Original title: Reflections on Restaking

By Larry Sukernik & Myles O'Neil

Compiled by: TechFlow

 

“If only you could see yourself in my eyes” — Lost by Dermot Kennedy

"If only you could see yourself in my eyes" - Dermot Kennedy, Lost

At Reverie, we spend a lot of time researching restaking protocols. It’s an exciting investment category for us because the market is still unclear (opportunities often exist in murky markets) and activity is high (dozens of projects are set to launch in the restaking space in the next 12 months).

We have found some observations about how the restaking market will develop over the next few years. A lot of things are new and what is true today may not be true tomorrow. Nonetheless, we would like to share with you some of our initial observations about the business dynamics that are reshaping the market.

Liquid Restaking Token (LRT) as a leverage point

Today, LRTs like Etherfi/Renzo occupy an important position in the restaking supply chain: since they are close to both the supply side (stakers) and the demand side (AVs), they are on both sides of the transaction. If development continues, this will enable LRTs to

(i) determine their commission rate,

(ii) Impacting the rake rate of the underlying market (e.g. EigenLayer, Symbiotic).

Given their strong position, we expect the re-staking market to see the launch of first-party LRTs to gain control over the power of third-party LRTs.

AVS/Re-stakeholders as Leverage Points

The best markets in the world have two characteristics: a decentralized supply side and a decentralized demand side. To develop an intuition for this, it is necessary to look at situations where one or both sides of a market are concentrated. Imagine a simple market for trading apples, where the largest seller of apples controls more than 50% of the supply of apples. In this case, if the market operator decides to increase the market cut from 5% to 10%, the large apple seller could threaten to take her business elsewhere. Similarly, on the demand side, if the largest buyer of apples controls more than 50% of the demand for apples, she could threaten to use another market (or buy directly from the apple supplier) if the market operator increases the market cut.

Returning to the re-pledge market, if the final market structure of the re-pledge market is concentrated on the AVS side (the top 10% of AVS account for more than 50% of the income) or the re-pledger side (the top 10% of re-pledgers account for more than 50% of the deposits), then the natural result is that the market has less ability to extract commissions for itself (and therefore should have a lower valuation).

While there is not enough data to conduct a rigorous analysis, our intuition is that the power law will apply here as well: large AVs will capture the majority of total payment volume and thus have bargaining power over the commission the market ultimately wants to charge.

Compete for exclusive AVS

From the perspective of each re-staking marketplace, any opportunity to do something that competing re-staking marketplaces cannot is worth seizing. The simplest way to differentiate as a re-staking marketplace is to provide re-staking participants with access to exclusive AVS - either first-party like EigenDA, or third-party through an exclusive partnership. This is similar in concept to Sony developing exclusive PS5 games to drive hardware sales.

As a result of these dynamics, we expect the re-staking market to see more first-party AVS launches and/or exclusivity agreements with third-party AVS. In short, the coming months will see a battle for AVS.

AVS Subsidy

AVS needs to pay operators/re-stakeholders for the services provided, which effectively means that AVS needs to be ready to pay in its native token, ETH/USDC, or possibly points/future airdrops. However, since most AVS so far are early-stage startups without tokens, large balance sheets, or well-designed points programs/airdrops, signing up operators/re-stakeholders has proven to be a cumbersome process (most EigenLayer partnerships are custom contracts negotiated privately). Simply put, this is a situation where a customer wants to purchase a service, may have the ability to pay, but does not yet have the funds.

In order to facilitate business, it is highly likely that the re-pledge market will "pre-pay" the launch operator/re-pledgee, either in its native token, balance sheet assets, or possibly by issuing "cloud credits" for AVS to use with operators/re-pledgees. In return for pre-paying funds, you would expect AVS to commit to airdropping/allocating tokens to the re-pledge market. Alternatively, the re-pledge market could pre-pay this money to AVS to convince it to choose you over a competing re-pledge market.

In short, we expect the restaking market to become highly competitive over the next 12-24 months by subsidizing AVS payouts. Similar to the Uber/Lyft market dynamics, the restaking market with the most funds/tokens will likely be the winner in the end.

