The Costs and Benefits of Ethereum Restaking

summary

This report is the second in a three-part series that dives into the risks and rewards of staking, re-staking, and liquidity re-staking. The first report provided a comprehensive overview of how staking and pledge work on Ethereum and important considerations for stakeholders when engaging in this activity. This report provides an overview of how re-staking and pledge work on Ethereum and Cosmos and the important risks associated with them.

Preface

The industry’s experiments in scaling blockchains through modularity have led to the creation of many new protocols and supporting middleware. However, each of these networks needs to build its own security moat, usually through a variation of Proof of Stake (PoS) consensus, a resource- and time-intensive process that has led to many isolated pools of security.

Restaking is the use of the economic and computational resources of one blockchain to secure multiple blockchains. In the case of PoS blockchains, restaking allows the stake weight and validator set of one chain to be used on any number of other chains. The result is a more unified and efficient security system that can be shared by multiple blockchain ecosystems.

While it’s not always called “restaking,” the concept has a long history. The Polkadot ecosystem experimented with the idea as early as 2020. Cosmos launched a version of restaking called Replication-Secure in May 2023; Ethereum will enable staking via EigenLayer in June 2023. The majority of the value of restaking protocols comes from staking on Ethereum. Ethereum is the most economically secure PoS blockchain, with over $100 billion in total staked value and over a million validators staking ETH (don’t confuse the term “validator” with validating nodes, as they are not the same in the Ethereum ecosystem). “Economically” is italicized to emphasize the distinction between the economic security of a chain and its overall immunity to attack or manipulation. A chain’s level of economic security does not always indicate the overall security of that chain.

As of June 25, 2024, $20.14 billion worth of assets have been re-staked. Ethereum is by far the largest protocol supporting re-staking, with $19.4 billion in re-staked deposits for ETH and its derivatives, of which $18.3 billion was deposited by users in 2024. Notably, $58.5 million was re-staked on Solana via Picasso and Solayer, and $223.3 million in BTC was re-staked on various chains including Bitlayer, Merlin, BSC, etc. via Pell Network and Karak. Below is a chart of the total value of re-staked assets by type for the leading re-staking solutions (EigenLayer, Karak, Symbiotic, Solayer, Picasso, and Pell Network) by total value locked.

An estimated $1.7 billion is also re-staked through Cosmos Hub validators and their re-stacking model called replicated security.

While the benefits of restaking for advancing modularity and the unified economic security thesis are clear, there are risks associated with its implementation that cannot be ignored. This report provides an overview of the main restaking solutions built on top of the Ethereum and Cosmos ecosystems. It does not delve into the risks posed by products built on top of restaking protocols such as Liquid Restaking. This will be the primary focus of the next report in this series.

Important definitions and models

The following is a list of terms and their definitions that will be used repeatedly throughout this report:

• Slashing – A penalty given to validators who fail to complete their work correctly or accurately. In addition to losing a portion of their stake, validators may also be jailed (temporarily removed from the set of active validators) or removed (permanently removed from the set of active validators) as supplementary non-financial penalties.

• Slashing conditions – The basis on which a validator is penalized (slashed). This may include double signing, downtime, or other misconduct unique to a particular network.

• Liquid Staking Tokens (LST) – Liquid fungible tokens representing illiquid assets deposited by chain validators.

• Liquid Rehypothecation Token (LRT) – Liquid fungible tokens representing illiquid ETH, LST, and other assets used as rehypothecation collateral.

• Node Operator – An entity that runs a node and provides other services for active validation services. This term covers EigenLayer node operators and Cosmos Hub validators for the purposes of this report.

• Active Validation Service (AVS) – Any platform that relies on re-staking resources for security. In this report, Active Validation Service is abbreviated as AVS. This term covers EigenLayer AVS and Cosmos Consumer Chain in this report.

• Economic Security – The USD-denominated value of assets staked by network validators.

• Computational Security – The hardware and software required to authenticate the network.

• Base Network – The network whose staked assets or validator set are used to economically and computationally secure the AVS, also known as the “base protocol” or “base chain.” This term can be applied in the context of the Cosmos Hub and Ethereum.

The following illustration is key to understanding the overview of some of the re-staking models covered in the report. It is based on Sunny Aggarwal’s keynote speech at the 2023 Shared Security Summit.

