Why is it the best time to pay attention to liquidity and re-collateralized tokens now?
Original author: IGNAS | DEFI RESEARCH
Translation: Deep Tide TechFlow
Last month, I shared bullish views on two emerging areas in DeFi: Liquid Restaked Tokens (LRT) and Bitcoin DeFi.
Both are exciting and currently in development, but this article focuses on LRT, and I believe now is the best time to pay attention to LRT.
What is restaking? Key points to know
Restaking is a feature of EigenLayer, which is a middleware that allows you to stake your ETH to multiple protocols, called Active Validation Services (AVS), providing security for multiple networks/services simultaneously.
These services typically handle their own security, including bridging, oracles, and sidechains, but we will see some crazy new ideas and concepts emerge in the future.
How it works
EigenLayer acts as a cross-chain bridge that allows you to "restake" your already staked ETH to various protocols - AVS. You can choose to restake ETH directly or use liquidity staking tokens such as stETH, rETH, or cbETH.
Advantages
Capital efficiency: Users can earn rewards from multiple protocols with the same capital.
Enhanced security: EigenLayer enables new protocols to leverage Ethereum's existing security layer.
Developer freedom: Saves developers time and resources in building new security layers.
Risks
Fine risk: Increased risk of losing staked ETH due to malicious activities.
Centralization risk: If too many stakers move to EigenLayer, it may pose systemic risks to Ethereum.
Return risk: High return competition between protocols may dilute staking rewards.
Restaking provides a way to maximize staking rewards and protocol security, but it also comes with its own set of risks, especially regarding fines and centralization.
Introducing Liquid Restaked Tokens (LRT)
EigenLayer's restaking model has a significant drawback for DeFi: once your liquidity staking tokens (LST) are locked in EigenLayer, they become illiquid. You can't trade them, use them as collateral, or use them anywhere else in DeFi.
Liquidity Rehypothecation Token (LRT) provides a solution to enhance returns by unlocking liquidity and adding an additional layer of leverage. Instead of directly depositing LST into EigenLayer, you have the option to deposit through the liquidity rehypothecation protocol. This is similar to our logic with Lido.
The core advantages of LRT include:
Liquidity: Unlock previously staked tokens for use elsewhere in DeFi;
Higher Returns: Increase returns by leveraging;
Governance Aggregator: Rely on DAO or protocol to manage rehypothecation without manual operations;
Compound Returns: Save on gas fees while optimizing returns;
Diversification and Risk Mitigation: If you rehypothecate on Eigenlayer, you are only able to delegate to one operator. LRT allows delegating to multiple different operators, reducing the risk of a single bad actor.
Why I am bullish on LRT
Liquidity Rehypothecation is building a high-yield card house for early adopters.
LRT provides higher returns for the most valuable crypto asset ETH. With LRT, we can earn Ethereum staking rewards (approx. 5%) + Eigenlayer rehypothecation rewards (approx. 10%) + LRT protocol token issuance (approx. 10% and above). It's not hard to imagine earning 25% returns from ETH before the real bull market arrives.
Airdrops. Eigenlayer + AVS + LRT protocol token airdrops.
I believe the unlocked liquidity through LRT (which would otherwise be locked in Eigenlayer) will create more leverage for DeFi, pushing up all TVL figures and the price of ETH in a similar way to what we experienced during the DeFi summer of 2020.
We are still early. Eigenlayer is still in the testing phase, and rehypothecation capacity is limited, so I think the real fun will start when Eigenlayer increases restrictions and new AVS launches that require rehypothecation.
Token Economics and the "LRT War" to come
Even though the LRT protocol token is not yet live, I believe there is a potential game here.
The token economics of the LRT protocol look very appealing, and I think they will develop in a similar way to veTokenomics.
When new AVSes launch securely in Eigenlayer pools, they will offer something valuable to attract ETH rehypothecation. New tokens and captivating narratives will emerge. The first launched AVS might have an easier time attracting liquidity because we have fewer choices.
However, it takes time and expertise to decide which protocol to re-pledge to. Most users would tend to provide AVS with the highest yield.
New AVS may find it more cost-effective to influence the LRT protocol to guide deposits to them, rather than directly attract users/TVL. Obtaining LRT tokens to vote on token issuances may be more effective than providing native token rewards.
