Author: Baiding & Jomosis, Geek web3

Introduction: Restaking and Layer2 are important narratives in the current cycle of the Ethereum ecosystem. Both aim to solve existing problems in Ethereum, but their specific paths differ. Compared to complex technical means such as ZK and fraud proof, Restaking is more about empowering downstream projects economically. It may seem like just staking assets and earning rewards, but its principles are not as simple as imagined.

It can be said that Restaking is like a double-edged sword. While empowering the Ethereum ecosystem, it also brings huge risks. People have different opinions on Restaking. Some say it brings innovation and liquidity to Ethereum, while others say it is too utilitarian and accelerates the collapse of the crypto market.

Undoubtedly, to determine whether Restaking is a panacea or a poison, it is necessary to understand what it is doing, why it is being done, and how it is being done in order to draw an objective and clear conclusion. This is also important for determining the value of its token.

When it comes to Restaking, Eigenlayer is an inevitable example. Understanding what Eigenlayer is doing means understanding what Restaking is doing. This article will use Eigenlayer as an example to introduce the business logic and technical implementation of Eigenlayer in the clearest and most understandable language, analyze the impact of Restaking on the technical and economic aspects of the Ethereum ecosystem, and its significance for the entire Web3.

Explanation of Restaking and Related Terms

Everyone knows that Restaking refers to "restaking," and it originally took root in the Ethereum ecosystem and became popular after Ethereum's transition to POS in 2022. What is "restaking"? Let's first introduce the background of Restaking, namely PoS, LSD, and Restaking, so that we can have a clearer understanding of Restaking.

1. POS (Proof of Stake)

Proof of Stake, also known as "POS," is a mechanism that probabilistically allocates the right to record transactions based on the amount of assets staked. Unlike POW, which allocates the right to record transactions based on the participants' computing power, it is generally believed that POW is more decentralized and closer to permissionless than POS.

On September 15, 2022, with the Paris upgrade, Ethereum officially transitioned from POW to POS, completing the merge of the mainnet and the beacon chain. The Shanghai upgrade in April 2023 allowed POS stakers to redeem their assets, confirming the maturity of the Staking model.

2. LSD (Liquid Staking Derivatives Protocol)

As we all know, the interest rate for Ethereum PoS staking mining is quite attractive, but retail investors find it difficult to access this part of the income. Apart from the requirement for hardware equipment, there are two reasons:

First, the staked asset amount of Validators must be 32 ETH or a multiple thereof, making it unattainable for retail investors.

Second, before the Shanghai upgrade in April 2023, users could not withdraw the staked assets, resulting in low capital utilization efficiency.

To address these two issues, Lido emerged. It adopts a staking model called collective staking, where users deposit their ETH on the Lido platform, which aggregates them as assets staked when running Ethereum Validators. This solves the pain point of insufficient funds for retail investors.

Furthermore, users who stake their ETH on Lido will receive stETH tokens anchored to ETH at a 1:1 ratio. stETH can be exchanged back to ETH at any time and can also be used as a token equivalent to ETH on mainstream DeFi platforms such as Uniswap and Compound to participate in various financial activities. This solves the pain point of low capital utilization efficiency in the POS Ethereum.

Since POS involves staking highly liquid assets, products led by Lido are called "Liquid Staking Derivatives" (LSD), which is what we commonly refer to as "LSD." As mentioned earlier, stETH, known as a liquid staking token (LST), is a derivative token of ETH.

It is easy to see that the ETH staked in the POS protocol is a genuine native asset, while tokens like stETH, which are anchored to ETH, are created out of thin air. This can be understood as creating a "financial leverage" in economics. The role of financial leverage in the entire economic ecosystem is not simply good or bad and needs to be analyzed in specific cycles and environments. It is important to remember that LSD adds the first layer of leverage to the ETH ecosystem.

3. Restaking

Restaking, as the name suggests, involves staking LST tokens as staked assets to participate in more POS network/public chain staking activities to earn rewards and help enhance the security of more POS networks.

After staking LST assets, a staker will receive a 1:1 staking certificate for circulation, known as LRT (Liquid Restaking Token). For example, staking stETH will yield rstETH, which can also be used to participate in DeFi and other on-chain activities.

In other words, the LST tokens created out of thin air in LSD are staked again, creating a new asset out of thin air through Restaking, namely the LRT asset, adding a second layer of leverage to the ETH ecosystem.

