Source: ARK Invest
In 1997, Robert Greer proposed three asset classes in The Journal of Portfolio Management:
1. Capital assets: assets that can generate value/cash flow, such as stocks, bonds, etc.;
2. Consumable or convertible assets: can be consumed, burned or converted once, such as oil and coffee;
3. Store-of-value assets: Value persists in time/space and is scarce, such as gold and Bitcoin.
In 2019, David Hoffman pointed out here that Ethereum can serve as all three of the above assets at the same time: staked ETH as a capital asset, Gas as a consumable asset, and ETH locked in DeFi as a store of value asset.
Over the past five years, with the vigorous development of the Ethereum ecosystem, the utility of ETH has continued to expand - intuitively reflected in ETH as the unit of account for NFTs, as the Gas Token of Ethereum Layer2, the unit of account for MEV activities, as well as LST and DeFi derivatives built on LST, etc.
Recently, EigenLayer has used re-staking to extend the economic security of ETH to middleware and even other ecosystems such as Cosmos, further strengthening the network effect of ETH.
We briefly summarize them:
1. Staked or re-staked ETH, including liquid staking and re-staking tokens such as stETH and eETH, representing assets that can generate value/cash flow as capital assets;
2. ETH is the gas spent by Layer 1 and Layer 2, including the data availability cost of Rollup in Layer 1, the cost of verifying zero-knowledge proof, etc., which can be consumed and burned at one time, so it is regarded as a consumable asset;
3. ETH is used as a reserve asset in the DAO treasury of each protocol, as collateral for CeFi and DeFi, as an accounting unit and medium of exchange for NFT transactions, MEV supply chain pricing, and token trading pairs, and its value persists in time/space, making it a value storage asset.
Among them, staking is the core pillar of the Ethereum network. By allowing participants to lock ETH and participate in the verification process, staking provides a strong economic incentive for the network, transforming Ethereum into a more secure, efficient and sustainable blockchain platform, laying a solid foundation for its long-term development.
This article will provide a systematic report on the staking and re-staking space and its ecology, as well as the investment logic and opinions we have accumulated from our investment layout in this field.
1. Staking
1.1 Overview
The concept of "staking" was born before Ethereum. In 2012, in order to solve the problem of high energy consumption in Bitcoin mining, Peercoin first proposed Proof-of-Stake (PoS), in which staking is one of its key attributes.
In the context of Ethereum, generally speaking, staking refers to the process of locking 32 ETH on the Ethereum blockchain to run the validator software, thereby helping the Ethereum network verify transactions and maintain security, and obtaining a certain amount of ETH rewards.
Currently, the annualized return on Ethereum staking is approximately 3.24%, provided by the issuance of ETH, and other income may come from Tips and MEV income from the Ethereum network.
1.2 Four forms of pledge
1.2.1 Solo Staking
Source: ConsenSys
Ideally, since individual staking is self-managed and does not require payment of service fees to any third party, the returns are the highest. However, compared with professional staking services, individual staking may also result in missed rewards or fines due to disconnection or malicious behavior, and the returns may fluctuate due to operation and maintenance costs.
The percentage of solo stakers is an important indicator of Ethereum’s decentralization. According to a study conducted by Rated , as of the end of 2022, solo stakers accounted for approximately 6.5% of all Ethereum validators.
Although single staking is a key pillar of Ethereum's decentralization, it is difficult for single staking to become mainstream due to the capital requirement of 32 ETH and the operational threshold. With the development of Ethereum's staking, the following staking methods have emerged in the market.
1.2.2 Staking Service Provider
In order to meet the scale development of the staking track, staking service providers usually provide large-scale and professional staking services to institutional clients or high-net-worth individuals, and charge a certain percentage of fees based on the staking income (ranging from 5% to 10% depending on the scale of funds involved in the staking). Companies such as Kiln and Figment are representatives of staking service providers, and the staking assets supported by Kiln's technology exceed US$8.6 billion.
In addition to providing staking services for Ethereum, staking service providers also basically cover the staking business of other PoS chains and are also involved in the re-staking business.
