What Happens When Every Token Gets Restaked?

Insurance, rehypothecation, and politics.

Marco Manoppo
September 10, 2024

Hi friends,

It has been a while since I did one of these. Recently, I’ve been thinking about the future of restaking as it’s been the primary narrative that drove the markets for the past 18 months.

For the sake of simplicity, I might be referring to EigenLayer or AVS in this article when describing broader restaking concepts, but I’m using the term generously to encapsulate all restaking protocols and the services built on top — not just specifically for EigenLayer.

EigenLayer and the concept of restaking have opened the Pandora’s Box.

Conceptually, extending the economic security of a highly liquid and globally accessible asset is great. It allows developers to build onchain applications without having to bootstrap an entirely new ecosystem for its project-specific tokens.

Source: EigenLayer’s Whitepaper

The premise is that ETH is such a blue-chip asset, that it:

makes sense for builders to use its economic security when building products as it enhances security, reduces cost, and enables the products to focus on their core functionalities.
provides a superior product experience for the end users

But fast forward to 18 months after the EigenLayer whitepaper was released, the restaking landscape has been reshaped.

We now have Bitcoin restaking projects such as Babylon, Solana restaking projects such as Solayer, and multi-asset restaking projects such as Karak and Symbiotic. Even EigenLayer has started promoting permissionless token support, allowing any ERC-20 token to be permissionlessly added as a restake-able asset.

Source: EigenLayer’s Blog

The market has spoken: every token will be restaked.

It’s no longer about extending the economic security of ETH. The true key unlock of restaking is about issuing a new type of onchain derivative → restaked tokens (and consequently, liquid restaked tokens).

Furthermore, with the rise of liquid staking solutions such as Tally Protocol, it is clear that the future of restaking will encapsulate all crypto tokens, not just L1 assets. We’ll see stARB getting restaked, rstARB, now wrap that as wrstARB.

So, what does this mean for the future of crypto? What happens when economic security can be extended from any token?

Restaking Supply-Demand Dynamics

These are two factors that determine the future of restaking.

You can write long threads and do mental jujitsu about intersubjective tokens and human coordination, but that’s a bit above my pay grade. If a restaking project wants to give me some advisory token allocation, I’ll consider writing about the above, anyway, I digress.

In crypto, two things are always true:

people want more yield
developers want to create tokens

People want more yield

Restaking protocols have the best PMF from the supply side.

Learning from our forefathers at Wall Street, crypto is quickly becoming a market of degeneracy that constantly seeks more risk. Case in point? There’s a derivative market for events news on Polymarket already. We’re all going to hell.

The way restakers get more yield is because of the services built on top of the restaking protocol, the AVSs. In an ideal world, developers would choose to build on top of restaking protocols and incentivize restakers to allocate their restaked assets to their projects. To do this, the developers might be sharing part of their revenue or giving out incentives in their native token as rewards to the restakers.

Let’s do some back-of-the-napkin math.

Data as of 7-Sep-2024.

Currently, $10.5B worth of ETH is being restaked on EigenLayer.
Let’s assume the majority of these restaked ETH are LSTs. So they’re already generating 4% APY, and they’re expecting to receive more by restaking it.
For an additional 1% in APY per year, EigenLayer and its AVSs need to generate $105M in value. This is before considering slashing and smart contract risks.

It’s quite obvious that the r/r of restaking isn’t worth it if it’s only for an additional 1% in APY. Dare I say it needs to be at least double, around 8% and above, for the risk to be worth it for capital allocators. This means that the restaking ecosystem needs to produce at least $420M in value annually.

Source: KelpDAO

Right now, the massive yield we’re seeing from restaking is being sponsored by the upcoming EIGEN token launch and liquid restaking protocols’ points programs (case in point above) — the actual return from revenue (or projected revenue) is insignificant in comparison.

Now imagine a scenario where there are 3 restaking protocols, 10 liquid restaking protocols, and 50+ AVSs. Liquidities will be fragmented; and developers (in this case, the consumers) will be burdened by the options that they have instead of being confident in the options presented. Which restaking protocols should I align with? Which assets should I pick to bolster my project’s economic security? etc.

So, either the amount of restaked ETH needs to increase significantly or we’ll need the money printer (aka native tokens issuance) to run full steam ahead.

TLDR — restaking protocols and their AVSs will need to spend a lot of capital in the form of their tokens as a way to keep the supply side alive.

Developers want to create tokens

On the demand side, restaking protocols argue that it’s cheaper and more secure for developers to use restaked assets to power their applications instead of using their own natively issued application-specific tokens.