Re-staking on Ethereum

EigenLayer is a set of smart contracts on Ethereum that can be used to re-stake assets to secure an external service called AVS (Active Validation Service). Smart contracts specify the details of the relationship between node operators and EigenLayer AVS. These details include components such as slashing penalties, reward payments, AVS registration, and validator exit. AVS does not inherit security from EigenLayer itself. EigenLayer smart contracts act as a middleware technology that connects AVS with Ethereum validators and node operators and their underlying staked assets.

The diagram below outlines how EigenLayer restaking works. Note that EigenLayer is an opt-in system. Not all Ethereum validators (also known as Beacon Chain validators) have to be EigenLayer node operators, and vice versa; Beacon Chain validators who choose to join EigenLayer can point their withdrawal vouchers to EigenLayer, allowing AVS to slash their stake and pay them rewards, while also assuming the responsibilities of being a Beacon Chain validator.

EigenLayer allows AVS to lease a subset of Ethereum stake, which can be ETH staked natively in a beacon chain validator or LST. AVS may or may not have its own validator set and staked assets. In return, the leased subset of Ethereum stake receives rewards from each AVS for complying with additional slashing conditions. They are in addition to the beacon chain rewards that beacon chain validators receive directly or accumulate through LST. A single ETH or LST unit can be leased by any number of AVS. However, each AVS adds additional slashing conditions for that unit of value.

At the time of writing, EigenLayer is in the early stages of development and does not enforce any slashing conditions or re-staking rewards. In theory, EigenLayer acts as an open market where AVS can freely purchase economic security from a subset of Ethereum validators, and Ethereum users and node operators can choose the AVS they are willing to secure with their staked assets. This is a feature of EigenLayer that other similar cross-chain staking solutions (i.e. replicated security) do not have. This is a market-driven approach to finding the balance of supply and demand for re-staked ETH with less friction, although today's airdrop may affect it.

Re-staking on Cosmos

Cosmos' replication safety is implemented by the Cross-Chain Verification (CCV) module, which sits at the application layer of the Cosmos protocol stack. Replication safety is implemented by the in-protocol infrastructure of the Cosmos Hub and consumer chains, not by applications on the chains themselves. Replication safety relies on light clients, lightweight versions of client software that can run on resource-constrained devices, for the Cosmos Hub and consumer chains. It also relies on the Inter-Blockchain Communication (IBC) protocol to transmit messages about Cosmos Hub validators, their shares, and the rewards they receive from protecting consumer chains.

Under the replication safety mechanism, nearly all Cosmos Hub validators and their stake (the top 95% of voting power) must secure a consumer chain that passes governance, even if they do not vote to join a consumer chain in the process (hence the term “replication safety”). The Cosmos Hub’s validator set and stake weight are actually replicated across all consumer chains. This is different from EigenLayer’s approach, where re-stakers, node operators, and beacon chain validators voluntarily decide to re-stake to an AVS of their choice. If ATOM stakers do not want their assets to be affected by consumer chain slashing, they can re-delegate their stake to validators outside the top 95% who may not be able to secure a consumer chain. However, doing so comes with trade-offs and may result in reduced ATOM staking rewards for delegators, as well as other risks. As of June 25, 2024, 113 of the 180 validators in the Cosmos Hub active set are below the 95% threshold.

The following diagram outlines how replicated security works; note that it looks similar to EigenLayer, except that the entire ATOM stake (minus the 5% red blocks) secures the consumer chain, and the consumer chain does not have its own sovereign validator set in any case (the Cosmos Hub validators take their place). The Cosmos consumer chain Stride uses "governors", validators who accept STRD stakes to vote on governance. However, these governors do not build blocks or validate transactions on the network.

It is important to note that Cosmos Hub validators run separate software, and in some cases separate hardware, to secure consumer chains with their ATOM stake. Although nearly every Cosmos Hub validator secures every consumer chain, consumer chain transactions are not executed on the Cosmos Hub and do not take up Cosmos Hub blockspace; the blockspace of the base chain and each consumer chain is mutually exclusive.

Partial Set Security (more information and proposal voting) was introduced as part of the Gaia upgrade, allowing a subset of the ATOM stake to secure a consumer chain. Partial Set Security is more similar to the EigenLayer model in that Hub validators can choose to secure a consumer chain; consumer chains can outline the minimum stake required to secure their chain. Partial Set Security will rely on governance in the first iteration before adding permissionless consumer chain launches. As of June 25, 2024, no Cosmos chain has been launched under partial set security.