In addition to the B2B business model, the B2B2C business model is also an important part of the revenue of these companies. For example, Kiln cooperates with mainstream wallets such as Ledger, Coinbase Wallet and Metamask to provide one-stop staking solutions for users of these wallets. Wallets provide distribution channels for staking service providers, while the latter provide infrastructure and services for the former, and the two share the revenue.
1.2.3 Staking on Centralized Exchanges
Centralized exchange staking is a staking service provided by various centralized exchanges to their users. This type of staking is custodial and requires almost no capital threshold, but the disadvantage is that the fees are usually high and opaque, and there are risks such as misappropriation of funds. Companies such as Coinbase and Binance are representatives of centralized exchange staking.
The proportion of staking on centralized exchanges has dropped from about 40% in 2021-2022 to 24.4% now. The reasons may be: first, after the collapse of FTX, users' trust in centralized, custodial solutions has declined; second, in February 2023, under regulatory pressure from the US SEC, Kraken announced the termination of staking services to US customers, causing users to worry about staking service providers in specific jurisdictions. Despite this, staking on centralized exchanges is still the second largest staking option after liquidity staking.
1.2.4 Liquid Staging (LST)
LST is an application of staking at the protocol and smart contract level. Protocols such as Lido collect ETH from users and outsource the business of running validators to third-party staking service providers, while charging fees .
The main feature of LST is that these protocols usually return 1 equivalent tokenized claim as a voucher to users (such as Lido's stETH), thereby freeing up liquidity. These vouchers can be roughly considered to be equivalent to ETH and can be used in multiple DeFi protocols to obtain additional returns. There is a risk of decoupling of LST's tokenized claims, but this risk has been reduced after the "Shanghai Upgrade" Ethereum activation withdrawal.
Lido currently holds the highest market share in LST, and its TVL is 12.9 times that of the second-ranked Rocket Pool. In addition to Lido, some differentiated products have also been derived.
1. For example, Rocket Pool allows anyone to run a validator for Rocket Pool’s stakers, with a total of 3,716 node operators, with better decentralization and capital efficiency compared to Lido’s professional staking service providers.
2. Institutions mainly consider three points when participating in staking: security, liquidity and compliance. Traditional institutions need to conduct due diligence on counterparty risks and complete a series of compliance processes such as KYC/AML. At present, unlicensed LSTs such as Lido cannot meet such needs. Alluvial, in conjunction with leading staking service providers such as Coinbase, launched the industry standard for LST: Liquid Collective to meet the compliance needs of institutions. It mainly provides "dedicated pools" that are fully compliant and meet KYC/AML requirements, which can better help traditional funds enter the Ethereum staking market.
Source: GSR, IOSG
The table above summarizes the foregoing.
1.3 Summary
a. Looking back at the development of the staking track, the emergence of LST not only solved the two major pain points of funds and operations mentioned above, but also further released liquidity. These three points are the primary reasons for Lido's success. The quality of liquidity is directly related to the user's psychological expectations and the degree of trust in the protocol. Lido had the best exit liquidity in the market before the "Shanghai Upgrade" activated withdrawals, which is also the main reason why Lido can attract new funds to participate in staking. When the competitive landscape of LST has been determined and fierce competition has begun between LRTs, Ether.fi has established a leading position in the market with a good liquidity pool, which also verifies this point.
b. Looking at the staking market, Lido has long been the leader with a market share of about 30%, and the head effect is quite obvious. Despite this, there are still some opportunities for differentiated products to perform in the market. For example, Liquid Collective's compliant staking solutions for more traditional institutional users; and the market opened up by the new narrative of re-staking - in fact, Ether.fi took advantage of the re-staking trend and quickly attracted funds in the short term. In the past 6 months, it has attracted 1.21 million ETH deposits, a growth rate of 288.1%, and has become the third largest staker of Ethereum, second only to Lido and Coinbase.
c. In addition to LST, we believe that staking service providers are also good investment categories. LST like Lido is essentially a middleman connecting node operators to end users, playing a role in distribution, and relying on node operators for actual operations and operations. Compared with running nodes by themselves, these node operators have scaled cost advantages and high-level service guarantees. Whether it is running nodes in cooperation with LST, re-staking agreements, etc., or helping wallet users participate in staking, node operators have a good ecological niche and a solid business model. In addition, as validators, these node operators are key checkpoints in the life cycle of on-chain transactions and have an important position. Pre-confirmation, which has recently appeared on the market, is one of the services that validators can provide.
