The Risks of Re-Staking: Beyond Tempting Returns, a Fragile House of Cards

This is the third article in my series on re-staking, initially focusing on EigenLayer, then delving deeper into the re-staking financial domain.

Since then, we have seen new entrants in the re-staking field, such as Kelp DAO, Renzo, and $RSTK, which have drawn increasing attention.

Re-staking seems to be positioned as one of the main narratives driving 2024. However, despite much talk about how re-staking works and its benefits, not everything is positive.

This article aims to take a step back, analyze re-staking from a higher level, highlight its risks, and answer the question: Is it really worth it?

Let’s first quickly introduce this topic.

What is Re-staking?

Re-staking is a concept in the Ethereum Proof of Stake (PoS) mechanism, which serves as a decentralized trust mechanism where participants ensure the security of the Ethereum network by committing their stakes.

Re-staking can be understood as programmable staking, where users opt into any positive or negative incentives to secure other infrastructures. In practice, re-stakers on EigenLayer provide economic trust (in the form of staking ETH) so that anything verifiable can be slashed.

EigenLayer is modularizing Ethereum’s decentralized trust, enabling Active Validation Services (AVS) to leverage Ethereum’s decentralized trust without needing to bootstrap a validator set, effectively lowering the barriers to enter the market. These modules usually require AVS with their distributed validation semantics for verification, protected either by their native tokens or essentially being permissioned.

The reason for re-staking stems from economic incentives and potential profits. If Ethereum staking yields hover around 5% annually, re-staking could offer attractive additional earnings. However, these rewards are currently unpredictable as they depend on the demand and supply dynamics on the Eigen Marketplace, introducing additional risks to stakeholders.

Besides the inherent risks of using their staked ETH, when users opt to re-stake their tokens, they essentially delegate the power to the EigenLayer contracts to slash their held tokens in events of errors, double signings, etc., in any AVS they protect. Thus, re-staking introduces an additional layer of risk, as re-stakers could be slashed on both the ETH and the re-staking layer.

Whether the extra earnings justify the risks of re-staking remains a consideration for stakeholders.

Why would someone choose to re-stake?

The question “Why would someone choose to re-stake?” can be answered simply as due to economic incentives and potential earnings.

If the annual yield from staking Ethereum hovers around 5%, re-staking could offer an appealing additional profit. However, it’s currently impossible to estimate these rewards as they depend on the demand and supply dynamics on the Eigen Marketplace.

Yet, this introduces additional risks for stakeholders. Beyond the inherent risks associated with staking their ETH, when users opt to re-stake tokens, they are essentially authorizing the EigenLayer contract to have the authority to slash their held tokens in events like errors, double signings, etc., in any AVS (Automated Validation System) they are protecting.

Therefore, re-staking adds an extra layer of risk, as re-stakers could face slashing on either the ETH layer, the re-staking layer, or both.

The question then becomes, is the additional profit worth the increased risk of re-staking?

The Risks of Re-Staking

For stakers, re-staking means you have the option to join as many networks as possible and increase your earnings, which is why EigenLayer calls itself the “Airbnb of decentralized trust.”

However, this is not entirely beneficial, as re-staking introduces several significant risks:

• ETH must be staked (or LST must be staked, hence the tokens are not liquid)
• Smart contract risks associated with EigenLayer
• Protocol-specific slashing conditions
• Liquidity risk
• Centralization risk

Indeed, by re-staking, users are leveraging a token already at risk (due to the initial staking) and adding additional risks on top of it, leading to compounded layers of risk, as illustrated below

Moreover, any additional narrative development on these fundamentals adds more complexity and additional risks.

Beyond the individual risks to re-stakers, as exemplified by Vitalik’s article on not overloading Ethereum consensus, the Ethereum developer community has also raised questions about re-staking. The issue with re-staking is that it introduces new pathways of risk for staking Ethereum to protect the mainnet, using some of it to protect other chains.

Therefore, if other protocols act improperly (possibly due to vulnerabilities or lower security), their deposits could be slashed.

