is such a platform. The white paper of Eigenlayer is called “The Restaking Collective”, which has two major features: “Pooled Security” and “free market”.
In addition to ETH staking, EigenLayer collects Ethereum's staking certificates to form a security rental pool, attracting pledgers who want to earn extra income to re-stake, and then rents out the economic security provided by these pledged funds to some POS network projects. This is "Pooled Security".
Compared with the unstable APY in traditional DeFi systems that may change at any time, Eigenlayer uses smart contracts to clearly mark the staking income and penalty rules for pledgers to choose freely. The process of earning income is no longer an uncertain gamble, but an open and transparent market transaction. This is the "free market".
In this process, project owners can rent the security of Ethereum to avoid building AVS themselves, while stakers receive a stable APY. In other words, Eigenlayer not only improves the security of the ecosystem, but also provides benefits to users in the ecosystem.
The security process provided by Eigenlayer is completed by three roles:
Safe lender - Staker. Staker pledges funds to provide security. Safe intermediary - Operator. Operator is responsible for helping Staker manage funds and AVS perform tasks.
Secure receiver - AVS of middleware such as oracles.
(Photo source: Twitter @punk2898)
Someone has made a vivid metaphor for Eigenlayer: using shared bicycles to compare the upstream and downstream of Eigenlayer. Shared bicycle companies are equivalent to Eigenlayer, which provides market services for LSD and LRT assets, which is equivalent to shared bicycle companies managing bicycles. Bicycles are equivalent to LSD assets because they are all assets that can be rented. Riders are equivalent to middleware (AVS) that requires additional verification. Just like cyclists rent bicycles, AVS rents LSD and other assets to obtain network verification services to ensure its own safety.
In the shared bicycle model, deposits and breach of contract liability are required to constrain users to pay deposits to prevent malicious damage to vehicles, while Eigenlayer prevents Operators involved in verification from doing evil through pledge and penalty mechanisms.
EigenLayer interaction flow from the perspective of smart contracts
There are two core concepts of Eigenlayer’s security: staking and confiscation. Staking provides basic security for AVS, while confiscation increases the cost of any entity committing evil.
The interactive process of staking is shown in the figure below.
In Eigenlayer, the main contract that interacts with stakers is the TokenPool contract. There are two types of operations that stakers can perform through TokenPool:
Staking - Stakers can stake assets into the TokenPool contract and specify a specific Operator to manage the staked funds.
Redemption — Stakers can redeem assets from the TokenPool.
Staker redemption of funds goes through three steps:
1) Staker adds the redemption request to the request queue and needs to call the queueWithdrawal method.
2) Strategy Manager checks whether the Operator specified by Staker is in a frozen state.
3) If the Operator is not frozen (described in detail later), the Staker can initiate the complete withdrawal process.
It should be noted here that EigenLayer gives Stakers full freedom. Stakers can cash out the staked funds and transfer them back to their own accounts, or convert them into staked shares and re-stake them.
According to whether Staker can personally run node facilities to participate in the AVS network, Stakers can be divided into ordinary stakers and operators. Ordinary stakers provide POS assets for each AVS network, while Operators are responsible for managing the staked assets in the TokenPool and participating in different AVS networks to ensure the security of each AVS. This is actually a bit like Lido's routine.
Stakers and AVS are like separated security suppliers and demanders. Stakers often do not understand the products of AVS project owners, cannot trust them, or do not have the energy to directly run equipment to participate in the AVS network; similarly, AVS project owners often cannot directly reach Stakers. Although the two parties are in a supply and demand relationship, there is a lack of an intermediary to connect them. This is the role of Operators.
On the one hand, the Operator helps the stakers manage funds, and the stakers often have trust assumptions about the Operator. EigenLayer officially explains that this trust is similar to Staker staking on the LSD platform or Binance. On the other hand, the Operator helps the AVS project to operate the node. If the Operator violates the restrictions, the malicious behavior will be slashed, making the cost of the malicious behavior far exceed the benefits of the malicious behavior. In this way, the AVS builds trust in the Operator. In this way, the Operator forms a trust intermediary between the stakers and AVS.