For example, a new Bridge X launch requires consensus layer ETH to secure the protocol. The Bridge X team can target Eigenlayer's re-pledging whales and retail investors by offering their own token rewards. However, lobbying to obtain a large amount of re-pledged ETH for the LRT protocol may be easier.
Conversely, this dynamic increases the demand for LRT tokens, especially for tokens that successfully attract a large amount of re-pledged ETH.
As we saw in the "Curve Wars," there may be fierce competition between AVSs vying for DAO votes. However, be careful of the story they sell you: these tokens may be highly inflationary.
Protocols to Watch
Since we are still in the early stages and Eigenlayer is in its initial launch, there are currently no LRT protocols live on the mainnet. This is good news if you want to receive airdrops and need time to keep up with the research.
Some promising LRT protocols include:
Stader Labs
They have launched rsETH, supported by LST accepted by EigenLayer.
rsETH is currently on the testnet. In addition, Stader is not just an LRT protocol. Two months ago, they launched a liquid staking token called ETHx, which has attracted $32 million in deposits. Although Stader may be a bit late to the LST game, it is early in the LRT era.
Stader already has a token SD, and the existence of the token may rule out the possibility of airdrops. However, with the momentum of the LRT narrative, SD may become an attractive bet.
Astrid Finance
Unlike Stader, Astrid has two LRTs instead of one.
You can deposit stETH or rETH (LST) into the pool and receive LRT (rstETH or rrETH) as a reward. These pooled tokens are then re-pledged to EigenLayer and allocated to individual operators by the Astrid DAO.
The earned rewards are automatically compounded, and the balances of rstETH or rrETH holders are determined through balance adjustments.
InceptionLST
Another new protocol being tested online.
You can deposit stETH or rETH to get an LRT called inETH 2.
Astrid and InceptionLST don't have tokens, so interacting with them now could be beneficial for potential airdrops.
Finally, Lido and Rocket Pool could also expand into LRT. I hope they don't because the new LRT project offers higher profit opportunities.
Script
I plan to do the following:
Learn: Since LRT is new, I need to familiarize myself with various protocols and closely follow Eigenlayer's updates.
Due diligence: Before any protocol launches, I test each one. I join their Discord channels and ask about their roadmap, upcoming upgrades, and overall strategy.
Market dynamics: Once Eigenlayer increases the deposit limit, real action will start. It will be important to see which LRT protocol gains the most TVL. I expect the LRT market to mirror the LST market, where one protocol may dominate up to 80% market share.
Risk management: Protecting my ETH capital by taking a conservative approach to the market. Specifically, I will not invest more than 5% of my total ETH holdings in any protocol. I will avoid anything too complex; after all, vulnerabilities, attacks, and exploits are inevitable.
Token strategy: My bet is on LRT governance tokens with attractive "Ponzi token economics" that can build self-sustaining flywheels. These tokens should offer attractive staking rewards, actual revenue incentives, and voting rights on which AVS receives re-staked ETH. Additionally, they need to have a low enough inflation rate to counter any miner selling pressure.
Exit strategy: When the market is euphoric and everyone is talking about LRT governance tokens as the new "metaverse" generating "generational wealth," I will cash out and rotate into ETH. Ideally, I will sell in batches during price upswings rather than all at once.
Review and adjust: Hoping the market will provide new things we haven't seen before, be prepared to learn and adjust. These are the best bets.
Risks: How It Could Crash
Like any financial leverage mechanism, liquidity re-staked tokens carry risks. We are essentially stacking leverage, similar to early DeFi, making the system more vulnerable to market fluctuations and system failures.
Vitalik himself warned that re-staking could introduce complex scenarios that threaten the security of the mainnet, such as fines in third-party chains. The co-founder of EigenLayer also agrees, suggesting that while re-staking can be used for low-risk purposes, unnecessary complexity that could endanger Ethereum's security should be avoided.
However, if history has taught us anything, it's that rehypothecation can be overused. Maximize it by launching AVS that doesn't require access to the Ethereum consensus layer.
However, while Ethereum might be fine, a large influx of new AVS and LRT tokens could dilute the dollar amount and attention entering this industry, leading to a collapse in governance token prices.
So, you see - liquidity rehypothecation tokens are opening a new chapter for DeFi.