Additionally, a proposal was released in early May 2024 to bring security aggregation to the Hub, starting with BTC. If passed, this would allow Hub validators to receive BTC delegations through Babylon to protect the Hub and its consumer chains, and pave the way for any on-chain asset to be used as economic security through Hub validators.

Universal Re-Pledge Protocol

Generalized re-pledge, also known as universal re-pledge, is a re-pledge system that pools native assets from many chains in the re-pledge process. This approach is agnostic about the asset and base chain as it allows many pledged assets from multiple chains to be pooled. The model is "generalized" because assets can be pooled from many chains. At a high level, generalized re-pledge relies on an additional layer or series of contracts across multiple blockchains that sits between the economic security source chain and AVS. Below is a simplified diagram of how generalized re-pledge works.

Picasso and Karak are examples of general or ubiquitous restaking platforms.

Picasso

Picasso is a general-purpose re-staking blockchain built using the Cosmos SDK. It connects base chains to Picasso via IBC. The Picasso chain receives details about deposited assets on the base chain via IBC and then allocates user funds to AVS accordingly. The “Orchestrator” smart contract on the Picasso chain is responsible for allocating user funds to Picasso node operators, registering and deregistering AVS, and a few other duties. At a high level, Picasso’s re-staking solution is very similar to that of EigenLayer, which allows a subset of the network’s stake weight to opt-in to secure AVS. The architecture is replicated on multiple base chains and ultimately converges on Picasso. Node operators under Picasso are selected through governance. At the time of writing, the re-staking layer only accepts deposits from Solana via SOL LST and native SOL as re-staking collateral. Picasso’s roadmap includes expansion to Cosmos chains and assets once AVS begins to roll out on Solana. The first AVS, launched in April 2024, supports IBC connections between Solana and external blockchains.

Karak

Karak is a universal re-collateralization layer that accepts deposits from Ethereum, Arbitrum, Mantle, BSC, and the Karak Network, which is built on top of Karak as a universal layer 2 for AVS. It relies on ETH LST as the primary collateral asset, supplemented by stablecoins, Pendle tokens, EigenLayer Liquid Re-collateralization Tokens (LRT), Liquid Collateral BNB, and Wrapped Bitcoin. The LST accepted are either wrapped and bridged from Ethereum, or are native assets of the chain they can be deposited on. It functions similarly to Picasso in that it allows for the pooling and re-collateralization of multiple assets across multiple networks. Unlike Picasso, which exists as a standalone layer 1 and propagates assets via IBC, Karak is strictly a collection of smart contracts built across multiple chains, including Ethereum layer 2. Karak also accepts a wider range of assets than Picasso, such as stablecoins.

Under any re-staking solution, the benefits of a unified security model also come with risks. The risks of the re-staking model can be categorized by the three main stakeholders involved in the re-staking supply chain. This includes the base layer network, node operators, and AVS. The next section of this report will delve deeper into the risks these entities take on in the context of EigenLayer and Cosmos re-staking. End users who delegate assets through re-staking solutions are downstream of these entities and therefore inherit the downsides of all risks, the symptoms of which are detailed below.

Risks to the basic network

The security of the base network comes from the original staked assets in its chain, which are the same assets used during re-staking. Therefore, the main risks of re-staking to the base network are slashing events that affect the security of the base chain and the centralization of the base chain's stake distribution.

Slashing events that affect the security of the base chain

Slashing conditions enforced at the re-hypothecation layer could negatively impact the security of the base chain and applications on top of it, primarily if the re-hypothecation layer’s stake is concentrated in the hands of a small number of node operators. This is particularly concerning for EigenLayer and Ethereum, as Ethereum has a diverse set of applications with a total value locked (TVL) of $41.2 billion as of June 25, 2024 (excluding EigenLayer’s TVL, which is $59.3 billion including it). Penalties triggered by AVS could significantly reduce the amount of staked assets available to secure the base chain, depending on the relative size of the re-hypothecation assets versus the staked assets on the base chain.