White glove door-to-door service

Going from “I want to launch an AVS” to “actually putting it into production” is much harder than it looks, especially for small teams without much R&D bandwidth. For example, questions that teams need to answer include: how much security should I buy, how long should I buy it for, how much should I pay operators/restakers, what should I cut, and how much?

Best practices will eventually emerge, but until then, the re-staking market needs to guide the AVS team through these issues (it is worth noting that EigenLayer does not yet have a payment or slashing mechanism). To this end, we expect successful re-staking markets to look a bit like enterprise sales businesses that provide white glove integration/service assistance to customers to use their products.

Graduated from the market

One interesting dynamic that could emerge is that the most successful Additional Validation Services (AVS) in the restaking market eventually leave the restaking market as projects grow and scale, and instead manage their security and validator networks themselves.

Today, restaking proposals are best suited for smaller projects that:

(i) No time/funds/brand/connections to recruit a validator set,

(ii) There are no highly valued tokens to secure the network.

But as projects get bigger, their next step may be to leave the re-staking market and instead recruit their own validator sets, secured with their own (now higher valued) tokens.

In concept, this is similar to dating marketplace dynamics (e.g. Hinge, Tinder), where the most successful customers eventually churn from the marketplace. However, churn is bad news for marketplace operators because you will lose a customer (which is one reason why dating marketplaces trade at lower valuations/multiples than marketplaces with low recurrence/churn).

One-stop encryption SaaS

To illustrate this point, let's first look at the history of software: Cloud providers such as AWS make it easy for developers to get everything they need to develop an application or web service (such as hosting, storage, and computing). By significantly reducing the cost and time required to develop software, a new class of web services has emerged, with more specialized services provided. First-party cloud services combined with the large number of "microservices" provided within the platform allow cloud providers to meet all needs except core business logic in a one-stop shop.

Restaking markets like EigenLayer aim to create a similar set of microservices for Web3. Before EigenLayer, crypto microservices had the choice of fully centralizing their off-chain components (and passing that risk on to their clients), or incurring the cost of launching a set of operators and economic stake to purchase security.

Restaking marketplaces have the potential to break this trade-off for microservices — if everything works as expected, you’ll be able to prioritize security without compromising on cost and speed to market.

Let's say you are developing a cheap, high-performance zk-rollup. If you go to a restaking market like EigenLayer, you will have multiple core service options like DA and bridges for easy onboarding. Along the way, you will also see many other AVS microservices that you can integrate with.

The more microservices that the re-pledge marketplace offers, the better the customer experience will be. Instead of evaluating the capabilities and security of services from dozens of independent vendors, applications will be able to purchase all the services they need from one re-pledge marketplace. Come for service X, stay for services Y and Z.

Some AVS will have network effects (e.g., preconfs)

To date, restaking use cases have primarily focused on exporting Ethereum’s validators and economic stake. But there is also a class of “inward” restaking use cases that can add functionality to Ethereum’s consensus without changing the protocol.

The idea is simple - you allow validators to choose to make additional commitments to the blocks they propose in exchange for a payout, and hold them accountable via slashing if they don't meet those commitments. We doubt that only a few commitment types will have enough demand to attract high levels of participation, but the value flowing in these commitments has the potential to be huge.

Unlike the “external” restaking use case, the effectiveness of this type of use case is directly tied to validator participation. That is, even if you are willing to pay to be included in a block, if only 1 out of 10 validators choose to join in on that commitment, it’s not very useful.

If every validator opts in to a given commitment, then the guarantee behind it will be equivalent to the guarantee provided by the Ethereum protocol itself (i.e. valid blocks). Following this logic, we can expect this category to have strong network effects, as users of AVS will benefit from every marginal validator that opts in to the commitment market.

While this class of AVS is still evolving, logical distribution channels to facilitate these use cases are emerging through Ethereum client sidecars and plugins such as Reth. And, similar to the proposer-builder split, proposers may outsource this work to professional actors in exchange for a revenue share.

What is less clear is what form these AVS will take. While one entity could create a general market for any commitment type, we suspect it is more likely we will see a number of players emerge that specialize based on the source of demand (e.g., L2 interoperability vs. L1 DeFi driven demand).

in conclusion

For students of business strategy, the business dynamics of the re-pledge market are a treasure trove of content that deserves further study.