ArkStream Capital: Thoughts on the Re-Pledge Protocol

Author: Larry Sukernik & Myles O'NeilL Source: ArkStream Capital Translation: Shan Ouba, Golden Finance

"If only you could see yourself in my eyes" — From Dermot Kennedy's "Lost"

We've spent a lot of time at Reverie researching re-pledge protocols. This is an exciting area of ​​investment for us because everything is still unclear (opportunities exist in murky markets) and there are a lot of projects going on (dozens of projects will be launched in the re-pledge space in the next 12 months).

As part of our research into re-pledge, we found some observations about how the re-pledge market will develop over the next few years.

These are all emerging things, so what is true today may no longer be true tomorrow. However, we still wanted to share some initial commercial observations about the re-pledge market.

LRTs as Leverage Points

Today, LRTs like Etherfi/Renzo occupy a powerful position in the re-staking supply chain: because they are close to both the supply side (stakers) and the demand side (AVs), they are in a privileged position on both sides of the transaction. If you think about it, this gives LRTs the ability to (i) determine their take rate, and (ii) influence the take rates of underlying markets (e.g., EigenLayer, Symbiotic). Given their powerful position, you can expect re-staking markets to launch their own LRTs to control the power of third-party LRTs.

AVS/Re-staking as Leverage Points

The best markets in the world share two characteristics: a fragmented supply side and a fragmented demand side. To form an intuitive understanding of this, it helps to look at the opposite case of concentration on either or both sides of the market.

Imagine a simple market for apples, where the largest seller of apples controls more than 50% of the supply of apples. In this case, if the market operator decides to increase the market take from 5% to 10%, the large apple seller can threaten to take his business elsewhere.

Similarly, on the demand side, if the largest buyer of apples controls more than 50% of the demand for apples, she can threaten to use another market (or buy directly from the apple supplier) if the market operator increases the market take.

Going back to the re-pledge market, if the resulting market structure of the re-pledge market is concentrated on the AVS side (the top 10% of AVS account for more than 50% of revenue) or on the re-pledger side (the top 10% of re-pledgers account for more than 50% of deposits), then the natural consequence is that the market has reduced ability to extract a take for itself (and should therefore demand a lower valuation).

While there is not enough data to conduct a rigorous analysis, our gut feeling is that a power law will apply here: large AVS will be the majority of gross payment volume, thus having negotiating power over the cuts the market will ultimately want to charge.

Fighting for exclusive AVS

From the perspective of each re-staking market, every opportunity is worth fighting for to do something that competing re-staking markets cannot do. As a re-staking market, the simplest way to differentiate is to provide re-staking users with access to an exclusive AVS - either an owned AVS like EigenDA or a third-party AVS through an exclusive partnership. Conceptually, this is similar to Sony developing exclusive games for the PS5 to drive hardware sales.

Due to these dynamics, we expect re-staking markets to launch more owned AVS and/or sign exclusive agreements with third-party AVS. In short, we will see a fight for AVS in the coming months.

AVS Subsidies

AVSs need to pay operators/re-stakeholders for the services they provide, which effectively means that AVSs need to be ready to pay in their native tokens, ETH/USDC, or possibly credits/future airdrops. That being said, since most AVSs to date are early-stage startups without tokens, large balance sheets, or well-designed credit programs/airdrops, the process of signing up operators/re-stakeholders has proven to be cumbersome (most EigenLayer partnerships are privately negotiated custom contract agreements). In short, it’s a situation where customers want to buy services, may have the ability to pay, but don’t have the money yet.

To get the business going, re-staking markets will likely “pre-pay” startup costs to operators/re-stakeholders, either through their native tokens, balance sheet assets, or by issuing “cloud credits” that AVSs can use to pay operators/re-stakeholders. In return for pre-paying funds, AVSs are expected to commit to airdrops/token allocations to the re-staking markets. Alternatively, the restaking market can prepay this money to the AVS to convince it to choose you over a competing restaking market.

In short, we expect the restaking market to compete fiercely over the next 12-24 months by subsidizing AVS spending. Similar to the market dynamics of Uber/Lyft, the restaking market with the most funds/tokens may eventually become the winner.

White Glove Onboarding

Going from "I want to launch an AVS" to actually going into production is harder than it looks, especially for small teams without much R&D capabilities. Examples of things teams need to solve include how much security should be purchased and for how long, how much should be paid to operators/restakeholders, what penalties should be imposed and how much.

