Liquid Restaking Lubricates The DeFi Economy

Exploring Liquid Restaking: Maximizing DeFi Investment Returns

Restaking, which refers to the idea of using crypto to secure blockchain-based applications, or dApps, rather than the network itself, has emerged as one of the fastest growing trends in the crypto industry. Almost every week we see the launch of new restaking protocols, pushing the boundaries of innovation and growing in value. 

Out of the restaking boom, we have seen the emergence of an entirely new concept called “liquid restaking”, led by protocols like Kelp DAO and Ether.Fi. They’re pouring even more fuel onto the fire and creating even more hype by extending the potential value of restaking activities. 

While many in the DeFi industry believe restaking and liquid restaking is a fantastic investment opportunity for crypto holders, others view the nascent industry as a house of cards, built on flimsy, speculative foundations that promise too-good-to-be-true rewards. 

For new investors, it’s hard to tell the difference between a solid investment opportunity and a high-risk gambit, but the tempting returns on offer make liquid restaking an attractive proposition nonetheless, hence the need for more in-depth knowledge on the subject. 

What’s Staking? 

To understand liquid restaking, we first need to know what restaking is all about. For the uninitiated, restaking refers to the idea of using economic trickery to secure decentralized networks from malicious attacks. 

Whereas proof-of-work networks like Bitcoin rely on miners that expend computing power to remain secure, proof-of-stake blockchains such as Ethereum rely on the concept of “validators”, who must stake cryptocurrency tokens into a smart contract as a deposit, or guarantee, that they’ll act honestly. 

On Ethereum, these validators earn regular rewards paid out in ETH tokens for their work, and the more ETH they stake, the bigger those rewards will be. Their stake acts as a collateral, and if they attempt to cheat or act maliciously in other ways, they can lose that deposit. This is what keeps all of Ethereum’s validators in line. 

The model is designed in such a way that the cost of attacking the Ethereum network would be as much as the total amount of ETH staked by all of its validators. So to attack it simply wouldn’t be profitable. This is why Ethereum is considered to be one of the most secure blockchains of all, second only to Bitcoin itself. 

What’s Restaking?

Restaking takes this concept further and applies the same kind of security to other dApps built on Ethereum. For investors, restaking provides a way to gain even more rewards than what they earn from regular staking, and it has become a huge incentive for many DeFi users. 

The basic idea is that, when a user stakes ETH, they receive a different token, such as stETH, as a kind of deposit for that staked token. Rather than leaving their stETH in their wallets, investors can take these tokens and stake them again. 

The biggest and best known restaking layer is EigenLayer, which allows users to “restake” their ETH deposits to secure what it calls “Actively Validated Services” or AVSs. The vast majority of AVSs are blockchain protocols that enable Ethereum scaling solutions. 

Fans of restaking say it can help to boost the security of smaller dApps, which can struggle to attract enough capital to secure themselves alone. Restaking provides a way for staked capital to be shared across multiple dApps, maximizing the efficiency of staked capital so multiple stakeholders can benefit. 

Going Further With Liquid Restaking

Now we have “liquid restaking”, which takes the concept even further, essentially allowing investors to restake their restaked tokens, effectively staking the same token for a third time to derive yet more rewards. 

When a user restakes their ETH or ETH derivative on a platform like Ether.Fi, Kelp or Puffer, they are provided with another receipt, called a “liquid restaking token” or LRT. These LRT tokens accrue interest and can also be reinvested in other DeFi protocols, meaning even greater yield for investors. 

Liquid restaking platforms take much of the burden away from investors, selecting which AVSs to work with and making it simpler for them to enter and exit restaking positions, while expanding their investment opportunities. 

As an example, Lido on Ethereum provides users who restake ETH with “Lido-staked ETH” or stETH tokens that track the price of ETH. stETH has become extremely popular across dozens of well known DeFi protocols. 

Top Liquid Restaking Protocols

Ether.Fi is by far and away the biggest liquid restaking protocol in DeFi, controlling over 50% of the LRT market, but it isn’t the only option for investors. For instance, Puffer Finance is the second-largest LRT protocol, and it boasts hundreds of DeFi integrations to make it easier for users to reinvest their LRT tokens. 

