Liquid staking and restaking protocols have shortly gained traction in decentralized finance (DeFi), pushed by their potential to boost blockchain safety and effectivity. However with fast innovation come inherent dangers.
Whereas these protocols can supply customers unprecedented yields, additionally they current potential systemic vulnerabilities. BeInCrypto spoke with completely different trade consultants to higher perceive the intricacies of staking mechanisms and the challenges they pose for customers.
The Rise of Restaking
Over the previous 12 months, staking has advanced from an rising idea within the DeFi sector to a mechanism that has fully reshaped the concept of safety throughout blockchain networks. Spearheaded by Ethereum, with EigenLayer taking the lead, this protocol has provided dynamic options to beat the fragmented safety of conventional Layer 2 blockchains.
When Ethereum transitioned to a proof-of-stake (PoS) ecosystem in 2022, it changed mining with staking, opening new potentialities for staking rewards and guaranteeing mainnet safety.
Historically, every decentralized community has been accountable for creating and sustaining its safety measures, typically counting on PoS mechanisms. This requires important funding in safety infrastructure, and it may be difficult for rising networks to attain the extent of safety provided by established networks like Ethereum.
To mitigate this draw back, the idea of restaking quickly appeared. This mechanism happens when already staked Ethereum is used to lend safety to different mainnet components, resembling bridges, protocols, oracle networks, and scaling options.
“Restaking is basically about bootstrapping financial safety for brand spanking new protocols, typically utilizing liquid-staked tokens which are already tied to offering safety elsewhere,” Laura Wallendal, CEO and Founding father of Acre, informed BeInCrypto.
Restaking provides a possible resolution by enabling smaller networks to leverage the safety of current PoS chains, thereby enhancing their general safety posture.
EigenLayer Pioneers Restaking Protocols
Constructed on high of Ethereum in June 2023, EigenLayer has change into the most-used restaking protocol at the moment. As of writing, the protocol’s Complete Worth Locked (TVL) is weighed at over $15 billion.
EigenLayer’s TVL as of January 16. Supply: DeFi Llama.
Sreeram Kannan, the mind behind the protocol, developed this mechanism to reap the safety advantages of the Ethereum community and prolong the identical to different protocols and blockchains.
EigenLayer lowers community startup and administration prices and eliminates the complexities of bootstrapping safety for brand spanking new initiatives. Through the use of their staked place to help extra functions on the Ethereum community additional, restakers can repurpose their stakes belongings and maximize their earnings.
“Restaking is a completely legitimate method that helps make blockchain incentives extra environment friendly; in the long run, it’ll change into the established method to securing a number of decentralized protocols based mostly on the identical set of financial incentives,” stated Sasha Ivanov, Founding father of Waves & Items Community.
Nonetheless, since restaking has been round for lower than two years, they’re nonetheless within the early phases of growth. In consequence, protocols like Eigenlayer include their justifiable share of challenges and considerations.
Safety Dangers
Because the adoption of re-staking protocols will increase, considerations relating to the potential safety dangers related to these protocols are additionally rising. The flexibility to reuse staked belongings throughout completely different protocols might supply elevated yield alternatives, but it surely additionally introduces new layers of danger inside the blockchain ecosystem.
Although blockchains guarantee safety with good contracts, these contracts can endure vulnerabilities resembling reentrancy assaults and fuel restrict points.
“Every restaking layer introduces new good contracts, rising the assault floor for exploits,” stated Matt Leisinger, Co-Founder and Chief Product Officer at Alluvial.
The complexity of restaking mechanisms additional will increase the potential for bugs and exploits within the good contracts governing these protocols. If a contract is compromised, customers might lose funds.
There are additionally slashing dangers. If a validator is discovered responsible of malicious conduct, a portion of their restaked ETH may be lower.
“Restaked tokens are sometimes uncovered to a number of validator networks. If one community underperforms or violates protocol guidelines, slashing penalties can cascade throughout all restaked layers,” Leisinger defined.
Slashing dangers can even weaken the safety the restaking protocol goals to offer within the first place.
“Let’s say that you just use staked ETH to safe a number of AVSs, and let’s say a type of will get slashed. Then primarily the ETH is held, and clearly penalized, and so somebody who’s offering financial safety could also be much less doubtless to offer financial safety sooner or later,” Leisinger concluded.
When safety is compromised, so does the general spine of the ecosystem.
Illiquidity Throughout Occasions of Market Downturn
Elevated danger publicity additionally brings elevated return volatility. As with crypto usually, market downturns could cause important monetary losses.
“The chance to reuse staked belongings throughout a number of protocols unlocks extra incomes alternatives. Nonetheless, this nonetheless carries the chance of volatility and cascading failures brought on by interdependencies. Moderation is vital right here. Having in place sustainable methods that pursue reasonable yields can present rewards in tandem with a manageable danger publicity. Moderation, when married to a transparent understanding of dangers, is essential for the sustainable pursuit of yields for each customers and the ecosystem alike,” stated Ivanov.
Market volatility additionally causes liquidity dangers.
“Restaking often locks belongings in illiquid varieties, making it tougher to exit positions throughout market volatility,” stated Leisinger.
In line with Ivanov, this decreased financial incentive for customers additionally compromises blockchain safety throughout market downturns.
“If the native blockchain token is re-staked, there can positively be an extra unfavorable suggestions loop throughout market crashes, which can diminish the financial incentives securing the blockchain. For example, a crash in token worth may end up in compelled liquidations, which will increase promote stress, thereby lowering the financial worth securing the blockchain, a basic incentive for validators to take care of operations.”
Given the monetary structure behind these protocols, restaking a number of instances inherently amplifies liquidity challenges.
