By LUCA PROSPERI
Compiled by: Block unicorn
I remember having those rare moments of personal revelation while studying principal components and factors in econometrics, where I could appreciate the elegance of mathematical structures in the context of great practical benefits. In principal component analysis (PCA), the covariance matrix of a data set (which contains most of the information about the relationships between variables) is compressed into abstract, reorganized components that are ranked by the amount of information they carry about the data set itself. It turns out that a small number of reorganized components carry most of the information in the data set. These components are the eigenvectors of the covariance matrix, and their corresponding eigenvalues are a measure of the amount of variability in the data set that can be extracted by that component. This linear transformation works so beautifully that we spend most of our time not calculating but naming the principal components we identify.
Re-staking (or double staking) on EigenLayer
As our team often does, we want to screen out the useless noise and extract the valuable parts from a large amount of data or information. Usually, one is contained in the other. ——Block unicorn Note: The process of principal component analysis (PCA). In this process, the covariance matrix of the data set (which contains most of the information about the relationship between variables) is compressed into structured, reorganized components).
But what is noise to EigenLayer? How does EigenLayer define itself? According to its whitepaper, EigenLayer is a re-pledged aggregate — a very simple and powerful feature in the crypto market indeed. But what exactly does a re-pledged aggregate mean? In the pursuit of simplification, I ask the technical experts to forgive my inaccuracies.
In short, EigenLayer enables Ethereum validators to opt-in to new modules built on EigenLayer by pointing their beacon chain withdrawal vouchers to the EigenLayer smart contract. Essentially, modules built on EigenLayer can leverage the security staking currently provided on the Ethereum mainnet to obtain funding support. Introduce additional temporary penalty conditions (because nodes are down or need to be punished for malicious behavior). Therefore, Ethereum validators (validation nodes) can obtain additional income streams by lending out their staked capital in some form for other uses, while on the other hand, security modules built on EigenLayer can leverage the existing Ethereum validator pool (staking vouchers such as stETH). Naturally, these additional modules must provide appropriate incentives for Ethereum validators to provide this increased security, which is the so-called re-staking process.
What everyone knows is that the team emphasized the ability to effectively unlock the staked ETH pool and highlighted the obvious advantages - we restate the white paper's point below and take it at face value for the time being:
For those modules built on Ethereum, no additional security layer is required, nor is another digital asset (token) required as security collateral.
This reduces fee overflow for users who no longer interact with the dedicated module (but only indirectly with Ethereum).
For stakers, capital (opportunity) costs can be reduced - this is the cost associated with the need to lock up capital to (purchase and) lock up specific security tokens. Block unicorn Note: For those stakers, they can reduce the capital costs incurred by the need to lock up capital to purchase and lock up specific security tokens (stETH). The "capital (opportunity) cost" here means that in order to purchase and lock up specific security tokens, stakers need to lock up their capital in this process, which means that they cannot use this part of the capital for other investments that may bring returns. This is the so-called opportunity cost. With EigenLayer, stakers can use their staked capital for other purposes, thereby reducing this part of the opportunity cost.
For DApps, the (security) startup costs can be reduced — considering that the initial risk capital in staked tokens can be significantly reduced.
Three of the four main advantages highlighted in the whitepaper are financial rather than technical. These advantages primarily relate to the structural costs associated with ensuring minimum viable security for users of decentralized applications. Given the financial tone of these statements, I thought it would be helpful to view them from the perspective of company (or indeed protocol) finances.
From a company or protocol finance perspective, these advantages can help reduce operating costs and improve capital efficiency, thereby improving the company's financial performance. For example, reducing the capital (opportunity) cost of locking up capital to purchase and lock up a specific security token can allow a company to use its capital more efficiently, thereby improving its return on capital.
In addition, lower (security) startup costs for DApps means that they can start and operate their applications with lower initial investments, which may attract more entrepreneurs to enter this field, thereby promoting the development of the entire ecosystem.
Collectively, these financial advantages can not only improve the company’s financial performance, but also drive the development of the entire cryptocurrency and blockchain ecosystem.