The above is the background of the Restaking track. At this point, there is certainly a question: the more leverage there is, the more unstable the economic system becomes. The layer of LSD can be understood, as it solves the problems of retail investors' inability to participate in POS and increases capital utilization efficiency. However, the necessity of the layer of leverage introduced by Restaking, and why LST tokens created out of thin air need to be staked again, is a different matter. This involves both technical and economic aspects. In response to this question, the following text will briefly outline the technical structure of Eigenlayer and then analyze the economic impact of the Restaking track, and finally provide a comprehensive evaluation of it from both technical and economic perspectives.

(So far, this article has introduced many English abbreviations, among which LSD, LST, and LRT are core concepts, which will be mentioned multiple times later. Let's reinforce our memory: the ETH staked in the POS is a native asset, and the stETH anchored to the staked ETH is LST. The rstETH obtained by staking stETH on the Restaking platform is LRT.)

Product Features of Eigenlayer

We must first clarify the core problem that EigenLayer aims to solve in terms of product features: to provide economic security from Ethereum to some underlying security-based POS platforms.

Due to its substantial staked asset amount, Ethereum has extremely high security. However, for some off-chain execution services, such as Rollup sequencers or Rollup verification services, their off-chain execution parts are not under Ethereum's control and cannot directly obtain Ethereum's security.

If they want to achieve sufficient security, they need to build their own AVS (Actively Validated Services). AVS is a "middleware" that provides data or validation services for DeFi, games, wallets, and other end products. Typical examples include "oracles" that provide data quoting services and "data availability layers" that can provide users with the latest data status.

But building a new AVS is quite difficult because:

1. The cost of building a new AVS is very high and takes a long time.
2. The staking of a new AVS often uses the project's native token, which has much weaker consensus than ETH.
3. Participating in staking for a new network AVS will cause stakers to miss out on stable returns from staking on the Ethereum chain, resulting in opportunity costs.
4. The security of a new AVS is much lower than that of the Ethereum network, and the economic cost of attacks is very low.

If there is a platform that allows early-stage projects to directly lease economic security from Ethereum, the above problems can be solved.

Eigenlayer is such a platform. Eigenlayer's whitepaper is titled "The Restaking Collective," with the characteristics of "Pooled Security" and "free market."

In addition to ETH staking, EigenLayer collects staking certificates from Ethereum to form a security leasing pool, attracting stakers who want to earn additional income to restake. It then leases the economic security provided by these staked funds to some POS network projects, which is the "Pooled Security."

Compared to the unstable and potentially changing APY in traditional DeFi systems, Eigenlayer uses smart contracts to clearly specify staking returns and penalty rules, allowing stakers to freely choose and earn returns. The process of earning returns is no longer an uncertain gamble but has become an open and transparent market transaction, which is the "free market."

In this process, project parties can lease security from Ethereum without having to build their own AVS, while stakers receive stable APY. In other words, Eigenlayer not only improves ecosystem security but also provides income for ecosystem users.

Eigenlayer's Security Provision Process is completed by three roles:

• Secure Lender - Staker (Staker) - Stakes funds to provide security
• Secure Intermediary - Operator (Node Operator) - Responsible for helping Stakers manage funds and helping AVS perform tasks.
• Secure Recipient - AVS of middleware such as oracles.

Someone has made an analogy for Eigenlayer: comparing it to the upstream and downstream of a shared bicycle. The shared bicycle company is equivalent to Eigenlayer, providing market services for LSD and LRT assets, similar to how a shared bicycle company manages bicycles. The bicycle is equivalent to LSD assets, as they are both assets that can be leased. The rider is equivalent to middleware requiring additional validation (AVS), just as the rider rents a bicycle, AVS rents LSD assets for network validation services to ensure their own security.

In the shared bicycle model, deposits and liability constraints are used to prevent malicious damage to the bicycles. Similarly, Eigenlayer uses staking and penalty mechanisms to prevent malicious behavior by participating validators (Operators).

Smart Contract Perspective of EigenLayer Interaction Process

Eigenlayer's core security provision ideas are staking and slashing. Staking provides basic security for AVS, while slashing increases the cost of malicious behavior for any party.

The interaction process for staking is shown in the following diagram.

In Eigenlayer, the main interaction with stakers is through the TokenPool contract. Stakers can perform two operations through TokenPool:

Staking - Stakers can stake assets in the TokenPool contract and specify a specific Operator to manage the staked funds.