Developers and EigenLayer are trying to find a way to reconcile and ensure that Ethereum is not weakened by these technological advances. Re-utilizing the most crucial Layer to ensure Ethereum’s security is indeed not an easy task.

Furthermore, a key issue in this regard is the extent to which re-stakers are allowed to manage risk.

Many re-staking projects delegate the AVS whitelisting process to their DAOs. However, as a re-staker, I would prefer to personally audit and decide which AVS to stake in, to avoid attacks by malicious networks and reduce the potential for new attacks.

In summary, re-staking is an interesting narrative worth exploring.

However, the concerns of Vitalik and others cannot be overlooked. When discussing re-staking, it’s important to remember how this will affect the security model of the Ethereum mainnet.

Nonetheless, it’s fair to position re-staking as adding an additional layer of risk on top of Ethereum’s most crucial mechanisms.

Risks of Re-Staking:

• Collusion risk: Multiple operators might collude to attack a set of AVS and compromise security.
• Slashing risk: Re-stakers face slashing penalties from both ETH and AVS.
• Single point of failure: Receiving withdrawal credentials from eth credentials presents systemic risks to the mainnet.
• Validator centralization risk
• Adding extra risk to ensure the security of Ethereum

Attractiveness of re-pledge institutions

Surprisingly, many institutions have expressed their interest in re-staking as an added bonus on top of staking Eth.

However, they will likely re-hypothecate through their custodian rather than joining any other services that would expose them to additional risk of haircuts.

Given the risks highlighted previously, it will be interesting to see whether retail or institutions have the greatest interest in rehypothecation.

For those already involved, the additional benefits on top of native Eth staking are appealing, but given the risks, these are not high for those seeking extreme returns.

Re-staking opens up new use cases for Ethereum as a financial instrument. Interestingly, some compare rehypothecation to corporate bonds.

The new network hopes to achieve L1 security, similar to how a company or country uses its financial system to create bonds and protect its assets.

In the crypto space, Ethereum is the broadest and most liquid network, probably the only one capable of sustaining such a market, and the most secure from a state perspective similar to that in a traditional financial economy.

Currently, most interest in restaking appears to be driven by speculation about the EigenLayer airdrop, which could be the largest airdrop in crypto history.

How will things change after the airdrop?

Perhaps a realistic risk and reward analysis might nudge some people toward other avenues that might be more fruitful.

I would venture to say that most of the capital in the re-hypothecation is hired capital and will probably leave after the airdrop.

To assess users’ true interest in this new narrative, it is necessary to separate out the speculative component.

Personally, the rehyping narrative is a bit overhyped and the current risks must be carefully assessed.

The Key to Re-staking

Due to re-staking, AVS has a lower cost barrier while leveraging the robust security layer of Ethereum. Users can choose to re-stake ETH, thereby increasing capital efficiency and earning more staking rewards. Re-staking adds additional risks on top of other risks.

Re-staking is an exciting narrative that can inspire a range of new use cases.

Although the full development of the Eigen market will be completed in about a year, there are already some interesting re-staking experiments being explored.

Some concerns raised by Vitalik relate to the centralization of staking power, where the centralization of staking power compromises the interests of independent staking.

It will be interesting to observe how EigenLayer will work with the Ethereum Foundation to address these issues. But beyond these, there are other issues.

How do we mitigate these risks?

Some solutions to mitigate re-staking risks include optimizing re-staking parameters (TVL cap, cut amounts, fee distribution, minimum TVL, etc.) and ensuring diversification of funds among AVS.

A direct step that re-staking protocols could consider is allowing users to choose different risk profiles when depositing for re-staking.

Ideally, each user should be able to assess and choose which AVS to re-stake with, without delegating this process to a DAO.

This requires the joint efforts of AVS and EigenLayer to ensure there is an ongoing plan to minimize these risks.

The EigenLayer team has already cooperated with the Ethereum Foundation to further coordinate and ensure that re-staking does not add systemic risks to Ethereum, LST, or the AVS utilizing it.

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