Security from a company (or protocol) financial perspective
Blockchain significantly reduces the cost of building, launching, and maintaining/developing applications by providing a common computing layer available. If we ignore these costs and simply view the computing layer as a public good, we can conceptualize that projects require financial resources to create and control an asset commonly known as security. Typically, security in DApps is achieved by requiring external parties to invest in protocol-specific tokens, which must be put at risk to ensure incentive alignment. To attract these investors, tokens offer some yield and, in the best case scenario, some residual claim to the protocol economy.
In protocol finance terms, it’s fair to say that protocols raise their security capital through the use of proxy equity instruments, which can be either pure or preferred, depending on the type of financial mechanism they’re attached to. From a protocol finance perspective, equity financing is actually the highest-cost source of funding for a company when markets are operating efficiently; if there’s a venture capitalist willing to invest in your startup and not come after you for the money invested even if the project fails, you can rest assured that a good investor has embedded in the valuation of such a company the 30-50% internal rate of return (or IRR) he or she expects to earn on some form of equity cash flow. This is an extremely dilutive form of financing for the team, even if the probability of success is relatively high.
In the token space, dilution occurs not only by giving up company ownership in exchange for cash financing, but also through often highly dilutive incentives to attract capital contributions from security providers (and often users) (which is rarely done with equity financing in crypto markets). When viewed through the super-simplistic flowchart above, token incentives further reduce ownership of best-case future valuations, and therefore further depress expected valuations today. Frankly — in my personal opinion, if we look at private valuations today, we can infer that those are more of a mispriced bet on the public market.
Lower Opportunity Cost → EigenLayer’s view is that equity-like instruments are a very expensive form of financing, and some form of rehypothecation of other types of instruments is a more efficient way to fund atomic security for a single protocol, which is absolutely not wrong from a financial perspective.
Elegantly, if we think of Ethereum as a sovereign economic system with its own rules and enforcement mechanisms, where investors (or citizens) assess risk directly with $ETH rather than dollars, then the process of allowing these investors to pledge $ETH for security is akin to allowing lenders to finance a company’s assets through a less volatile hybrid form of debt. This type of debt, even at the lowest level physically possible, is cheaper than equity in a particular project. The effect will be to reduce the cost of capital for projects and lower the barrier to innovation.
EigenLayer's description of trust enforcement (i.e. security) is very elegant. The research team identified three sources of trust available to developers:
Economic feasibility: The relative amount of risk capital reflects the investor's confidence level in the project.
Decentralization-based: Inferred from having a sufficiently decentralized network of independent and isolated operators.
Related to inclusion: Ethereum validators have the power to propose blocks and run the consensus software, so their privileged position creates a sense of trust.
Here, given the nature of the research I do (and my limited capabilities) and the far-reaching significance of this phenomenon, we focus on economic-based trust. Staking incentive alignment is not new in the trading space, providing transparent and observable consistency and enabling timely correction of misconduct. However, this approach is inherently inefficient in the use of capital because it requires locking up a large amount of resources in an unproductive way to ensure trust, a topic we explored above and a problem that EigenLayer wants to alleviate.
Insufficient economic security and market efficiency
EigenLayer places a heavy emphasis on the ability to significantly reduce the cost of economic security by re-hypothecating $ETH as an alternative to native equity-like instruments. From a protocol finance perspective, do I agree with this statement? My answer is, it depends on who is asking.
For $ETH-denominated investors, it makes a lot of sense to save a lot of costs by using $ETH instead of similar equity instruments. But for USD-denominated investors, it is less so. For investors who think, value and price in USD, using $ETH instead of the native staking token is not very effective in reducing risk and gaining additional yield. Fortunately or unfortunately, 99.99% of investors and builders in this space think, value and price in USD.