Redemption - Stakers can redeem assets from the TokenPool.

Staker's redemption of funds involves three steps:

1) Staker adds the redemption request to the request queue, requiring a call to the queueWithdrawal method.

2) The Strategy Manager checks if the Operator specified by the Staker is in a frozen state.

3) If the Operator is not frozen (detailed description follows), the Staker can initiate the complete withdrawal process.

It is important to note that EigenLayer gives Stakers full freedom. Stakers can liquidate their staked funds back to their own accounts or convert them into staking shares for re-staking.

Based on whether Stakers can personally run node facilities to participate in the AVS network, Stakers can be divided into regular stakers and Operators. Regular stakers provide POS assets for each AVS network, while Operators are responsible for managing the staked assets in the TokenPool and participating in different AVS networks to ensure the security of each AVS. This is somewhat similar to Lido's approach.

Stakers and AVS are like fragmented security supply and demand. Stakers often do not understand the products of AVS project parties, cannot trust them, or do not have the resources to directly participate in the AVS network; similarly, AVS project parties often cannot directly reach Stakers. Although they are in a supply and demand relationship, they lack an intermediary to connect with each other. This is where the role of the Operator comes in.

On one hand, the Operator helps stakers manage funds, and stakers often have a trust assumption about the Operator. EigenLayer's official explanation of this trust is similar to the trust stakers have in the LSD platform or Binance staking. On the other hand, the Operator helps AVS project parties operate nodes. If the Operator violates the restrictions, malicious behavior will be slashed, making the cost of malicious behavior far exceed the benefits, thereby establishing trust between AVS and the Operator. In this way, the Operator becomes a trusted intermediary between stakers and AVS.

Operator must first call the optIntoSlashing function of the Slasher contract to allow the Slasher contract to constrain/punish the Operator.

After that, the Operator needs to register through the Registery contract. The Registery contract will call the relevant functions of the Service Manager to record the Operator's initial registration behavior and then transmit the message back to the Slasher contract. Only then will the Operator's initial registration be completed.

Now let's look at the contract design related to slashing. In Restaker, Operator, and AVS, only the Operator will be the direct subject of slashing. As mentioned earlier, for an Operator to join the Eigenlayer platform, they must register in the Slasher contract and authorize the Slasher to carry out slashing operations against the Operator.

Of course, in addition to the Operator, the slashing process also involves several other roles:

1. AVS: While the Operator accepts the commission from the AVS operation, they also have to accept the triggering conditions and standards for slashing proposed by the AVS. Two important contract components to emphasize here are the dispute resolution contract and the Slasher contract.

The dispute resolution contract is established to resolve challenges from challengers, and the Slasher contract will freeze the Operator and carry out slashing operations after the challenge window ends.

2. Challenger: Anyone who joins the Eigenlayer platform can become a challenger. If they believe that the behavior of a certain Operator triggers the conditions for slashing, they will initiate a fraud proof process similar to OP.

3. Staker: Slashing of the Operator will also result in corresponding losses for the Staker.

The process for executing slashing against the Operator is as follows:

1) The challenger calls the challenge function in the Dispute Resolution contract established by AVS to initiate a challenge.

2) If the challenge is successful, the Dispute Resolution contract will call the freezeOperator function of the Service Manager, causing the Slasher contract to trigger the OperatorFrozen event, changing the specified Operator's status from unfrozen to frozen, and then entering the slashing process. If the challenge fails, the challenger will receive a certain penalty, to prevent malicious challenges against the Operator.

3) After the slashing process is completed, the Operator's status will be reset to unfrozen and continue to operate.

Throughout the process of executing slashing, the Operator's status is always in a frozen "inactive" state. In this state, the Operator cannot manage the funds staked by stakers, and stakers who have staked funds with this Operator cannot withdraw them. It's like being under a cloud of suspicion and unable to escape punishment. Only when the current penalty or conflict is resolved and the Operator is not frozen by the Slasher, can they engage in new interactions.

All contracts in Eigenlayer adhere to the above freezing principle. When a staker stakes funds with an operator, the isFrozen() function is used to check the Operator's status. When a staker initiates a request to redeem their staked funds, the isFrozen function of the Slasher contract is still used to check the Operator's status. This is Eigenlayer's comprehensive protection of AVS security and staker interests.