2. Restaking
2.1 Overview
Source: ETH Restaking Dashboard by @blocklytics
Based on Ethereum staking, projects represented by EigenLayer have proposed re-staking, that is, the pledger makes a second pledge based on the original Ethereum staking exposure, promising to honestly provide economic security for the middleware and obtain corresponding benefits; at the same time , the re-staker needs to bear the risk of slashing the pledge exposure due to improper operation and other factors.
In terms of market size, EigenLayer surpassed Uniswap and AAVE shortly after the mainnet was launched, quickly becoming the second largest DeFi protocol after Lido. As of now, EigenLayer's TVL has reached 15.5 billion US dollars, three times that of Uniswap, with 19 AVS and 339 node operators running on the mainnet.
In addition to EigenLayer, Symbiotic, a re-pledge protocol supported by Lido and Paradigm, has also been launched. Symbiotic is a re-pledge solution supported by Lido and Paradigm. On the asset side, Symbiotic accepts any ERC-20 token or LP position as a re-pledge asset. As of now, Symbiotic's TVL has reached 1.2 billion US dollars, mainly composed of ETH-based LST and stablecoins.
This chapter will mainly discuss based on EigenLayer.
2.2 EigenLayer
To become a validator (node operator) of the middleware, you first need to invest money. In order to capture the value of tokens, validators are often required to pledge the native tokens of the middleware, which requires a certain marginal cost, and due to the volatility of token prices, there is uncertainty in their risk exposure, and even the loss caused by the decline of tokens may be far greater than the gains.
And the project party needs to maintain a certain token value, otherwise rational funds will move to other platforms or protocols with higher returns. Secondly, the security of the middleware depends on the overall value of the staked tokens; if the tokens plummet, the cost of attacking the network will also decrease. This problem is particularly prominent in the early stages of the project and when the token value is low.
For some dApps that rely on middleware (such as derivatives that require oracle price feeds), their security actually relies on the trust assumptions of both Ethereum and the middleware. This creates a barrel effect - the security of the system depends on the weak link in it.
These are the fundamental problems that EigenLayer aims to solve.
Source: EigenLayer, IOSG
EigenLayer solves the above problem by introducing re-staking: re-staking by existing Ethereum stakers means that there is no need to invest additional funds, but instead the existing ETH staked share is extended to the new protocol (of course, this introduces new risk exposure and assumptions), and the price of ETH is relatively stable, making the economic security based on ETH more reliable.
The project can adopt a dual staking model, that is, the validator simultaneously stakes the native token and ETH, which can avoid the death spiral caused by the price drop of a single token without sacrificing the utility of the token. At the same time, Ethereum's validators are more decentralized.
Source: IOSG
Structurally, EigenLayer is a three-party market:
AVS (Actively Validated Service). It refers to infrastructure such as cross-chain bridges and oracles. As a consumer of economic security, AVS is protected by economic security and pays re-stakers. Re-stakers. Re-stakers with ETH exposure can participate by transferring their stake withdrawal vouchers to the EigenLayer smart contract, or simply depositing LST (e.g. stETH). If a re-staker is unable to run an AVS node, they can delegate this task to an operator. Operators. AVS nodes are run by operators commissioned by re-stakers or provide verification services. Operators can choose which AVS to provide services for. Once they provide services to AVS, they must comply with the penalty rules set by AVS.
Source: EigenLayer
Economic Trust: Economic trust relies on people’s confidence in the pledged assets. If the profit from corruption is lower than the cost of corruption, economically rational actors will not launch an attack. For example, if the cost of attacking a cross-chain bridge is $1 billion, but the profit is only $500 million, it is obviously irrational from an economic point of view to conduct the attack. As a widely adopted cryptoeconomic primitive, slashing can greatly increase the cost of corruption, thereby strengthening economic security.