Best practices will eventually emerge, but for now, restaking markets need to hand-hold AVS teams to solve these problems (it is worth noting that EigenLayer does not have payment or penalty mechanisms yet).

To this end, we expect the winning restaking marketplaces to function somewhat like enterprise sales operations, providing white glove integration/services help to clients to onboard their own products.

Graduation from the marketplace

An interesting dynamic is that the most successful AVS may “graduate” from the restaking marketplace to use their own tokens/revenue to purchase security.

Today, the appeal of restaking is primarily to smaller projects that (i) don’t have the time/money/brand/connections to recruit a validator set, and (ii) don’t have a high-value token to secure the network. But as projects grow, there’s a possibility that the natural next step for them is to leave the restaking marketplace and recruit their own validator set and secure it with their own higher-value tokens.

Conceptually, this is similar to the dynamics of dating marketplaces (e.g., Hinge, Tinder), where the most successful customers eventually leave the marketplace. However, for the market operator, this churn is bad news because you lose a customer (which is one reason why dating markets have lower valuations/multiples than those with repeat usage/low churn).

One-Stop Crypto SaaS

To illustrate this observation, let’s dive into some software history: Cloud providers like AWS make it easy for developers to access everything they need to launch an application or network service (e.g., hosting, storage, and compute). By significantly reducing the cost and time required to develop software, a new class of network services emerged that are more specialized in their service provision. The combination of first-party cloud services and the large number of “microservices” provided within the platform has made cloud providers a one-stop shop for everything they need except their core business logic.

Restaking marketplaces like EigenLayer aim to create a similar batch of microservices for Web3. Before EigenLayer, crypto microservices had the choice of fully centralizing their off-chain components (and passing this risk to their customers) or incurring the cost of launching a team of operators and economic staking to purchase security.

If re-staking markets work as intended, they could break this trade-off for microservices — you’ll be able to prioritize security without sacrificing cost and speed to market.

Let’s say you’re developing a cheap, high-performance zk-rollup. If you go to a re-staking market like EigenLayer, you’ll have multiple choices for core services (like DA and bridging) to ease onboarding. Through this process, you’ll see many other AVS microservices that you can integrate.

The more microservices that re-staking markets offer, the better the customer experience will be — instead of evaluating the capabilities and security of services from dozens of independent vendors, applications will be able to purchase all the services they need from a single re-staking market. Come because of service X, stay because of services Y and Z.

Some AVSs create network effects (e.g. pre-provisioning)

To date, the use cases for restaking have been primarily focused on exporting validators and economic stake in Ethereum. But there is another class of “internal” focused restaking use cases that can actually add functionality to Ethereum consensus without changing the protocol.

The idea is pretty simple — you allow validators to choose to make additional commitments around their proposed blocks in exchange for payment, and hold them accountable via slashing if they don’t follow through on those commitments. We suspect that only a few of these commitment types will have enough demand to get high levels of participation, but the amount of value flowing through these commitments has the potential to be huge.

Unlike the “external” restaking use case, the effectiveness of this class of use case is directly tied to validator participation. That is, even if you’re willing to pay to join a block, it’s not very useful if only 1 out of 10 validators choose to follow through on that commitment.  

But if every validator opted into a given commitment, then the guarantee behind it would be equal to the guarantee provided by the Ethereum protocol itself (i.e., valid blocks). Following this logic, we can expect this category to have strong network effects, as users of AVS benefit from every marginal validator that chooses to enter the commitment market.
While this category of AVS is still emerging, the logical distribution channel for facilitating these use cases will be through Ethereum client sidecars and plugins (e.g., Reth). Similar to the separation of proposers from builders, it is likely that proposers will outsource this work to specialized participants in exchange for a share of the revenue.  

What is less clear is what form these AVS will take. While it is possible for one entity to create a general purpose market for any type of commitment, we suspect it is more likely that we see the emergence of a number of participants that specialize based on the source of demand (e.g., L2 for interoperability vs. L1 for DeFi-driven demand).      

Conclusion

For students of business strategy, the business dynamics of re-capturing markets is a treasure trove of content worth digging into. As you can probably tell from the above, we had a lot of fun diving into these projects.