As of June 25, 2024, only ~17% of the total ETH staked on the Beacon Chain has been re-staked, while 98.26% of all re-staked ETH is captured by EigenLayer. The percentage of Beacon Chain deposits re-staked via EigenLayer is 11.93%. Slashing re-staked ETH has the most direct impact on the security of the Ethereum protocol, as these deposits represent collateral staked directly to the Ethereum protocol. This is different from re-staked LST, where tokens with the value of Beacon Chain deposits can be slashed before the underlying deposits themselves. Therefore, there is a potential path to slashing LST without changing the security of the underlying chain. More information on this idea will be presented in a future report, focusing on the dynamics of LRT. EigenLayer does not currently enforce any slashing conditions on node operators, so there is little risk of negatively impacting the security of Ethereum through re-stacking. However, this will change when slashing is implemented. Cosmos Replication Security took a similar approach to limiting slashing penalties when it first launched. The steps EigenLayer is taking in this regard are not unique to restaking solutions.

With replication safety, 95% of Cosmos Hub stake is used to secure AVS. Therefore, slashing penalties enforced on the AVS layer have a near 1:1 impact on Hub economic security. This idea also applies to centralized power on Hub stake, which will be examined later. Unlike Ethereum, the Cosmos Hub does not support smart contracts or the applications they support. However, economic security still plays an important role in securing the network.

In addition to the base chain security share that is at risk of slashing through re-staking, one also needs to consider the types of violations that AVS can enforce that could result in slashing.

Intersubjectivity defects at the feature level

Not all slashing violations on the AVS may be objectively and cryptographically verifiable. The Eigen Foundation proposed this idea in a white paper explaining the $EIGEN token. In the paper, the team explains that inter-subjective failures (i.e. failures that are not easily verifiable on-chain) in certain AVS (such as oracles) may cause the base chain to split. Enforcing on-chain actions on the EigenLayer AVS may require off-chain agreement or social consensus among network observers - a cumbersome process that may cause the base chain to fork if node operators have widespread disagreement about the correct state of the AVS.

To address the burden on Ethereum consensus due to inter-subjective faults, validators can use EIGEN tokens to perform inter-subjective slashing via token forks rather than base chain forks. This idea was originally proposed by Paul Sztorc in 2014 via the Truthcoin whitepaper and has recently been popularized by EigenLayer. It essentially alleviates the need for social agreement between base layer validators by allowing node operators to express their preferences for inter-subjective faults and assertions on the restaking layer via EIGEN tokens.

The following diagram highlights the EIGEN token slashing process:

The left side of the figure above shows the objective slashing procedure. Objective slashing penalties are mathematically and cryptographically provable violations, such as double signing and downtime, which can be verified through the on-chain protocol. For these violations, the re-pledged assets can be slashed without general consent among chain observers. The right side of the figure shows the inter-subjective slashing procedure. Penalties in these cases may require social agreement among chain observers. With the EIGEN token, node operators can rely on the protocol to slash the staked EIGEN supply instead of the staked ETH. Therefore, there are two "categories" of EIGEN:

1) Raw EIGEN, which can be stored in an Externally Owned Account (EOA) or used to interact with decentralized finance (DeFi) applications.

2) bEIGEN or staked EIGEN, which can be forked and may be subject to slashing penalties.

Each new fork of bEIGEN results in a reduction in supply, as slashing penalties manifest as the removal of slashing violators’ bEIGEN from the circulating supply. By slashing tokens and reaching social consensus on the next fork, EigenLayer can more effectively extend Ethereum PoS security beyond its boundaries by limiting the inputs required by the Ethereum base layer. AVS can also replace EIGEN with its own token as the inter-subject token if it wishes. This is a basic explanation of how EIGEN tokens and inter-subject slashing work; precise details can be found in the EIGEN whitepaper.

Objective flaws of Cosmos

Under replicated security, AVS is limited to slashing in the same manner as the Cosmos Hub. This includes downtime and double signing, objectively verifiable failures leading to jail time, and up to 5% of stake being slashed. This is in part because replicated security requires a supermajority (95%+) of base layer economic security and validators to secure AVS. Therefore, a collusion between validators to attack the consumer chain would cause the price of ATOM (the Cosmos Hub staked asset) to plummet. This idea does not work with partial set security or EigenLayer's re-staking methods, as only a small fraction of the total stake is available to secure AVS.

Cosmos Hub validators vote on governance proposals to review which AVS can be protected with replication security. This process vets consumer chains before they can participate in shared security. Once accepted as a consumer chain and launched on mainnet, additional measures are taken to protect the Hub from consumer chain slashing. They include:

1) A governance proposal to review the integrity of dual-signed claims by AVS to Hub node operators. This protects the Hub from accepting slash packets sent by malicious AVS, thereby permanently removing honest validators from the network. In the future, Cosmos Hub developers are working to enable AVS to submit slash packets that can be automatically verified by the Hub, rather than through governance. Proposal #818 is an example of this process. In this case, two Hub validators accidentally double-signed on Neutron (the Cosmos consumer chain).