Decentralized Trust: The essence of decentralized trust is to have a large and widely distributed set of validators, both virtually and geographically. In order to prevent collusion and Liveness Attacks between nodes in an AVS, it is best not to have a single service provider run all nodes. On EigenLayer, different AVS can customize their degree of decentralization. For example, they can set geographic location requirements for node operators, or only allow individual operators to provide node services, and provide more incentives to attract such operators accordingly.
Economic Trust: Economic trust relies on people’s confidence in the pledged assets. If the profit from corruption is lower than the cost of corruption, economically rational actors will not launch an attack. For example, if the cost of attacking a cross-chain bridge is $1 billion, but the profit is only $500 million, it is obviously irrational from an economic point of view to conduct the attack. As a widely adopted cryptoeconomic primitive, slashing can greatly increase the cost of corruption, thereby strengthening economic security.
Ethereum "Inclusion" Trust: In addition to making a commitment to Ethereum through staking, Ethereum validators can also make a credible commitment to AVS if they further re-stake on EigenLayer. This allows proposers to provide some services on Ethereum (for example, partial block auctions through MEV-Boost++) without making changes to the Ethereum protocol level. For example, forward block space auctions allow buyers to ensure that they get future block space in advance. Validators who participate in re-staking can make a credible commitment to block space, and if they do not include the buyer's transaction afterwards, they will be fined.
2.3 Babylon
(Conceptually, Babylon does not belong to "re-staking", but to Bitcoin "staking", but because its use case is similar to EigenLayer, providing economic security for blockchains, middleware, etc., it is discussed in this section)
Babylon was launched against the background that Bitcoin cannot generate “native” revenue due to the limitations of the Bitcoin blockchain’s programmability. Generally speaking, there are two main ways for Bitcoin to generate revenue:
Wrapped Bitcoin. Solutions similar to WBTC issue WBTC on Ethereum through a 1:1 acceptance method, allowing Bitcoin to participate in various DeFi activities on Ethereum in a mapping manner. The current volume of WBTC is around 10 billion US dollars. However, such solutions are usually based on multi-signature and custodian mechanisms, and are highly centralized. Deposit in a centralized exchange. The financial products of centralized exchanges provide Bitcoin returns. However, the returns are often not transparent and there are greater financial risks.
Babylon introduced native Bitcoin pledge on the Bitcoin blockchain with the help of Bitcoin time lock opcode and signature algorithm Extratable One-time Signature (EOTS), without relying on any third-party custody, packaging and cross-chain bridge. This technical mechanism is Babylon's technological innovation, which releases the utilization value of idle Bitcoin and provides extremely important infrastructure for the Bitcoin ecosystem.
The following diagram outlines the methods and workflow for participating in Bitcoin staking on Babylon.
Source: IOSG
3. Re-staking and its ecology
3.1 Liquid Restaking (LRT)
LRT is a new asset class derived from the three-party market around EigenLayer. Currently, the total TVL of the LRT protocol is about 6.4 billion US dollars, accounting for about 41.29% of EigenLayer TVL. The starting point of LRT is similar to that of LST, mainly to liberate liquidity (locked in re-pledged ETH). Due to the different composition of LRT's underlying assets, LRT is more complex than LST and has a dynamically changing nature.
Source: IOSG
The yield of LST is currently around 2.6%~3%, which comes from the joint income of the Ethereum consensus layer and execution layer and is composed of ETH. The yield of LRT is uncertain, but it basically comes from the fees paid by each AVS, and may be composed of AVS tokens, ETH, USDC, or a mixture of the three. According to the information we obtained from communication with some AVS, most AVS will reserve several percentage points of the total token supply as incentives and security budgets. If AVS is online before the token is issued, it may also pay ETH or USDC, depending on the specific situation. Since it is based on AVS tokens, the risk of token fluctuations will be greater than that of ETH, and APR will fluctuate accordingly. AVS may also have rotations of entry and exit. This will bring uncertainty to the yield of LRT.