Finally, it should be noted that within Eigenlayer, AVS does not unconditionally obtain security from Ethereum. Although the process for project parties to obtain security on Eigenlayer is much simpler than building their own AVS, attracting Operators on Eigenlayer to provide services and attracting more stakers to provide assets for their POS systems is still a challenge, which may require effort in terms of APY.

The Economic Impact of Restaking on the Crypto Market

There is no doubt that Restaking is currently one of the hottest narratives in the Ethereum ecosystem, and Ethereum occupies a significant position in Web3. In addition, various Restaking projects have gathered a very high TVL, making it crucial for the crypto market. We can analyze its impact from both micro and macro perspectives.

Micro Impact

We must recognize that the impact of Restaking on various roles in the Ethereum ecosystem is not singular, and it brings both income and risk. Income can be divided into the following points:

(1) Restaking indeed enhances the underlying security of downstream projects in the Ethereum ecosystem, which is beneficial for their long-term development.

(2) Restaking frees up the liquidity of ETH and LST, making the economic circulation in the ETH ecosystem smoother and more prosperous.

(3) The high yield of Restaking attracts staking of ETH and LST, reducing the active circulation and benefiting the token price.

(4) The high yield of Restaking also attracts more funds into the Ethereum ecosystem.

At the same time, Restaking also brings significant risks:

(1) In Restaking, an IOU (financial obligation) is used as collateral in multiple projects. If there is no proper coordination mechanism between these projects, it may lead to an excessive amplification of the value of the IOU, resulting in credit risk. If multiple projects demand redemption of the same IOU at the same time, it will not be able to meet the redemption requirements of all projects. In such a situation, if one project encounters problems, it may trigger a chain reaction, affecting the economic security of other projects.

(2) A considerable amount of LST liquidity is locked in Restaking. If the price of LST fluctuates more than ETH and stakers are unable to withdraw LST in a timely manner, they may suffer economic losses. Additionally, the security of AVS also depends on TVL, and high price volatility of LST poses a risk to the security of AVS.

(3) The staked funds in Restaking projects are ultimately stored in smart contracts, and the amount is very large, leading to excessive concentration of funds. If the contract is attacked, it will result in significant losses.

Microeconomic risks can be mitigated through adjustments to parameters and flexible rules, but this will not be further elaborated here due to space constraints.

Macro Impact

It is important to emphasize that the essence of Restaking is a form of leverage. The influence of Restaking on the crypto market is closely related to the market cycle. To understand the macro impact of Restaking on the crypto space, it is necessary to first understand the relationship between leverage and the market cycle. Restaking adds two layers of leverage to the ETH ecosystem, as mentioned earlier:

First layer: LSD creates a doubling of value for staked ETH assets and their derivatives out of thin air.

Second layer: Restaking does not only stake ETH, but also LST and LP Tokens. Both LST and LP Tokens are tokenized assets and not the physical ETH. This means that the LRT generated by Restaking is an asset built on top of leverage, equivalent to the second layer of leverage.

So, is leverage beneficial or harmful to an economic system? Let's start with the conclusion: leverage must be discussed within the context of the market cycle. In the upward phase, leverage accelerates development; in the downward phase, leverage accelerates collapse.

The development of the social economy is as shown in the above figure, with prolonged ascents leading to descents, and prolonged descents leading to ascents. Each ascent and descent forms a cycle, and the total economic volume spirals upward in this cyclical process. The bottom of each cycle is higher than the previous one, and the overall volume continues to increase. The current cycle of the crypto market is very apparent, as it is currently in the Bitcoin halving period. In the 2-3 years after the halving, it is highly likely to be in a bull market, followed by 1-2 years in a bear market.

However, while the Bitcoin halving cycle roughly aligns with the bull and bear cycles of the crypto economy, the former is not the fundamental cause of the latter. The true cause of the bull and bear cycles in the crypto economy is the accumulation and rupture of leverage in the market. The Bitcoin halving is just the trigger for the influx of funds and the appearance of leverage in the crypto market.

How does the process of leverage accumulation and rupture lead to the succession of cycles in the crypto market? If everyone knows that leverage will eventually rupture, why use leverage in the upward phase? In fact, the underlying laws of the crypto market are similar to those of the traditional economy. Let's first look for patterns in the development of the real economy. In the development of the modern economic system, leverage is bound to appear and must appear.