2) Limit or tier downtime slashing penalties so that at a single point in time, at most 1% of the Hub validator set can be slashed and jailed. This can keep the Hub active even in the event of true misconduct at the AVS layer. However, proving downtime cryptographically can be difficult.

3) Limit the influence of consumer chains on slash parameters. Only Hub validators can outline the penalties that consumer chains can impose on their stake and validator set. Doing so ensures that the liveness and overall security of the Hub are not threatened by AVS.

Fraudulent voting will be introduced in the next iteration of Cosmos shared security. These governance proposals allow slashing of validators that perform non-objectively verifiable attacks that stem from properties unique to partial set security (i.e. the subset problem).

Restaking introduces the possibility of slashing based on additional parameters enforced by the AVS (rather than strictly enforced by the base chain). This introduces a higher degree of rewards and penalties. However, on the Cosmos Hub, the ability of consumer chains to enforce additional slashing penalties is strictly limited and controlled by Hub validators through governance. On Ethereum, due to the nascent and diverse nature of its restaking solutions and AVS, it is unclear what impact slashing will have on the security of the base chain. Similarly, no penalties are currently implemented on EigenLayer AVS, the largest restaking solution on Ethereum. In the future, it may be possible to introduce functionality in EigenLayer to support automatic slashing initiated by AVS, resulting in the underlying interests protecting Ethereum being compromised.

Centralization of basic chain equity distribution

The same reasons that drive centralization of stake in the underlying network environment can exert additional centralization pressure through validation of AVS. This is primarily driven by the revenue and overall profitability earned by node operators (which is closely tied to the opportunities provided by AVS), their timing of listing, and their ability to scale. Therefore, measures taken to prevent centralization of stake on the underlying protocol, whether algorithmically enforceable rules or self-regulatory measures taken by base layer validators, may be circumvented by the introduction of re-staking returns.

Replicated Security is unique in that the Cosmos Hub validator set and native stake are effectively replicated in the AVS, and every node operator participating in Replicated Security runs the same additional services. However, node operators are not equally rewarded for their stake. Node operators with larger managed stake balances receive higher rewards than those with smaller managed stake balances. While the cost of protecting the AVS is the same for all Hub node operators, the reward is variable and depends on the amount of stake managed. Therefore, Hub node operators with larger managed stake balances have a better chance of offsetting the cost of protecting new AVS. Smaller node operators face a greater risk of operating at a loss or shutting down operations entirely.

Under the implementation of partial pool security and security aggregation, the cost/reward dynamics of running AVS will change for node operators, as they will be able to choose to protect different AVS pools. However, this may still result in unequal access to staking rewards for large node operators, as users may choose to delegate additional stake to operators that receive higher re-staking returns than other operators. In these cases, the base layer's staking distribution may experience stronger centralization pressures than it does today.

Restaking also puts pressure on centralization in Ethereum. Some restaking protocols, such as Karak and Symbiotic, do not offer permissionless onboarding of Beacon Chain node operators. In these cases, users who want to restake native ETH must do so through a set of permissioned node operators, or they can stake other assets, such as LST, which are already a source of base layer centralization. A restaking protocol that supports permissionless native restaking is better for base layer staking centralization because it allows anyone to earn restaking rewards at any time without requiring a set of permissioned node operators. EigenLayer supports permissionless onboarding of native staked ETH through EigenPods. Any user can launch an EigenPod to run as a Beacon Chain validator node operator and earn restaking rewards. To do this, node operators must enable the EigenLayer smart contract to enforce additional slashing conditions on their staked ETH. As of June 27, 2024, 3.9 million native ETH is locked in EigenPods.

Liquidity re-staking on Ethereum can also create centralization pressures. LRT applications that accept native ETH deposits as re-staking collateral may centralize Beacon Chain staking in a similar manner to LST applications. LST applications incentivize users through higher staking returns and liquidity on native ETH deposits, just like LRT applications. The advantage of LRT over LST is that LRT passes the additional returns from re-staking to users, while LST does not. If LRT applications do not accept native ETH as re-staking collateral, users must stake other assets, most commonly LST, thereby increasing demand for LST and exacerbating the centralization of these liquid staked assets at the base layer.