3.2 AVS (Actively Validated Service)
AVS is the object of economic security provided by EigenLayer. According to the official documentation of EigenLayer, AVS covers the following infrastructure: side chains, data availability layer, new virtual machines, guardian networks, oracle networks, cross-chain bridges, threshold encryption schemes, trusted execution environments, etc. The following table lists more types that may be built on AVS.
Source: EigenLayer, IOSG
Around the core primitives of re-staking, EigenLayer has built a good AVS pipeline. Currently, 19 AVSs are online on the mainnet.
For example, EigenDA is a data availability solution developed by EigenLabs and launched as the flagship AVS. EigenDA's solution is derived from Danksharding, the Ethereum scaling solution. The concept of data availability sampling (DAS) is also widely used in DA projects such as Celestia and Avail.
For AVS, EigenLayer provides the following benefits:
Economic security and node operation services in the project startup phase. In the mature stage of the project, if there is a sharp increase in economic security demand in the short term, EigenLayer can also provide rentable elastic security;
AVS's node verification service is run by Ethereum validators, which can achieve better decentralization compared to independent operation by the project party or centralized node service providers;
Potentially lower verification and operational costs (depending on the circumstances), lowering marginal costs;
The Dual Staking model proposed by EigenLayer can provide certain token utility for AVS;
Building certain services and products, such as pre-confirmation, based on the trusted commitment of Ethereum validators;
As an EigenLayer ecological project, it has received certain endorsements, marketing support, market exposure, etc.
As a technical solution, AVS is often more natural and concise than L1 and middleware starting their own node network. In addition, it should be recognized that AVS is essentially a middleware and infrastructure project. The logic of investing in AVS should be based on the logic of evaluating such projects (products, technology, competitive landscape, etc.). AVS itself does not provide special differentiation.
As mentioned above, AVS is the consumer and borrower of re-staking, and is also the core of the three-party market. The market relies on AVS for payment, which is generally paid in AVS's native token (if the token is not online, it may be in the form of points), usually 3%-5% of the total supply of AVS tokens. In the near future, EigenDA will begin to pay re-stakers and node operators at a price of 10 ETH per month. EigenLayer itself will also support all early-stage AVS with 4% of its total token supply to help them through the cold start period.
From a medium- to long-term perspective, the driving force for the sustainable development of the EigenLayer ecosystem lies in the demand side. There needs to be enough AVS to pay for economic security, and it must be sustainable. This is related to the business situation and operational capabilities of AVS itself, and will eventually be reflected in the token price.
The income from Ethereum staking will exist for a long time and remain in a stable range, but the income from AVS may not be the same. The income, durability, and volatility provided by each AVS token are different, and the risk preference and pursuit of income of each re-stakeholder are also different. In this process, there will be spontaneous dynamic regulation by the market (more ETH staking to a certain AVS will reduce the yield, prompting stakers to turn to other AVS or other protocols).
3.3 Summary
After the airdrop craze faded and the market cooled, EigenLayer's TVL fell by about 20%, entering the mean reversion period we predicted earlier. In the long run, we believe that EigenLayer's re-staking will not be a short-term narrative on the emotional side, but will become a permanent attribute of the Ethereum ecosystem, used to externalize Ethereum's economic security and help projects get started.
According to the above, TVL is not the most core indicator for evaluating EigenLayer, but the quality of AVS is. If there are more high-quality AVS built on EigenLayer, they will definitely bring high returns, and TVL will follow. Therefore, the competition between re-pledge protocols is actually a competition to identify and "invest" in AVS at an early stage. Re-pledge protocols will obviously be a winner-takes-all market. For the LRT protocol, TVL is certainly one of the explicit indicators to measure the performance of the protocol, but the TVL figure alone cannot summarize the entirety of a protocol. For protocols such as "saving money", the support of users, especially large users, is the core element. Compared with retail investors, large users are more "lazy" with funds, have a lower willingness to seek short-term and quick returns, and have a more stable risk appetite, so they are more likely to stay on the platform for a long time. Liquidity is a top priority for large users and is related to their confidence in the project. Therefore, establishing and maintaining liquidity should be one of the primary goals of the LRT protocol.