The fundamental reason is that in the upward phase, the development of social productivity leads to an excessive accumulation of material wealth, and to circulate the surplus products in the economic system, there needs to be a sufficient amount of currency. Currency can be issued, but it cannot be issued arbitrarily and infinitely, otherwise the economic order will collapse. However, if the amount of currency cannot meet the circulation needs of the surplus material wealth, it can easily lead to stagnation in economic growth. What to do at this point?

Since currency cannot be issued infinitely, the utilization rate of unit funds in the economic system must be increased. The role of leverage is to increase the utilization rate of unit funds. Here's an example: Suppose $1 million can buy a house, and $100,000 can buy a car. The house can be used as collateral for a loan, with a collateral ratio of 60%, meaning the house can be used to borrow $600,000. If you have $1 million and no leverage is allowed, you can only choose to buy one house or ten cars.

With leverage, allowing borrowing, you can buy one house and six cars, so isn't your $1 million now worth $1.6 million? From the perspective of the entire economic system, without leverage, the circulation of currency is limited, everyone's purchasing power is restrained, market demand cannot grow rapidly, and naturally, there will not be high profits on the supply side, leading to slower or even regressive development of productivity.

However, with leverage, the issue of currency quantity and purchasing power is quickly resolved. Therefore, in the upward phase, leverage accelerates the development of the entire economy. Some may say, isn't this a bubble? It's okay, in the upward phase, there will be a large influx of off-market funds and commodities into the market, so there is no risk of the bubble bursting at this time. This is similar to going long with contracts; in a bull market, there is often no risk of liquidation as the coin price rises.

But in the downward phase? The funds within the economic system are continuously absorbed by leverage and will eventually be exhausted, leading to the downward phase. In the downward phase, prices will fall, so the collateralized house will no longer be worth $1 million, and your collateralized property will be liquidated. From the perspective of the entire economic system, everyone's assets face liquidation, and the sudden shrinkage of the circulation of funds that were originally supported by leverage will lead to a rapid decline in the economic system. Using the example of contracts, if you only trade spot without contracts, when the coin price falls in a bear market, your assets will only shrink; but with contracts, there is not only asset shrinkage, but direct liquidation to zero. Therefore, in the downward phase, having leverage will lead to a faster collapse than without leverage.

From a macro perspective, even though it will eventually rupture, the appearance of leverage is inevitable. Furthermore, leverage is not entirely good or entirely bad; it depends on which phase it is in. Returning to the macro impact of Restaking, the leverage within the ETH ecosystem plays a very important role in driving the bull and bear cycles. Its appearance is also inevitable, and in each cycle, leverage will inevitably appear in the market in some form. The so-called DeFi Summer in the previous cycle was essentially the dual pool mining of LP Tokens, which greatly fueled the bull market in 2021. This round's catalyst for the bull market may have turned into Restaking, although the mechanisms may appear different, the economic essence is the same, both are for the purpose of digesting the influx of funds in the market and meeting the demand for currency circulation through leverage.

Based on the discussion of the interaction between leverage and the market cycle above, this multi-layer leverage of Restaking may accelerate the upward phase of this cycle, leading to a higher peak, while also accelerating the downward phase of this cycle, resulting in a more severe decline and a wider chain reaction.

Conclusion

Restaking is a derivative of the PoS mechanism. Technically, Eigenlayer uses the value of restaking to maintain the economic security of AVS, using the mechanism of staking and slashing to achieve "easy borrowing and repayment." The redemption window for staked funds not only provides enough time to check the reliability of Operator behavior, but also avoids the collapse of the market and system due to a large amount of funds being withdrawn in a short period.

In terms of its impact on the market, it needs to be analyzed from both micro and macro perspectives. From a micro perspective, while Restaking provides liquidity and returns to the Ethereum ecosystem, it also brings some risks, which can be mitigated through parameter adjustments and flexible rules. From a macro perspective, Restaking is essentially a multi-layer leverage, exacerbating the overall economic evolution of the crypto market within the cycle, creating a significant bubble, making the upward and downward phases more rapid and intense. There is a high likelihood that this multi-layer leverage will be a significant factor in the rupture of this cycle and the transition to a bear market. This macroeconomic impact is in line with the underlying economic laws and cannot be changed, only adapted to.

We need to understand the impact of Restaking on the entire crypto space and utilize its dividends in the upward phase, while preparing for the rupture of leverage and the market's decline in the downward phase.

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