The transition of Ethereum to a Proof-of-Stake network, followed by the Shapella upgrade, introduced liquid staking to its ecosystem. This innovation not only boosted the utility of staked ETH by allowing users to engage in DeFi with their stake but also enhanced Ethereum’s network security through its increased adoption; acting as a dual-purpose mechanism for cryptoeconomic security and DeFi collateral.

Restaking & LRTs

In comes restaking and EigenLayer.

In 2021, EigenLayer introduced restaking, a mechanism that leverages already staked ETH—be it in the form of LSTs or natively staked ETH—to secure a range of new services, including shared sequencers, oracle systems, or other Actively Validated Services (AVSs). Restakers can earn additional yield from this activity but, at the same time, be exposed to an additional set of slashing risks.

EigenLayer works as a two-sided marketplace of decentralized trust: restakers supplying cryptoeconomic security through their stake, and AVSs seeking this pooled security to efficiently run their services, without the complexities and challenges that come with bootstrapping a new network of validators, attract stakers to pool funds and launch their own native, highly-volatile token. Although restaking sounds deceptively simple, it may really catalyze a new era of permissionless innovation through this process.

From there, liquid restaking providers emerged to address the need for a liquid representation of restaked positions in restaking through the minting of a liquid restaking token (LRT), which enables users to earn restaking yield from EigenLayer and simultaneously—much like with LSTs—use these assets in DeFi.

Addressing the Risks to Ethereum’s Tokenomics

Ethereum’s tokenomics are designed to incentivize behaviors that ensure the network’s efficiency, security, and decentralization. As Ethereum has become a PoS network, the main topic of its tokenomics has become the importance of safeguarding its cryptoeconomic security through staking.

Financial Risks of Restaking

Restaking within the Ethereum ecosystem presents distinct financial risks that could impact the network’s tokenomics:

1. Concentration Risk: A scenario in which a disproportionate amount of Ethereum’s staked ETH is concentrated within a single or very few AVSs presents a critical risk. Such concentration could surpass the Byzantine Fault Tolerance safety threshold, paving the way for non-consensus-related slashing events. This situation poses substantial economic risks to Ethereum by undermining confidence in its staking mechanism and potentially diluting the integrity of the network’s tokenomics. Similarly, excessive capital being funneled into a single LRT or a limited selection of LRTs raises concerns of undue influence over the choice of the AVSs that integrate the portfolio of those LRT protocols; moreover, it introduces the additional risk of systemic failure and potential loss of user funds if those concentrated LRTs were to be compromised. This concentration risk, both in terms of staked ETH within AVSs and capital within LRTs, necessitates a careful evaluation to safeguard against undermining Ethereum’s decentralized ethos and economic stability.

2. Liquidity Risk: When a substantial portion of an LST is restaked, the resultant liquidity crunch could lead to increased volatility of the LSTs. This not only could affect the stability and predictability of an AVS but also undermine the broader market’s perception of Ethereum’s tokens as stable and reliable assets, which is vital for sustaining DeFi’s growth on the platform. Furthermore, this liquidity risk extends to LRTs, which, as relatively new financial products, inherently carry their own set of uncertainties and vulnerabilities in the financial markets. This dual aspect of liquidity risk underscores the intricate challenges Ethereum faces in maintaining asset fluidity and reliability within its expanding ecosystem.

3. Slashing Risk: The novel problem of the potential for loss of principal caused by AVSs’ slashing rules and adversarial attacks also came to the fore as well. This risk is notably exacerbated by the interconnected nature of these applications and systems, where slashing events can trigger a domino effect across an AVS ecosystem and even impact the foundational Ethereum L1 layer-–such a cascade has the potential to significantly destabilize Ethereum’s entire token economy. Errors made by node operators thus extend beyond individual stakes to influence the wider perception of Ethereum’s PoS mechanism’s reliability, potentially affecting the network’s token value and overall confidence. Furthermore, the APYs of LRTs are influenced not only by the rewards from the Beacon chain but also by the revenue generated from their portfolio of AVSs. A slashing event within this portfolio could pose inherent challenges for those LRTs, further highlighting the complexity of managing risks in this intertwined ecosystem.