When will new tokens be issued or launched? Realistically, project-specific tokens with some form of governance function, utility, economic or scarcity claims, whether or not they are actually securities, are viewed by investors as proxies for project success or visibility. Market sentiment holds this view even without any remaining financial or control claims. In smaller industries like cryptocurrencies, tokens are often more tied to narratives or expected liquidity changes than cash flows. Regardless of how we look at it, it is clear and provable that in cryptocurrencies, the market for representing equity is far from efficient, and token prices that are higher than rationally recognizable mean that the cost of capital for projects is lower than what is rationally expected. Typically, low-cost capital is reflected in lower dilution rates in venture capital rounds, or higher valuations than other industries. It can be said that due to the market inefficiencies that exist in the capital markets as a whole, the cost of capital for project creators using native tokens is lower than using $ETH (Block unicorn note: Most projects will issue their own tokens, and using their own tokens can have lower costs, re-customize capital allocation, and better match the continued development of the project).
Double Staking Allows → Rather than working in isolation, the EigenLayer team is actively aware of and engaged with the surrounding landscape and trends, as can be seen in the last section of the whitepaper, on multi-token arbitration. In what has come to be known as double staking, Verifiable Security (AVS) can specify multiple arbitrations, one based on staked $ETH and another based on the native token. While EigenLayer has identified the project’s definition of a more precise consensus system as a key goal of double staking, we cannot overlook that this mechanism is really meant to satisfy the desire to launch a native token to provide investors and the team with a proper exit liquidity window. Ironically, taking this approach may inadvertently exacerbate native token confusion, lead to significant bad choices, and increase inherent capital costs for builders — who have largely raised funds through (pre)sales of tokens.
In their whitepaper, the EigenLayer team further describes a market for efficiently allocating $ETH resources, further reducing funding costs, and increasing pooled security, although it’s still not entirely clear to me how this benefit is achieved. The whitepaper describes how the protocol maximizes re-staking flexibility by providing appropriate ways for independent stakers, LST (liquidity stake token) holders, or LP token holders to interact with the EigenLayer smart contracts — what are known as superfluid stakers (with super high liquidity and yield). While these are various approaches to wrapping Ethereum’s native yields and enhancing its interoperability, each has its own financial and technical risks, and we’ll leave these differences aside for now as they are not directly relevant to the analysis of the EigenLayer protocol itself.
ETH being staked
According to the latest data (March 11th), there is about $12 billion worth of staked $ETH (or about 3.1 million $ETH) deposited in EigenLayer contracts, of which about 1.3 million $ETH is staked natively and the rest is in the form of LST, with Lido having the largest share. The total value locked (TVL) has grown significantly since the protocol launched, making EigenLayer the second largest Ethereum DeFi protocol based on DefiLlama data, second only to Lido. The irony of the double counting between Lido’s $stETH and Lido’s re-staked $stETH did not escape my attention.
The process of restaking on the platform depends on the type of restaking. LSD (Liquid Staking Token) can be easily re-staked by interacting with the front end, and the deposit limit of LSD has been reached. Local restaking is slightly more complicated and involves creating an EigenPod contract and defining a set of validators to extract credentials. We do not intend to (and cannot) provide a technical overview of EigenLayer, but instead intend to focus on the financial and incentive implications of the setup.
According to this excellent Dune dashboard, the total $ETH supply is ~$120M, ~26% is currently staked, with ~2.5% re-staked to ~116,000 deposit wallets on EigenLayer. That’s a lot of numbers. The demand side (Rollups that can verify security and benefit from re-staking pools) is growing, but this is definitely just the beginning.
EigenLayer Integration
So why should $ETH stakers participate in the pooled restaking community? At the peak of the 2020-2022 bull run, the answer was tokens. But today, the answer is points, and that’s a big difference.
Points are loyalty measures stored and verified off-chain that theoretically provide the right to participate in future airdrops or digital token distributions. In other words, they are a loose derivative of a digital asset, providing holders with a degree of comfort that they will receive digital assets, most likely in the form of airdrops, with some financial value in the more distant future. If tokens are a (usually poor) proxy for equity interests in a project, then points are a proxy for that proxy, with less certainty and rights.
EigenLayer users earn points based on their re-staking time and amount - $ETH re-staking units per hour. For example, staking 1 $stETH for 10 days will generate 240 re-staking points, and about 2 billion re-staking points have been issued so far.
