Liquid restaking: A money market investor perspective

TL;DR

In this article, we looked at restaking as a new primitive in decentralized finance and infrastructure. From a money market investor's perspective, we expect increase of ETH benchmark yields driven by emergence of liquid restaking token (LRT) protocols. Current yield economy is based predominantly on incentive farming. The utility yield will not come into play until the second half of 2024. Our take is that ETH LRTs will become a building block for multiple strategies, including directional, delta-neutral, but also structured products with non-linear payoffs.

RESTAKING BACKGROUND: A MARKET FOR SECURITY

In 2021, EigenLayer introduced the concept of restaking. By restaking via EigenLayer, users can leverage their staked ETH for additional validation services — this is called pooled security. This process enables the staked assets to secure not only Ethereum, but specific protocols as well. In exchange for agreeing to more stringent slashing conditions — enforced by EigenLayer through control over the withdrawal rights of the staked ETH — participants are rewarded with extra incentives. Validators who join this system not only contribute to a more secure pooled environment, but also benefit from the extra income generated by the actively validated services (AVSs) they support. So restakers reap the dual benefits of increased rewards for stakers and additional revenue for validators.

This creates a market where protocols can access the pooled security offered by EigenLayer, while users who opt into restaking can earn extra rewards by providing their staked assets for validation services beyond Ethereum.

However, managing restaked positions directly with associated projects via EigenLayer has minimum capital requirements (32 ETH minimum deposit) and does not allow for liquid sale of such positions. Therefore, in a similar way to liquid staking tokens (LSTs), a number of liquid restaking token (LRT) solutions has emerged.

WHAT ARE LIQUID RESTAKING TOKENS (LRTS)?

LRTs solve the problem of managing restaked tokens for users. By choosing to restake through platforms like KelpDAO’s rsETH, EtherFi’s eETH, Renzo’s ezETH, RestakeFi’s rstETH, or Puffer’s pufETH, users can receive LRTs representing their staked assets. These LRTs provide liquidity and allow users to participate in the DeFi ecosystem.

With LRTs, users can access liquid assets representing their staked positions. These assets can be used for lending, borrowing, and trading within DeFi, offering flexibility and yield opportunities.

ECONOMICS OF LRTS

Economic incentives of LRTs are based on risk and reward principles. LRT holders will be exposed to the risks associated with the chosen AVSs, which are mitigated through governance mechanisms and portfolio management by LRT platforms. This creates a balanced framework that attracts participation. Risk management within these platforms may include incorporating insurance mechanisms and slashing protection to safeguard stakers from potential threats.

The question is, which AVSs will be used by which LRTs? We expect that LRT protocols will encourage AVSs to buy LRT governance tokens, and source integration voting into governance to spark bidding process to allocate restaked tokens, essentially launching ‘LRT wars’ on the back of each restaking solution.

CURRENT STATE OF LRTS

According to DefiLLama and this Dune dashboard, top-5 LRT projects (Ether.Fi, Puffer, Kelp, Renzo and EigenPi) have locked-up funds of at least $3 bln and constitute almost 90% of the market.

LRT Total Supply chart, 27 Feb 2024

There is an active competition among these major LRT projects. The drivers of such competition are constantly changing tokenomics and new proposals (e.g. unique anti-slashing tools of Puffer Finance). There are some great articles (Ignas and Shoal research) that already discuss economical and technical differences between the protocols.

Currently, the projects are at the stage of active TVL attraction via incentive mechanics. All of main projects provide point mining incentives in anticipation of future governance token launch.

What are risks associated with deploying Ether into EigenLayer directly, or LRT protocols? Currently, there is no actual restaking through AVSs, so deposited ETH is not at risk of slashing. The only AVS deployed in testnet, EigenDA, is expected to go live in 2H 2024. It means that provision of liquidity into restaking protocols is only exposed to smart contract risk of the LRT as wrapper products, and liquidity / market risks of being able to withdraw ETH with little or no slippage.

A PRACTICAL PERSPECTIVE

One straightforward use case of an ETH LRT token is allocating capital to express directional view on ETH price growth and earn protocol points. It is also possible to fix the performance via yield trading DeFi protocols, Pendle being the most prominent.

Pendle is an example of a platform that offers attractive fixed yields on tokens like ETH, stETH, and restaked tokens such as ezETH, rsETH, and eETH. As of time of writing, 27/02/2024, Pendle provides 27–44% on restaked tokens (ezETH, rsETH, eETH) for tenors varying from 2 to 4 months.

Pendle Finance, LRT fixed yields, 27/02/2024

Speaking about fixing yield of ETH restaking pre-live economy, how else can it be used? It allows to build an investment portfolio with predictable non-linear payoff depending on ETH prices.

An example that we would recommend to consider to investors looking for mildly bullish ETH scenario within a 3 month horizon is a call spread note, which allows to take a leveraged exposure on ETH growth trajectory, giving up excess upside but also hedging any downside. Below are indicative terms for such note.

Call Spread Note

Maturity Date: 4 months;

Redemption price:

• 140% if ETH grows more than by 20% from start date to the Maturity Date;

• 117% * ETH(Maturity) / ETH (Start) if ETH growth is in the range [0%; 20%];

• 100% if ETH price at the Maturity Date is lower than at start date.

Here is a chart illustrating payoff of a call spread instrument against ETH LRT investment with rate fixed on rsETH via Pendle.

Call Spread Note payoff chart

WHAT’S IN FUTURE?

As airdrops find their landing and the projects mature, the yield on LRTs is expected to decrease. However, the providers will make efforts to ensure that the yields remain attractive to incentivize users’ participation in restaking.

At Resolv, we are closely monitoring the developments of LRTs and would be delighted to discuss potential collaborations related to structuring yield products based on LRTs. We recognize the potential of LRTs as a backbone yield component for structured products and are interested in exploring opportunities in this space. Feel free to reach out to us if you would like to engage in further discussions or explore potential collaborations!