The new liquidity re-pledging platforms, such as Puffer and Ether.Fi, have attracted billions of dollars in deposits, but they have also sparked a risky "point" frenzy.
Author: Sam Kessler / Source
Translation: Plain Blockchain
In just the past month, billions of dollars have poured into new Ethereum-based liquidity re-pledging projects, such as Ether.Fi and Puffer. These emerging platforms are vying to replace Lido's staked ETH (stETH) token as the preferred asset for decentralized finance (DeFi) traders.
At the core of the entire trend is the development of a new protocol called EigenLayer, which first introduced a new "re-pledging" system in June last year. The platform is building a solution that allows blockchain applications and networks to borrow the security of Ethereum and has attracted over $1 billion in new deposits in a 24-hour period this month. Now, the total amount exceeds $7 billion, which according to DefiLllama's data, means that the platform alone has accumulated over 1.5% of the circulating Ether (ETH).
Re-pledging provides a way to protect blockchain protocols and networks using the security borrowed from Ethereum's proof-of-stake network. ETH deposits in EigenLayer can be "re-pledged" to other protocols, meaning they do not have to build their own proof-of-stake network.
Investors have flocked to EigenLayer because it promises higher interest rates than traditional ETH staking. However, the recent growth of the platform is mainly attributed to a group of third parties - "liquidity re-pledging protocols" such as Ether.Fi, Puffer, and Swell, which claim to simplify the re-pledging process on behalf of users.
These liquidity re-pledging platforms act as intermediaries between users and EigenLayer: these platforms re-pledge users' deposits to EigenLayer and deliver the corresponding newly generated LRT in exchange, allowing users to continue trading even when their deposits are used for re-pledging.
LRT represents users' deposits in EigenLayer, meaning they can accumulate staking interest and can be exchanged back for their underlying value. LRT can also be used in DeFi, meaning people can borrow and exchange LRT for greater returns.
In addition to the convenience of LRT, the recent real attraction of liquidity re-pledging platforms lies in the "points" - these rewards may qualify users for future token airdrops. Although the monetary value of points is unclear, they have spawned a whole new additional platform ecosystem, such as Pendle, which allows users to maximize points through trading strategies that typically involve high leverage.
This complex points system, high returns, and high-risk trading strategies inevitably bring to mind the situation in 2021 - "yield farming" and the pursuit of high returns sparked the boom and bust of DeFi, and the industry has not fully recovered to this day. Although some experts are cautious about the risks of liquidity re-pledging, supporters of this technology insist that there is real substance beyond speculation.
1. Staking 101
Liquidity re-pledging is built on the foundation of two years of growth in the Ethereum staking industry.
Ethereum is operated by over 900,000 validators, who are addresses from people around the world locking ETHToken on the network to help secure the chain. Staked tokens accumulate stable interest, but once they are used to run the network, they cannot be used for other purposes, such as loans or other types of investments.
This limitation has led to the rise of "liquidity staking". Services like Lido represent users for staking and give them "liquidity staking tokens" (LST) representing their underlying deposits. Like Lido's staked ETH (stETH) token, LST can earn interest like regular staked Ether (currently about 3%), but they can also be used in DeFi - meaning investors can borrow these tokens to earn additional returns.
The liquidity staking industry has flourished in the past few years. The largest liquidity staking protocol to date, Lido, has over $25 billion in deposits. Its staked ETH (stETH) token often sees higher trading volumes in the network's largest borrowing protocols than regular ETH.
2. From Liquidity Staking to Liquidity Re-pledging
Now, a similar liquidity staking trend is emerging on EigenLayer, a highly anticipated new protocol introducing re-pledging to Ethereum.
"EigenLayer has essentially built a tool that allows other networks to leverage the security of Ethereum," explained Austin Kim, CEO of Omni Labs, who is building a re-pledging-driven bridging protocol.
Investors have turned to EigenLayer to earn additional rewards on their ETH: on one hand, for the interest earned in protecting Ethereum, and on the other hand, for the re-pledging interest earned in protecting the so-called AVS (Active Verification Services) using Ethereum security through EigenLayer.
According to EigenLayer, these AVS will eventually include Celo, which is a first-layer blockchain transitioning to a second-layer network based on Ethereum; EigenDA, EigenLayer's own data availability service; and Omni, which is building bridging infrastructure to help different blockchain networks communicate with each other.
However, the system also has drawbacks, with a key issue being that tokens re-pledged through EigenLayer cannot be used in DeFi after deposit. This locking mechanism is a major disadvantage for investors looking to maximize returns.