Risks faced by node operators

The risks facing node operators are primarily operational, relating to their ability to scale and establish a streamlined process for adding and removing AVS. Failure in any of these areas could result in reduced collateral or a less competitive product. Each AVS added by an individual node operator creates additional complexity, cost, and liability for them.

The different types of AVS also mean that node operators may need unique costs and procedures to support each AVS, making processes and infrastructure difficult to replicate across services. This can lead to node operators running dozens or even hundreds of services, requiring unique infrastructure and processes to run across hundreds to thousands of validators. Ultimately, the diversity of AVS may make it difficult for node operators to scale and manage operations.

The process of removing AVS support is just as important as adding support. This is especially important in the context of re-staking, where AVS churn rates can be high. Ensuring a smooth delisting process is important to avoid getting slashed or causing disruption to AVS operations. This is especially true in cases where node operators use the same servers to run both AVS and Ethereum validator software.

Node operators also face social risks. Adding and removing AVS directly impacts the returns and risks of end users who re-stake their assets through re-staking node operators. Communicating details about opting in/out of AVS and notifying end users of actions that may affect their delegated funds is an extremely important responsibility of node operators. Failure to do so may result in a loss of trust from end users, which can harm business and create reputational risk for node operators.

Risks of Active Authentication Services

Economic security is shared or centralized under restaking, meaning that many AVS and base chains have the power to slash the same value that collectively secures them. The risk is that entities outside the protocol could directly impact the security of the AVS (AVS to AVS and base chain to AVS), such as the impact of AVS slashing on base chain security. Other AVS and base chain slashing risks include fluctuations in the USD value of the assets securing the AVS, and their ability to adequately incentivize node operators.

Economic security is measured in USD and provided in the native units of the digital asset (e.g. AVS is backed by $100 million worth of ETH). Fluctuations in the value of the assets securing AVS affect its economic security. Using higher quality, more liquid assets to secure AVS is key to mitigating the volatility of its economic security. Some AVS may still choose to use more volatile assets for various reasons (e.g. new user acquisition or ecosystem coordination). The risk of USD volatility is not unique to AVS, base chains also face the same resistance, namely fluctuations in the USD value of the native staked assets, especially in the first few months and years after the mainnet launch.

Second, node operators and end users put pressure on AVSs to see if they will generate enough “real” value (whether from transaction fees or revenue generated by AVS functionality) to make it profitable enough for node operators to provide services to them. As a result, AVSs may choose to launch with inflationary tokens to fully repay the debt owed to node operators. Even so, over time, node operators may decide that they are not receiving enough incentive to continue running certain AVSs. This could result in certain AVSs not having enough validators and staked assets to protect them, which would negatively impact the security of those AVSs.

While we don’t know what the incentive landscape will look like through EigenLayer restaking, we have an idea of ​​what Cosmos replicated security (excluding MEV) will look like by April 2024 (at a price of ~$8.75 per ATOM). Galaxy Research estimates that the spendchain adds ~0.04% to Hub validators, or ~$0.003 per ATOM earned by the top 95% of validators by voting power.

Under replicated security, the re-staking dynamics on Cosmos differ from Ethereum in that the market-driven nature of EigenLayer allows the supply and demand of re-staking services to naturally find equilibrium when they are too scarce or too abundant.

Similarly, base chains face the same headwinds in incentivizing participation in security in the early months and years after mainnet launch. However, both of these risks are particularly important for AVS relying on re-staking solutions, as they do not directly own the security they rely on. Depending on re-staking yields and EigenLayer smart contract functionality, competition between AVS for shared security could be intense and lead to validators frequently re-adjusting the set of AVS they support at any given time. This in turn could promote faster turnover of AVS and increased volatility in the economic security of AVS.

Other considerations

There are a number of other risks and considerations worth highlighting. These include re-pledge and leverage, the impact of airdrops on re-pledge protocols, and the impact of re-pledge on asset liquidity.

Re-Pledge and Leverage

Restaking itself is not financial leverage. Rather, it is a more abstract type of leverage that is contingent upon the responsibility and capabilities of node operators. This is because node operators are penalized based on their behavior and operational capabilities based on the AVS rules they opt-in to, rather than being penalized based on asset prices (e.g. margin calls). This is similar to taking on more and more responsibility at work. The more projects you take on, the more likely you are to make a mistake, get fired, or take a pay cut. However, if you misallocate your company-sponsored 401k and lose all your savings, you won't lose your job.