4. Investment logic and layout
We actively deployed the Staking & Restaking track around the two key time nodes of Ethereum "The Merge" and "Shanghai Upgrade". In general, it is mainly based on the following predictions:
Ethereum’s “The Merge” means that PoS becomes a permanent attribute of Ethereum, and staking is an indispensable part of it. After the “Shanghai Upgrade”, Ethereum staking, as a means of asset management, changes from “only in but not out” to “in and out”, thus realizing a closed loop of capital flow. These two landmark events are the basis for our focus on this track.
We believe that the staking track will inevitably develop in the direction of product diversification. The market favors diversified solutions. As a pioneer and absolute leader in the staking track, Lido will be more cautious in launching new products due to its sensitive position (the community has repeatedly expressed concerns about Lido's market share exceeding 33%). Therefore, we believe that as other competitors launch differentiated strategies, Lido's market share will show a long-term slow decline.
More than a year has passed, and the market performance has also verified our prediction:
Source: ETH Staking Dashboard by @hildobby
The Ethereum staking rate has increased from about 12% a year ago to 27.28%, a growth rate of 227.3%. In the current Ethereum staking queue, there are 6,425 stakers entering the queue, who need to wait for 3 days and 14 hours; while there is only 1 staker in the exit queue, who almost does not need to wait (data on May 31). It has been in a state of supply exceeding demand for a long time.
Driven by the Restaking narrative, many LRT protocols (such as Ether.fi, Renzo) have in fact become the top stakers of Ethereum. In addition, institutional-level staking solutions and independent staking solutions are also flourishing. Lido's market share has also dropped from a peak of 32.6% to 28.65%.
5. Conclusion
Source: Justin Drake
Looking back at the development of Ethereum’s staking and re-staking ecosystem, we can clearly see that the value of ETH as a multi-functional asset has been continuously strengthened and expanded. From the initial single pricing and Gas function to the diverse roles it plays today, ETH has become an indispensable cornerstone in the crypto economy.
As the Ethereum roadmap continues to expand and the staking ecosystem matures, the role of ETH is becoming increasingly important in the entire blockchain industry. Through staking and re-staking, ETH not only provides a solid foundation for network security and decentralization, but also demonstrates its unique role in the three major attributes of capital, consumable and value storage assets by expanding economic security and enriching the ecosystem.
In the future, ETH may play a more important role in the following aspects:
As a value anchor for the cross-chain ecosystem: Through re-staking protocols such as EigenLayer, ETH has the potential to become the economic security foundation of a multi-chain world.
Promote composable financial innovation: DeFi products based on LST and LRT will be more abundant, providing users with more income and risk management options.
Deepen integration with traditional finance: The entry channel provided by the ETH ETF and the stability of ETH staking returns may attract more institutional investors and promote the integration of crypto assets with traditional financial markets.
A few predictions:
In the future, as the ETH staking rate increases, the staking income will gradually decrease, and funds will seek more diversified income structures. As the re-staking solution matures, re-staking will take over the flow of this part of funds and provide certain additional income. (Just like MEV-Boost has become the default block construction method adopted by almost all validators to increase income) The proportion of ETH involved in re-staking relative to ETH involved in staking will gradually increase.
In the field of re-pledge, due to the flexibility of LRT in asset management, its positioning will gradually expand from a liquidity re-pledge platform to a cross-protocol, cross-ecological "asset management center" and a connecting DeFi Hub, and even connect to the real world. For example, Ether.fi has launched its crypto-native credit card, which is linked to its LRT and Liquid products. In this process, the market leader has a higher bargaining power when negotiating with upstream and downstream.
We firmly believe that Ethereum will continue to serve as the cornerstone of the decentralized economy, supporting and promoting the widespread adoption of decentralized applications around the world. We will continue to pay close attention to this rapidly developing field and align our investment layout with the future development trend of Ethereum.