As a result, liquidity re-pledging has emerged, essentially designed as liquidity staking for EigenLayer.
Liquidity re-pledging protocols accept deposits (such as stETH), re-pledge through EigenLayer, and then issue "liquidity re-pledging tokens," such as pufETH, eETH, and rswETH, which can be used in DeFi to earn additional points and other rewards.
Explained by relevant parties: "It's basically the value proposition of staked ETH, where you can earn staking rewards without the hassle of setting up validator nodes. Not only that, but you can also be compensated for any rewards brought by these AVS networks."
3. Incentive Game
Puffer's pufETH, Ether.Fi's eETH, Swell's rswETH, and other liquidity re-pledging tokens (LRTs) are competing with Lido's stETH to become the next important asset in DeFi. To achieve this, they have turned to the current incentive model in DeFi: points.
Although EigenLayer has already received billions in deposits, its AVSs have not yet been activated, meaning depositors have not received interest on their deposits. Currently, the main incentive for depositing tokens into EigenLayer is re-pledging points, which is a vaguely defined count that investors hope will qualify them for future confirmed EigenLayer airdrops.
"EigenLayer has not been activated, it has no re-pledging," said Amir Fouladani, CEO of Puffer Finance, in an interview with CoinDesk last month. "Their only incentive now is points, which is basically a speculation on the future value of these points." Major liquidity re-pledging protocols (including Puffer) have started offering their own points as an additional incentive for early investors.
Around the points exchange, new services have emerged, promoting high-risk trading strategies involving repeated re-pledging of the same token - increasing exposure to the protocol at the expense of higher future returns.
One of the protocols is Pendle, which divides liquidity re-pledging tokens into two separate tokens - Yield Tokens and Principal Tokens - to unlock leveraged trading. One of Pendle's products accepts deposits of Ether.Fi's eETH Token and, according to the website's advertisement, can earn 45 times the Ether.Fi points and 15 times the EigenLayer points.
While the points are still highly speculative, they seem to have a positive impact on liquidity re-pledging deposits. According to data from DeFiLlama, the market leader Ether.Fi now has $1.2 billion in deposits, five times more than a month ago. Puffer Finance follows closely with $970 million in deposits, a tenfold increase in just the past three weeks.
4. Penalty Risks
With the surge in liquidity re-pledging deposits, the risks of this trend are also increasing.
On one hand, the general risk associated with EigenLayer is the complexity of putting funds into a complex system composed of layered protocols: as the complexity of interconnected AVS networks increases, errors are inevitably more likely to occur.
The greatest risk of these errors will be "penalties," which result in economic penalties for depositors due to violations of network rules or using flawed software to connect to the network. Liquidity re-pledging protocols often mention "anti-penalty" features in their marketing, but these promises will not be validated in practice until the AVSs start running.
In the context of EigenLayer re-pledging, penalties occur at the AVS level: each AVS will set its own penalty rules, and liquidity re-pledging providers will be able to choose which AVS protocols they want to validate for users. If a liquidity re-pledging platform chooses to validate a network with malicious (or flawed) penalty parameters, it exposes users to the risk of their deposits being slashed.
"We will build a similar reputation system in the broader re-pledging ecosystem," predicted Riad Wahby, CEO of key management service company Cubist, in an interview with CoinDesk. "If I'm going to put funds into an operator, I'm likely to choose one that gives me the right balance between risk and reward."
5. Speculative Risks
The most obvious risk of liquidity re-pledging is that, despite billions of dollars in deposits, the practice is currently highly speculative.
AVSs may not be able to provide depositors with the expected interest returns, which could lead investors to leave the system in search of more profitable betting opportunities. Amid all the excitement about points, there is also the possibility that the associated airdrops may fail or never occur, rendering the points and the new markets built on them almost worthless.
The risk of this outcome is magnified by the fact that points are usually not issued on the blockchain but tracked directly by the issuer. This makes it difficult to know how much of a specific type of points is in circulation, making it difficult to determine their value.
The speculative allure of liquidity re-pledging points is reminiscent of the days of yield farming. In 2021-2022, when the DeFi industry reached its peak, funds poured into projects like Olympus and Terra, which promised market-leading returns to users in exchange for trust in their complex systems. Critics accused these projects of creating worthless tokens and printing them at will to artificially support yield figures, and after these platforms collapsed, these criticisms were ultimately proven correct.
Regardless of the surface similarities, EigenLayer has entered the minds of Ethereum developers in a way that yield farming's worst actors never did, and supporters of liquidity re-pledging argue that it has the potential to support the development of applications and infrastructure beyond the narrow realm of points and gamified speculation.
Source: Coindesk
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