Liquidity Redemption Platform Revives Ethereum DeFi: Can the Hype Last?

Author: Sam Kessler; Compiled by: Vernacular Blockchain

In the past month alone, billions of dollars have poured into new Ethereum-based liquidity re-collateralization projects such as Ether.Fi and Puffer. These emerging platforms are vying to replace Lido’s collateralized ETH (stETH) token as the asset of choice for decentralized finance (DeFi) traders.

At the heart of the entire trend is the development of a new protocol called EigenLayer, which debuted last June as a new "re- Mortgage” system. The platform is building a solution that lets blockchain applications and networks borrow Ethereum’s security system, and it attracted more than $1 billion in new deposits in a 24-hour period this month. The total amount now exceeds $7 billion, which means the platform alone has accumulated more than 1.5% of circulating ether (ETH), according to DefiLllama.

Restaking provides a way to secure the blockchain protocol and network using security borrowed from Ethereum’s proof-of-stake network. ETH deposits in EigenLayer can be "re-staking" into other protocols, meaning they don't have to build their own proof-of-stake networks.

Investors are flocking to EigenLayer because it promises higher interest than traditional ETH staking. However, the platform’s recent growth is largely due to a group of third parties – “liquidity re-staking protocols” such as Ether.Fi, Puffer and Swell – which claim to streamline the re-staking process on behalf of users.

These liquidity re-hypothecation platforms act as intermediaries between users and EigenLayer: these platforms "re-hypothecate" users' deposits to EigenLayer and deliver corresponding new LRT is generated in exchange so that users can continue trading even when their deposits are used to re-mortgage.

LRT represents user deposits in EigenLayer, meaning they accumulate mortgage interest and can be redeemed back to their underlying value. LRT can also be used inDeFi, which means people can borrow and exchange LRT for greater returns.

Apart from the convenience of LRT, the real attraction of recent liquidity re-collateralization platforms is "points" - this kind of reward may allow users to have Be eligible for future Token airdrops. While the monetary value of points is unclear, they have spawned a whole new ecosystem of add-on platforms, such as Pendle, which allows users to maximize their points through trading strategies that often involve high leverage.

This complex points system, high-yield and high-risk trading strategies are reminiscent of the scene in 2021 - "yield farm" and The chase for high returns triggered booms and busts inDeFiand the industry has yet to fully recover. While some experts are wary of the risks of liquidity rehypothecation, proponents of the technology insist there is real substance beyond the hype.

1. Staking 101

Liquidity re-mortgage is based on two aspects of the Ethereum mortgage industry. based on annual growth.

Ethereum is run by over 900,000 validators, who are people around the world who lock ETHTokens to addresses on the network to help secure the chain. Safety. Staked Tokens accumulate steady 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 restriction prompted the rise of "liquidity mortgage". Services like Lido allow users to stake on their behalf and give them "Liquidity Staking Tokens" (LST) that represent their underlying deposits. Like Lido’s Collateralized ETH (stETH) Token, LST earns interest like regular collateralized Ethereum (currently around 3%), but they can also be used in DeFi – meaning investors can borrow these tokens , to obtain additional income.

The liquidity mortgage industry has boomed over the past few years. Lido, the largest liquidity staking protocol to date, has over $25 billion in deposits. Its collateralized ETH (stETH) token regularly sees higher transaction volume than regular ETH in the largest lending protocols on the network.

2. From liquidity staking to liquidity re-staking

Now, similar flows The staking trend is picking up on EigenLayer, a high-profile new protocol that introduces restaking to Ethereum.

"EigenLayer basically builds a tool that allows other networks to leverage Ethereum's security to boot," explained Omni Labs CEO Austin King Dow, who is building a bridge protocol powered by re-mortgage.

Investors have turned to EigenLayer to receive additional rewards on their ETH: Earned for protecting Ethereum on the one hand Interest, on the other hand, is the re-staking interest earned to protect the so-called AVS (Active Verification Service) that uses EigenLayer to borrow Ethereum’s security.

According to EigenLayer, these AVS will eventually include Celo, a layer-1 blockchain that is transforming into a layer-2 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.

But this system also has shortcomings. One of the key issues is that tokens re-mortgaged through EigenLayer cannot be used in DeFi after depositing used in . For investors looking to maximize returns, this lock-in mechanism is a major disadvantage.

So, liquidity re-mortgage came into being, which is essentially a liquidity mortgage designed for EigenLayer.