A measure of the participation of a depositor i at time t for a certain amount of token j, measured in nominal units of $ETH
While there is no guarantee that points will be converted into tokens via a future airdrop, users expect EigenLayer’s Token Generation Event (TGE) to occur sometime between Q2 and Q3 2024.
Other protocols also quickly began to create aggregate structures on top of the EigenLayer points exposure. For example, on Etherfi, users can earn $eETH, a native re-staked liquid staking token. Yes, you read it right, it is a derivative of a derivative of a re-staked digital asset. Users will be able to convert staking rewards with re-staking rewards and loyalty points into re-staked points. Swell, Kelp, StakeWise provide similar functionality, and this trend has already emerged.
Let me summarize because there are so many factors at play — oh boy, I might miss the best of the bull run: Protocol points earned in the bull run, promising exposure to future (hypothetical) token airdrops, to accumulate liquidity and provide to another protocol (EigenLayer) in exchange for another type of points, promising exposure to future (hypothetical) token airdrops, to launch a re-staking pool designed to avoid creating the project’s token in the first place. If you recall the Curve wars, you are not alone.
Where does the money come from? We are not a research venue focused on technical or trading topics, but rather on value analysis, aiming to deepen our understanding of economic designs in the hope of helping us improve those designs. Any value analyst should start by asking where the money comes from, and the relationship between expected economic returns and money flows. In a pure system, using $ETH entirely as an economic security instrument for AVS (verifiable security), economic value is primarily in (i) the issuance of $ETH (staking returns) and (ii) asset appreciation, achieved through lower supply and/or higher demand. For reference, currently (thanks to the ultrasonic crowd) Ethereum offers ~$1 billion in profits, or ~500x P/E at current prices, an incredible value if we exclude any implied monetary premium. However, we do not have to estimate the implied returns of $ETH to assess whether storing value in EigenLayer is reasonably priced - multi-staking makes it so that $ETH stakers do not give up these returns.
What is the market pricing in the value stored in EigenLayer, and why? KelpDAO tokenizes EigenLayer credits 1-to-1 through $KEP tokens, which helps us (analysts) analyze. At the time of writing, these tokens are trading at around $0.133 each, which means that staking one more unit of $ETH for a year would earn 8,760 credits or $1,165, or 30% additional yield at current (higher) $ETH prices. What could justify this 30% gain?
1. Additional destruction due to increased staking on Ethereum
2. Additional requirements for Ethereum as a consensus layer
3. Improve the user experience of DApp and AVS, thus bringing about the effects of (1) and (2)
4. A certain degree of economic capture for future re-staking of EigenLayer tokens
5. Market dynamics (which I am going to ignore)
Interestingly, even if we take (1), (2), and (3) as reality, EigenLayer is more like a public good with positive externalities than anything else. (4) is barely enough to justify a 30% return premium over $ETH at current prices. The most likely is (5) - betting on the "total locked value goes up, the token will go up" heuristic. While EigenLayer may indeed represent a major innovation for projects to leverage by standardizing the design and enforcement practices of protocol security, and I sincerely believe it has that potential, the data don't quite match up from a values perspective. a16z recently announced a $100 million investment in the company, and interestingly, the announcement mentioned contributions to the public good; for a16z, investing in improving the Ethereum ecosystem more broadly makes economic sense given their broader investments in this area. Therefore, the investment in EigenLayer should be viewed holistically, rather than in isolation.
Risk and irony
The nominal return analysis performed above is obviously superficial, not risk-adjusted, and excludes the additional smart contract risk faced by re-stakers, penalty risk at the AVS (verifiable security) level, and the potential negative return impact of turbulence in the $ETH consensus layer due to the integration of re-staking. Re-staking is indeed a dangerous factor that increases opacity and systemic risk. I recommend that those who have trouble sleeping read a 2017 report from the Financial Stability Board on this topic.
So why doesn’t EigenLayer take this approach itself? Why not simply develop a useful, standardized staking framework, rather than promote its adoption through the financialization of the same tokens it aims to partially obsolete? Because this is crypto, folks, people need to pay their bills, may the bull market forgive us all.