Dangers Related to Excessive Yield Returns
Whereas protocols like EigenLayer push the boundaries of yield maximization, the promise of upper returns additionally raises different concerns.
For the reason that idea of restaking surfaced, many protocols supply these providers. Some achieve this extra responsibly than others.
“A variety of these protocols depend on hype cycles to construct traction, providing excessive short-term rewards whereas they work to develop their consumer base and validate their mannequin. For instance, new protocols won’t generate sufficient transactions to pay validators sustainably, so that they layer extra incentives to compensate early adopters. It’s a wager that the protocol will ultimately obtain long-term stability—or a short-term play to gather rewards earlier than transferring belongings to the following alternative,” stated Wallendal.
Although excessive charges of annual share yields (APYs) could seem interesting to junior traders, they might not absolutely perceive the related dangers.
“With some restaking protocols providing APYs of 15-20% on belongings like ETH, there’s a major danger of traders chasing yields with out absolutely understanding the related dangers. To deal with this, protocols may undertake graduated entry methods—as an example, beginning customers with easier staking choices providing 5-7% APY earlier than granting entry to extra advanced and higher-risk merchandise,” stated Marcin Kazmierczak, Co-founder & COO of Redstone.
To that time, Ivanov added:
“Re-staking protocols are akin to conventional compounded monetary devices, the place worth can typically be created out of skinny air, and which Warren Buffett referred to as ‘weapons of mass monetary destruction.’ Alternatively, re-staking, after all, has legitimate use instances the place new worth isn’t created, however as a substitute, established incentives are used to safe extra protocols. It might be a positive line between unhealthy and good re-staking, so wanting deeper at how the protocols truly work is crucial.”
When protocols prioritize yield methods over sustainability, the chance of hypothesis inherently rises.
“Restaking does present financial safety for bootstrapping networks, but it surely typically veers into hypothesis. And not using a clear, long-term worth proposition, customers are simply biking by protocols to maximise short-term rewards. It’s turning into much less about supporting the ecosystem and extra about chasing token publicity throughout a number of networks,” stated Wallendal.
Hypothesis can even inadvertently have an effect on the credibility of the foundational layer of any blockchain.
“If staking had been to change into equated with speculative yield, this may put in query its position as a basis of blockchain safety and decentralization,” Ivanov added so far.
Constructing sustainable financial fashions might be essential to their success as protocols refine themselves.
Centralization Issues
EigenLayer was the primary protocol to popularize the idea of restaking on Ethereum. Right now, it has change into probably the most extensively adopted restaking mechanisms. In consequence, it has confronted rising centralization pressures.
“EigenLayer centralizes danger by serving as a crucial hub for a number of protocols, making the ecosystem extra susceptible to systemic shocks.
Competitors from different gamers is vital to stop this from taking place.
Final June, Symbiotic made a notable entry into the DeFi sector with $5.8 million in seed funding from Paradigm and Cyberfund. Its debut marked a major problem to the prevailing restaking narrative at the moment dominated by EigenLayer.
Since then, different options have additionally emerged.
“Whereas EigenLayer at the moment dominates with over 80% of the restaking market share, we’re seeing emergence of options like Symbiotic, Babylon or Solayer. The ecosystem wants this variety – having over 90% of restaked belongings managed by a single protocol may create systemic dangers and variety sparks additional innovation,” stated Kazmierczak.
Nonetheless, the truth that few gamers dominate restaking providers at the moment supplies a possibility to investigate their pitfalls extra intently.
“There’s additionally a flipside—having one large participant can even assist check the method extra shortly. EigenLayer’s present centralized place permits for observing how the system behaves in real-world situations, with a possibility to pinpoint vulnerabilities and inefficiencies quicker than a fragmented ecosystem. The fast testing by one large participant facilitates the evolution of the broader ecosystem by the important thing learnings attained in stated testing,” stated Ivanov.
As these methods mature, the sector is exhibiting guarantees of competitor diversification.
Accessibility Points
Academic obstacles and lack of understanding surrounding restaking protocols amplify publicity to the primary issues related to this mechanism.
As restaking methods change into extra advanced, this concern may also rise.
“Current surveys counsel solely about 30% of DeFi customers absolutely perceive the mechanisms behind restaking. We’d like higher instructional sources and danger visualization instruments. At RedStone, we’ve noticed that customers who perceive the underlying mechanics usually tend to make sustainable funding selections,” stated Kazmierczak.
The extra customers restake, the extra they expose themselves to dangers.
“Having transparency into the place individuals’ stake goes might be vital. There’s a little bit little bit of a danger of shared safety versus native safety—one AVS that you just’re securing versus a number of, and whether or not or not you’re sharing that safety throughout a number of AVSs. This might be dangerous, since you may have a state of affairs the place a node operator that you could be not even be staking to may impression your stake. This brings up dangers that traders at face worth possibly wouldn’t pay attention to, and so there needs to be transparency into any danger vectors or exercise like this that would doubtlessly impression one’s stake,” stated Leisinger.
Finally, solely customers themselves have the ability to coach themselves earlier than partaking with completely different restaking protocols.
“Solely by wanting deeper into what the protocol truly does can we actually perceive it. Sadly, there’s no manner round this. This entails due diligence by crucial evaluation of the protocol’s documentation, audits that uncover how rehypothecation is dealt with, and the safeguards in place that handle dangers related to leveraging consumer belongings,” Ivanov defined.
Growing instruments that facilitate entry to those mechanisms for a wider vary of traders may also assist domesticate the long-term viability of restaking protocols.
“The important thing to long-term success is making these methods extra inclusive and constructing infrastructure that helps new individuals. Whereas the trail ahead will take time, I’m optimistic that we’re heading towards a future the place sustainable staking yield turns into the usual—not the exception,” Wallendal concluded.