While this might be true for some applications that require an enormous amount of trust and security such as bridges, the reality is that the ability to issue your own token, and use it as an incentive mechanism, is the key unlock for any crypto projects, no matter if you’re a chain or an application.

Using restaked assets as a complementary feature to your product can be an added benefit, but it should not direct the core value proposition of your products, and it should not be designed in a way that would cannibalize the value of your own tokens. ****

Some folks like Kyle from Multicoin have even taken a harder stance and posit that economic security is not a significant factor that will help drive product growth at all.

Source: Kyle Samani

Honestly, it’s hard to argue against his view.

I’ve been in crypto for 7 years and I’ve never heard a fellow crypto power user, fellow industry friends that store most of their net worth onchain, tell me that he’s choosing one product over another because of the economic security behind it.

From the economic side, Luca from M^0 has written an exceptional piece explaining how it might even be cheaper for a project to use their native token than ETH due to market inefficiencies.

Wen token? Let’s be real, whether they are de facto securities or not, project-specific tokens that have some form of governance functionality, utility, economic, or scarcity claim have been considered by investors a proxy of a project’s success or fame. The same market sentiment has existed even without any residual financial or control claim. In a sector as small as crypto, tokens have been often more connected to narratives or expected liquidity shifts, rather than cash flows. No matter how we see it, it is clear and documentable how the market for equity proxies is far from being efficient in crypto, and how higher-than-rationally-justifiable token prices translate in a lower-than-rationally-expectable cost of capital for projects. Often lower cost of capital happens in the form of lower dilution for venture-funded rounds, or higher valuations compared to other sectors. It might well be argued that native tokens actually carry lower cost of capital than $ETH for builders due to the market inefficiencies across the capital markets stack.

Source: Dirt Roads

To be fair, EigenLayer seems to have anticipated that this would be the case, as it designed the dual-staking system. Now, its competitors are even using the marketing angle that they support multi-asset restaking as a differentiator.

If the future of restaking means that all tokens will get restaked, then what’s the true value of restaking protocols for developers?

I posit that the answer is insurance and enhancement.

Multi-Asset Restaking Future: Fragmentation of Choices

Restaking will be a complementary feature improvement for projects to integrate if they want to better their product and differentiate themselves.

Insurance: It provides an additional guarantee that the products being offered should work as advertised as there’s more capital insuring it.
Enhancement: The best strategic move for restaking protocols is to reshape the entire narrative and convince builders that the default mode should include some restaking technology element in any product because it just makes everything generally better.

Oh, you’re an oracle that’s prone to price manipulation attacks? What if we’re also an AVS

The question of whether end users care or not remains to be seen.

All tokens will compete to become the preferred restaked assets as it imbues them with perceived value and reduces selling pressure. AVSs will have multiple types of restaked assets to choose from, depending on their risk appetite, incentive rewards, specific features, and ecosystem alignment that they want to have.

It is no longer about core economic security but insurance, rehypothecation, and politics.

One area that remains clear is that as every token gets restaked, AVSs will have a lot of choices.

Which assets should I use for economic security, what political alignments do I want to create, and which ecosystem makes the most sense for my products?

Ultimately, this decision comes down to whatever is giving my product the best functionality. Just like how apps are deploying on multiple chains and eventually becoming appchains, AVSs will eventually utilize economic security from whatever assets and ecosystems benefit the most, sometimes even using multiple of them.

This tweet from Jai encapsulates beautifully how most builders will be thinking about restaking benefits.

Obligatory portco shill: we’re already seeing some projects such as Nuffle working to address this situation.

Source: Jai Bhavnani

Conclusion

Crypto Twitter likes to think in absolutes. The reality is that restaking will be an interesting primitive that expands developers’ options and affects the onchain market by issuing a new type of derivative, but it’s not the second coming of Jesus.

At the very least it allows crypto asset holders with higher risk appetite to receive additional yield while expanding the technical options and reducing the engineering overhead for developers. It offers a complementary feature for developers and creates a new derivative market for onchain asset owners.

Many assets will be restaked, giving developers a lot of choices to make before deciding which restaked assets to integrate. Eventually, developers will act just like how they’ve acted when choosing a new chain to deploy on, choosing the restaked asset ecosystem that will benefit their products the most, sometimes even choosing multiple of them.

Tokens will compete to be used as restaked assets as the new derivative markets of rehypothecated restaked assets will benefit the tokens, giving them more widespread usability and perceived value.

It’s never about economic security, but insurance, rehypothecation, and politics.

Reference

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