For an Operator to enter the Eigenlayer platform, it must first call the optIntoSlashing function of the Slasher contract to allow the Slasher contract to constrain/punish the Operator.
After that, the Operator needs to register through the Registery contract, which will call the relevant functions of the Service Manager, record the Operator's initial registration behavior, and finally transmit the message back to the Slasher contract. At this point, the Operator's initial registration is completed.
Next, let’s look at the contract design related to slashing. Among Restaker, Operator, and AVS, only Operator will be the direct target of slashing. As mentioned earlier, if Operator wants to join the Eigenlayer platform, it must register in the Slasher contract and authorize Slasher to perform slashing operations on Operator.
Of course, in addition to the Operator, the slashing process also involves several other roles:
1. AVS: When the Operator accepts the AVS operation commission, it must also accept the slashing trigger conditions and slashing standards proposed by AVS. Two important contract components should be emphasized here: dispute resolution contract and slasher contract.
The Dispute resolution contract is set up to resolve disputes among challengers. The Slasher contract will freeze the Operator and perform slashing operations after the challenge window period ends.
2. Challenger: Anyone who joins the Eigenlayer platform can become a challenger. If they believe that an Operator’s behavior has triggered the penalty conditions, they will start a fraud proof process similar to OP.
3. Staker: The penalty imposed on the Operator will also cause the corresponding Staker to suffer losses.
The execution process of penalty for Operator is as follows:
1) The challenger calls the challenge function in the Dispute Resolution contract established by AVS to initiate a challenge;
2) If the challenge is successful, the DisputeResolution contract will call the freezeOperator function of the ServiceManager, causing the Slasher Contract to trigger the OperatorFrozen event, changing the state of the specified Operator from unfrozen to frozen, and then entering the slashing process. If the challenge fails, the Challenger will be punished to prevent malicious challenges to the Operator.
3) After the slashing process is completed, the Operator’s status will be reset to unfrozen and continue to operate.
During the execution of the slashing operation, the Operator is always in a frozen "inactive state". In this state, the Operator cannot manage the funds staked by the staker, and the stakers who choose to stake their funds to this Operator cannot withdraw their funds. This is like a person who has committed a crime and must be punished, and cannot be allowed to go unpunished. Only when the current punishment or conflict is resolved and the Operator is not frozen by the Slasher, can new interactions be carried out.
Eigenlayer contracts all follow the above freezing principle. When a staker pledges funds to an operator, the operator's status will be checked through the isFrozen() function; when the staker initiates a request to redeem the deposit, the Slasher contract's isFrozen function will still be used to check the operator's status. This is Eigenlayer's full protection of AVS security and Staker interests.
Finally, it should be noted that AVS in Eigenlayer does not unconditionally obtain the security of Ethereum. Although the process of obtaining security on Eigenlayer is much simpler than building AVS by itself, how to attract Operators on Eigenlayer to provide services and attract more pledgers to provide assets for their own POS system is still a problem, which may require hard work on APY.
The economic impact of restaking on the crypto market
There is no doubt that Restaking is one of the hottest narratives in the current Ethereum ecosystem, and Ethereum occupies half of Web3. In addition, various Restaking projects have gathered extremely high TVL, which has a significant impact on the crypto market and may last for the entire cycle. We can analyze it from both micro and macro perspectives.
Micro-influence
We must recognize that Restaking has more than one impact on the various roles in the Ethereum ecosystem, and it brings both benefits and risks. The benefits can be divided into the following points:
(1) Restaking does enhance the underlying security of downstream projects in the Ethereum ecosystem, which is beneficial to the long-term construction and development of the latter;
(2) Restaking liberates the liquidity of ETH and LST, making the economic circulation of the ETH ecosystem smoother and more prosperous;
(3) The high yield of Restaking attracts ETH and LST to stake, reducing the active circulation, which is beneficial to the token price;
(4) The high yield of Restaking has also attracted more funds into the Ethereum ecosystem.