The basis for penalties for restaking is within the control of the node operator, as they voluntarily opt-in to the slashing conditions and control the hardware/software they run. This is not the case with financial leverage, as individuals cannot control the market that ultimately penalizes them. This is a critical distinction, as the basis for penalties is entirely dependent on the capabilities and behavior of the node operator, and penalties against one node operator have no impact on the stake of another (i.e., one validator cannot be slashed for the misbehavior of another validator), just as there is a negative feedback loop/daisy chain effect with financial leverage unwinding.

Even so, as explained earlier in this report, penalties on node operators can have knock-on effects on the security of AVS and the underlying chain. For example, if 1 ETH protecting three AVS is slashed by one of them, then all three AVS protected by that 1 ETH will have their security negatively impacted. This can make malicious attacks and collusion against AVS and its underlying chain easier to conduct.

The impact of airdrop mining and price-buying on re-staking

Airdrop mining could distort the supply of re-collateralized tokens. Points incentivize users to deposit assets into re-collateralized protocols independent of the demand for AVS re-collateralized securities, thereby increasing the supply of re-collateralized assets. Airdrop mining can also negatively impact the design of applications. The fast-paced nature of points and the momentum of the ecosystem could drive developers to launch applications before they are ready to deploy or fully fleshed out for their intended use. The result could be phantom applications that sit unused for long periods of time, or applications that lack critical functionality, such as the ability to withdraw or transfer assets. Eventually, all of these forces driving the inorganic supply of re-collateralized tokens will have to unwind, which could negatively impact asset prices and cause other issues for re-collateralized DeFi products. Over time, the industry will have a clearer picture of what the true supply of re-collateralized tokens looks like (which is a function of demand), especially as re-collateralized protocols deployed on Ethereum and Cosmos become more fully functional.

Re-staking liquidity vacuum

Another consideration in the context of Ethereum restaking is to attract liquidity to Ethereum L1. The goal of Ethereum’s rollup-centric roadmap is to drive L1 activity and liquidity downlink, but restaking incentivizes activity to stay or return to L1. This dynamic is emphasized through restaking protocol and LRT protocol-level points program.

The following figure shows this trend through the perspectives of restaking LSTs on Ethereum L1 and circulating LSTs on L2. The number of LSTs on L2 peaked in April 2024 and has been in range volatility since February 2024 after 21 months of continuous growth. Meanwhile, the number of LSTs on Ethereum L1 has grown parabolicly.

The figure below tracks the entire process trend of LST observed on L2 and superimposes key replacing events.

With the flat liquidity of LST on L2 and the increasing hype of restaking applications, the Daily Active Address (DAA) on Ethereum L1 also reached its highest level in 35 months with a 30-day moving average; this indicates that restaking is attracting users to return to L1. The 30-day moving average of the number of DAAs on Ethereum last reached 460,000 addresses in May 2021.

Although LST liquidity on L2 has been flat, LRT is becoming increasingly prominent. LRT can be found on Arbitrum, Base, Blast, Linea, Mode, OP Mainnet, and Scroll, with 69% of native unit supply on Arbitrum and Blast. Not shown in the chart are 24,744 ezETH and 7,396 eETH on Mode.

Despite the increasing importance of LRT on L2, the liquidity and adoption of LST is much higher than that of LRT. However, as mentioned in the above analysis, the importance of LST is beginning to weaken because they are locked in the restaking protocol initiated on the Ethereum base chain. It is important to consider the potential impact of the stagnation of LST expansion on the overall liquidity of decentralized financial applications on L2, especially when LRT liquidity is comparable.

in conclusion

Restaking is an important primitive in the evolution of public chains; it aims to create a more unified and efficient security model for blockchain applications that can be exported and shared by multiple protocols simultaneously. This idea and its implementation in the Ethereum and Cosmos ecosystems are still in the early stages of experimentation and research. Many details about how restaking protocols work in practice are still unknown. In addition, their exact impact on stakeholders such as underlying networks, node operators, and AVS are still unclear. However, in this report, we detail the important risks and considerations of restaking for the major entities involved in the activity at the early stages of its evolution. Areas of further research include mobile restaking protocols and other types of products and services that can be built on restaking protocols.