Applications & Infrastructure Risks of Restaking

Other concerns raised by prominent researchers in the space regarding the impact of restaking applications and infrastructure, and LRTs on Ethereum’s tokenomics are:

1. Overleverage Risk: The case where restaking applications or platforms like EigenLayer could garner greater staked capital than their network base layer: Ethereum L1. Through the years, Ethereum has grown commensurate in value to the total applications that have been built on top of it, and its staked capital has grown to be large enough to warrant a cryptoeconomic attack by an adversary (~$100B as of Feb 28, 2024). A similar dynamic could follow the new applications built with the restaking primitive. Since restaking funnels most of the value back to Ethereum, ETH itself grows in value relative to every application that is built on top. This fact only underscores that Ethereum is actually not overleveraged and — by extension — restaking applications on Ethereum will likely not end up being either.

2. Centralization Risks: The increased computational load on validators at the Beacon chain level is being proactively addressed by EigenLayer through the promotion of lightweight AVSs, such as EigenDA, coupled with special economic incentives for solo validators. Additionally, efforts to ensure an open operator ecosystem are underway to preserve Ethereum’s censorship resistance and decentralization. These measures aim to prevent monopolies on any LST or LRT, thereby promoting fairness and supporting Ethereum’s mission to remain a secure, decentralized network. Moreover, as stressed in the financial risks, an overly-monopolized LRT protocol could pose undue influence towards its portfolio of AVSs.

Social-Consensus Dependency Risk: Social consensus refers to the community’s collective agreement and understanding of a protocol’s functionality and goals. The ethos behind restaking, along with the introduction of LRTs, introduces a novel paradigm and added complexity to Ethereum’s core protocol. This could potentially challenge the existing social consensus by introducing new layers of interaction and governance within the ecosystem. Therefore, restaking should aim to operate independently of Ethereum’s social consensus to navigate these complexities effectively.

Vitalik’s Take

In two of his blog posts, Vitalik Buterin has covered some of the potential risks to Ethereum he sees, that are related to its tokenomics, as well:

On Don’t overload Ethereum’s consensus (https://vitalik.eth.limo/general/2023/05/21/dont_overload.html): 

“We should instead [of overloading consensus] preserve the chain’s minimalism, support uses of re-staking that do not look like slippery slopes to extending the role of Ethereum consensus, and help developers find alternate strategies to achieve their security goals.” 

On Should Ethereum be okay with enshrining more things in the protocol? (https://vitalik.eth.limo/general/2023/09/30/enshrinement.html):

“Enshrining too much can over-complicate the protocol. Protocol complexity is a systemic risk, and adding too many features in-protocol increases that risk.”

In the broader context of Ethereum’s development philosophy, Vitalik’s cautionary remarks on restaking and the introduction of LRTs underscore a pivotal debate within the Ethereum ecosystem—balancing innovative expansion with the preservation of foundational principles such as decentralization, security, and scalability. These comments suggest a thoughtful approach to Ethereum’s development, stressing the need to preserve network simplicity and social consensus. With Ethereum’s shift to PoS and exploration of L2 solutions, restaking and LRTs promise functional improvements, introduction of new and innovative applications, and increased user adoption, but also greater complexities. Vitalik’s insights spotlight the trade-offs of these advancements, igniting a community discourse on responsibly expanding Ethereum’s layering capabilities.

Conclusion

Restaking is poised to further Ethereum’s value proposition by boosting network security, promoting greater adoption and utility, offering additional yield opportunities to stakers, while also boosting the emergence of innovative DApps on the platform. All major contributions to Ethereum’s tokenomics.

Despite concerns regarding restaking and LRTs—including risks of centralization, liquidity issues, slashing, and the potential to undermine social consensus and the foundational simplicity of Ethereum L1—meticulously designed and engineered platforms, like EigenLayer, aim to safeguard Ethereum’s core security and tokenomics. The empirical impact of these measures will become clear following their mainnet launches.

The momentum is evident in the numbers: from 447K ETH restaked (~$1B) as of December 31, 2023, to 2.8M ETH (~$7.8B) by February 22, 2024. Restaking and LRTs now have great significance to Ethereum’s ecosystem, and, with them, came a crucial need for thorough risk analysis to fully reap their benefits.