At the same time, Restaking also brings huge risks:
(1) In restaking, an IOU (financial claim) is used as collateral in multiple projects. If there is no proper coordination mechanism between these projects, the value of the IOU may be over-magnified, thereby causing credit risk. If at a certain moment, multiple projects simultaneously demand the redemption of the same IOU, then this IOU cannot meet the redemption requirements of all projects. In this case, if one of the projects has problems, it may trigger a chain reaction and affect the economic security of other projects.
(2) A considerable portion of LST liquidity is locked. If the price of LST fluctuates more than ETH and the staking users are unable to withdraw LST in time, they may suffer financial losses. At the same time, the security of AVS also comes from TVL. The high volatility of LST prices will also pose a risk to the security of AVS.
(3) The staked funds of the Restaking project are ultimately stored in the smart contract. The amount is very large, which leads to excessive concentration of funds. If the contract is attacked, huge losses will occur.
Microeconomic risks can be mitigated by adjusting parameters, changing rules, etc., but due to space limitations, we will not elaborate on this here.
Macro Impact
First of all, it should be emphasized that the essence of Restaking is a kind of multiple leverage. The crypto market is very obviously affected by cycles. If you want to understand the macro impact of Restaking on the crypto field, you must first understand the relationship between leverage and cycles. Restaking adds two layers of leverage to the ETH ecosystem, as mentioned above:
First layer: LSD doubles the value of pledged ETH assets and their derivatives out of thin air.
The second layer: Restaking is not all ETH, but also LST and LP Token. LST and LP Token are voucher tokens, not real ETH.
The LRT generated by Restaking is an asset built on leverage, which is equivalent to the second layer of leverage.
So is leverage beneficial or harmful to an economic system? Let me first state the conclusion: leverage must be discussed in a cycle. In an upward range, leverage will accelerate development; in a downward range, leverage will accelerate collapse.
The development of social economy is as shown in the above figure. If the price rises for a long time, it will fall, and if the price falls for a long time, it will rise. One rise and one fall is a cycle. The total economic volume will spiral upward in this cycle. The bottom of each cycle will be higher than the previous one, and the overall total volume will also increase. The current cycle of the crypto market is very obvious. It is in the four-year halving period of Bitcoin. In the first 2-3 years after the halving, it is likely to be in a bull market, and the next 1-2 years are often in a bear market.
However, although the Bitcoin halving cycle is roughly the same as the bull-bear cycle of the crypto economy, the former is not the root cause of the latter. What really causes the bull-bear cycle of the crypto economy is the accumulation and collapse of leverage in this market. The Bitcoin halving is just an inducement for funds to flow into the crypto market and leverage to appear.
What is the process of leverage accumulation and rupture leading to the replacement of crypto market cycles? If everyone knows that leverage will definitely break, why do we need to add leverage when it is going up? In fact, the underlying laws of the crypto market and the traditional economy are the same. We might as well look for laws from the development of the real economy. In the development of the modern economic system, leverage will definitely appear and must appear.
The fundamental reason is that in the upward range, the development of social productivity has led to too fast material accumulation, and if the overly abundant products are to circulate in the economic system, there must be enough currency. Currency can be increased, but it cannot be increased arbitrarily and infinitely, otherwise the economic order will collapse. However, if the amount of currency is difficult to meet the circulation required after the material surplus, it will easily lead to stagnation of economic growth. What should we do at this time?