Another major force in liquid restaking is Kelp DAO, which supports both native restaking and LST restaking, accepting token such as ETHx, stETH and wBETH, among others. In addition, Kelp goes a step further, introducing the concept of KEP tokens, which represent the EigenLayer points users earn for restaking ETH. 

Because EigenLayer has not yet created its own native token, its rewards are instead paid out as points that promise access to its real token once it finally launches. But these tokens are illiquid, as they cannot easily be used elsewhere in the DeFi industry. 

Kelp DAO’s KEP token addresses this inefficiency, bringing liquidity to EigenLayer’s points-based rewards and making it possible for investors to expand their rewards potential by using it in third-party protocols. 

In a post on X announcing the launch of KEP earlier this year, Kelp explained that its goal is to bring liquidity to EigenLayer points. It allows them to be freely traded and used to earn other staking rewards. The protocol distributes the EigenLayer points it earns from restaking its native rsETH tokens to users as KEP tokens. 

Shortly after the launch of KEP, Messari analyst Kunal Goel hailed the initiative as being “absolutely wild”, saying it’s the closest we have yet come to seeing an official EigenLayer token. 

Risks Of Liquid Restaking

Before going all-in on liquid restaking, investors should pay attention to the concerns that have arisen following its incredible growth over the last year or so. Some critics liken liquid restaking to a ticking time bomb, and worry that the entire ecosystem is built on trust alone, meaning it’s incredibly flimsy and prone to collapse. 

One particular concern is the risk of contagion. For example, if an operator on EigenLayer is slashed by an AVS, the impact could be felt across the entire liquid restaking ecosystem. That would quickly deplete the value of its entire restaking pool, causing panic that would likely spread like wildfire across the rest of the ecosystem, reducing the security of every other AVS while disintegrating investor’s holdings. 

The other concern regards when this will end. DeFi users can now stake their original tokens, restaking tokens and now even their liquid restaking tokens, growing the potential surface area and exposing the entire industry to a catastrophe. All it takes is a single weak link… 

New DeFi Strategies 

Thanks in part to the way liquid restaking protocols automate much of the process, they have attracted considerable numbers of investors, improving the overall liquidity in DeFi markets. Additionally, they have also given birth to entirely new DeFi investing strategies. 

One of these new paradigms is the concept of a layered staking strategy, which involves distributing staked assets across a variety of risk layers, each with their own profit potential and level of risk. Investors can spread their bets across a mix of low-risk layers that offer relatively stable returns, and high-risk layers that can potentially deliver bigger rewards, but carry a higher risk of things going belly up. 

It’s a flexible system that makes it possible for DeFi investors to allocate their digital assets according to their specific level of tolerance for risk. However, the implementation of these layered staking strategies requires investors to use multiple smart contracts and employ complex risk management strategies to get the right balance between profitability and security. 

Another kind of strategy is smart contract-based automated staking, where smart contracts attempt to boost staking efficiency by automating the entire process on the behalf of users. Smart contracts will attempt to stake, unstake and reallocate assets at the most optimal times to maximize investor’s returns. Users can define their level of risk tolerance by setting up parameters within their smart contracts, which will then automatically adjust their staking positions to suit. 

There are also new collective staking and profit-sharing strategies, where multiple investors can pool their resources and stake them collectively, sharing the profits proportionally based on each participant’s overall stake. Once more, smart contracts are used to ensure the fair distribution of rewards, while the investors use their collective intelligence to try and maximize their returns. 

Final Thoughts

Liquid restaking has emerged as one of the fastest-growing segments in the DeFi industry this year and it has the potential to transform how new dApps are secured. It brings enormous potential to DeFi investors looking for yet more ways to increase their crypto industry gains, but with such rapid rates of innovation comes a significant degree of risk. 

Still, there is a lot of demand for liquid restaking and, so far, the sector has proven to be hugely successful with no negative incidents taking place so far. It could well be that liquid restaking is built on solid foundations after all, and its rapid pace of growth ensures it will be an area that’s extremely closely watched for some time to come.