The liquidity re-hypothecation protocol accepts deposits (such as stETH), re-hypothecates through EigenLayer, and then issues "liquidity re-hypothecation Tokens" such as pufETH, eETH and rswETH , which can be used in DeFi to earn additional points and other rewards.

Relevant personnel explained: "Basically it is the value proposition of mortgaging ETH, you Earn earnings for staking ETH without having to bother setting up a validator node. Not only that, but get compensated for any rewards brought by theseAVSnetworks." >

3. Incentive games

Puffer’s pufETH, Ether.Fi’s eETH, Swell’s rswETH, along with other Liquidity Recollateralized Tokens (LRTs), are competing with Lido’s stETH to become the next big asset in DeFi. To do this, they have turned to the current incentive model in DeFi: points.

Although EigenLayer has accepted billions in deposits, its AVSs have not yet been launched, meaning depositors have not received interest on their deposits . Currently, the main incentive for depositing tokens into EigenLayer is to re-mortgage points, a vaguely defined count through which investors hope to earn future confirmed EigenLayer airdrops.

"Puffer Finance CEO Amir Foruzani pointed out in an interview with CoinDesk last month: "EigenLayer has not been launched yet, it has not had any restarts. mortgage. " "Their only incentive now is points, which is basically a guess at the future value of those points. " Major liquidity restaking protocols (including Puffer) have begun offering their own points as an additional incentive for early investors.

Swap around points New services have also emerged that promote risky trading strategies that involve repeatedly staking the same token - increasing exposure to the protocol at the expense of higher future returns.

One ​​such protocol is Pendle, which splits a liquidity recollateral token into two separate tokens - a yield token and a principal token - to unlock leveraged trading. One of Pendle's products accepts Ether.Fi's eETHToken Deposits, and according to the site's advertising, can earn 45x Ether.Fi points and 15x EigenLayer points.

While the points are still highly speculative, They appear to be having a positive impact on liquidity recollateralizing deposits. Market leader Ether.Fi now has $1.2 billion in deposits, five times what it had a month ago, according to DeFiLlama data. Puffer Finance follows with $970 million in deposits Since then, it has increased tenfold in the past three weeks alone.

4. Penalty risk

As liquidity rehypothecation deposits surge, the risks of this trend are also increasing.

On the one hand, the general trend related to EigenLayer The risk comes when investing money into a complex system made up of layers of protocols:As the complexity of interconnected AVS networks increases, errors will inevitably become more likely.

The biggest risk from these errors will be "penalties", which are financial penalties to the mortgagor due to violating network rules or using defective software to connect to the network. Liquidity recollateralization protocols often mention “penalty-proof” features in their marketing, but until AVS starts running, these promises will not be verified in practice.

In the context of EigenLayer recollateralization, penalties occur at the AVS level: Each AVS will set its own penalty rules, and liquidity recollateralization providers will be able to choose what they want for AVS protocol for user authentication. If a liquidity recollateralization platform chooses to validate a network with malicious (or flawed) penalty parameters, it puts users at risk of having their deposits slashed.

"We will build a similar reputation system in the broader re-hypothecation ecosystem," Riad Wahby, CEO of critical management services company Cubist, told CoinDesk predicted during the interview. "If I were to put money into an operator, I would probably choose one that gives me the right balance between risk and reward."

5. Speculative risk

The most obvious risk of liquidity rehypothecation is that despite billions of dollars in deposits, this practice is currently very Speculation.

AVS may not be able to provide depositors with the interest returns they expect, which may cause investors to leave the system in search of more profitable Betting Opportunities. Amid all the excitement about Points, there is also some possibility that the accompanying airdrop could fail or never happen, making the Points and the new markets built on top of them virtually worthless.

The reason the risk of this outcome is amplified is that points are typically not issued on the blockchain but are tracked directly by the issuer. This means it’s difficult to know how many points of a particular type are in circulation, making it difficult to determine their value.

The speculative appeal of liquid recollateralized points is reminiscent of the days of yield farming. In 2021-2022, when the DeFi industry is at its peak, money is pouring into projects like Olympus and Terra, which promise to provide users with market-leading returns in exchange for trust in their complex systems. Critics accused these projects of creating worthless tokens and printing them indiscriminately to artificially prop up revenue numbers, and these criticisms were ultimately proven correct after the platforms collapsed.

Regardless of the superficial similarities, EigenLayer has entered the lives of Ethereum developers in a way that the worst actors of yield farming have never done. thinking, and supporters of liquidity re-collateralization say it has the potential to support the development of applications and infrastructure beyond the narrow realm of points and gamified speculation.