Since it is not possible to issue unlimited new bonds, we must improve the utilization rate of unit funds in the economic system. The role of leverage is to improve the utilization rate of unit funds. Here is an example: suppose $1 million can buy a house, $100,000 can buy a car, and the house can be mortgaged for loans, and the mortgage rate is 60%, which means that you can borrow $600,000 by mortgaging the house. If you have $1 million, without leverage and without borrowing, you can only choose to buy 1 house or 10 cars;
If there is leverage and borrowing is allowed, you can buy a house and 6 cars. In this way, can your $1 million be spent as $1.6 million? From the perspective of the entire economic system, if there is no leverage, the currency circulation is limited, everyone's consumption capacity is curbed, the market demand cannot grow rapidly, and the supply side will naturally not have too high profits, so productivity will not develop so fast or even decline;
With the addition of leverage, the problem of currency volume and consumption capacity is quickly solved. Therefore, in the upward range, leverage will accelerate the development of the entire economy. Some people will say, isn't this a bubble? It's okay. In the upward range, a large amount of off-market funds and commodities will flow into the market, and there is no risk of the bubble bursting at this time. This is similar to when we use contracts to long, there is often no risk of liquidation when the price of the currency rises in the bull market.
What about in the downward range? The funds in the economic system are constantly absorbed by leverage, and there will be a day when they will be exhausted, and then it will enter the downward range. In the downward range, prices will fall, so the mortgaged house will not be worth $1 million, and your mortgaged property will be liquidated. From the perspective of the entire economic system, everyone's assets are facing liquidation. The capital circulation that originally relied on leverage suddenly shrinks, and the economic system will decline rapidly. Let's still use the contract as an example. If you don't open a contract and only play spot, the price of the currency will fall in the bear market, and the assets will only shrink; and if the contract is opened and the position is liquidated, it is not just the shrinkage of assets, but a direct return to zero. So in the downward range, leverage will definitely collapse faster than without leverage.
From a macro perspective, even if it will eventually break, the emergence of leverage is inevitable; secondly, leverage is not entirely good, nor is it entirely bad, it depends on which cycle it is in. Back to the macro impact of Restaking, leverage within the ETH ecosystem plays a very important role in leveraging the bull-bear cycle, and its emergence is inevitable. In each cycle, leverage will definitely appear in the market in some form. The so-called DeFi Summer in the last cycle was essentially the second pool mining of LP Tokens, which greatly contributed to the bull market in 2021, and the catalyst for this round of bull market may have become Restaking. Although the mechanisms seem different, the economic essence is exactly the same. Leverage is used to digest the large amount of funds pouring into the market and meet the demand for currency circulation.
According to the above explanation of the interaction between leverage and cycle, multi-layer leverage such as Restaking may cause this round of bull market to rise faster and reach a higher peak, while also causing this round of bear market to fall more sharply, resulting in a wider chain reaction and greater impact.
Summarize
Restaking is a secondary derivative of the PoS mechanism. Technically, Eigenlayer uses the value of restaking to maintain the economic security of AVS, and uses the mechanism of pledge and confiscation to achieve "borrowing and repaying, and borrowing again is not difficult." The window period for redeeming pledged funds not only leaves enough time to check the reliability of Operator behavior, but also avoids the collapse of the market and system caused by the withdrawal of a large amount of funds in a short period of time;
As for the impact on the market, we need to analyze it from both macro and micro perspectives: From a micro perspective, while Restaking provides liquidity and returns to the Ethereum ecosystem, it also brings some risks, which can be mitigated by adjusting parameters, changing rules, etc.; From a macro perspective, Restaking is essentially a multi-layer leverage, which has exacerbated the overall economic evolution of cryptocurrencies within the cycle, created a large bubble, and made the upward and downward movements of cryptocurrencies more rapid and intense, and it is very likely to become an important reason for the leverage rupture of this cycle and the transition to a bear market. Moreover, this macroeconomic impact conforms to the underlying economic laws and cannot be changed, but can only be followed.
We need to understand the impact of Restaking on the entire crypto space, and take advantage of the dividends it brings in the upward range, and be prepared for leverage collapse and market downturn in the downward cycle.
