IOSG: Starting from the underlying logic, in-depth discussion of the future development of LRT

There has been a lot of discussion recently around EigenLayer’s re-pledge and LRT (Liquid Restaking Token). Users are betting on the potential airdrop expectations of each protocol, and re-pledge has become the hottest narrative in the Ethereum ecosystem. This article will briefly discuss some of the author’s thoughts and opinions on LRT.

The underlying logic of LRT

LRT is a new asset class derived based on EigenLayer, aiming to achieve the goal of "liberating liquidity" similar to LST. However, due to the different composition of the underlying assets of LRT, LRT is more complex than LST, with more diverse and dynamic characteristics.

Using ETH as the benchmark and treating the Ethereum pledge below LST as a currency fund, then LRT as an asset manager can be regarded as a fund for AVS. Comparing LST and LRT is a quick way to understand the underlying logic of LRT.

Source: IOSG Ventures

1. Portfolio

LST’s portfolio only contains Ethereum staking, while LRT’s portfolio It is more diversified and funds can be invested in different AVS to increase financial security, but it also comes with different levels of risk. Different LRT protocols have different fund management methods and risk preferences. In terms of money management, LST adopts a passive management strategy, while LRT adopts an active management strategy. LRT may provide multiple management strategies for different levels of AVS (such as EigenDA and newly launched AVS) to suit the user's return and risk preferences.

2. Yield, source and composition

The yield, source and composition of LST and LRT are different:

• The yield of LST is currently It is approximately stable at around 4.9%, which comes from the joint income of the Ethereum consensus layer and the execution layer, and is composed of ETH.
• The rate of return of LRT is not yet certain, but it is basically derived from the fees paid by each AVS, and may be composed of AVS tokens, ETH, USDC, or a mixture of the three. According to information we have received from communicating with some AVS, most AVS will set aside a few percentage points of the total token supply as incentive and security budgets. If AVS is already online before the currency is issued, it may also pay ETH or USDC, depending on the specific situation. (In this way, Restaking can actually be understood as the process of replenishing ETH to mine third-party project tokens)

Due to the AVS token standard, its token value will fluctuate more dramatically than ETH, which also means APR will fluctuate accordingly. In addition, rotation in and out of AVS may occur, and these factors will bring a certain degree of uncertainty to LRT's yield.

3. Penalty risk

There are two types of penalties for Ethereum staking: Inactivity Leaking and Slashing, such as missing block proposals and double voting, and the rules are very certain. If operated by a professional node service provider, Correctness can reach around 98.5%.

The LRT protocol needs to believe that the AVS software coding is correct and have no objection to the penalty rules to avoid triggering unexpected penalties. There is inherent uncertainty due to the diverse nature of AVS and the fact that most are early-stage projects. Moreover, AVS may have rule changes as its business develops, such as iterating more functions and so on. In addition, at the risk management level, it is also necessary to consider the upgradeability of the AVS Slasher contract, whether the slashing conditions are objective and verifiable, etc. Since LRT acts as an agent for managing user assets, LRT needs to comprehensively consider these aspects and choose partners carefully.

Of course, EigenLayer encourages AVS to conduct a complete audit, including AVS's code, slashing conditions, and logic that interacts with EigenLayer. EigenLayer also has a multi-signature veto committee to conduct final review and control of forfeiture events.

LRT's rapid growth in the short term

Source: EigenLayer

EigenLayer adopts a phased opening model for re-pledge of LST, and There are no restrictions on Native Restaking. Restricting LST may be a means of hungry marketing, but in fact it is more important to promote the growth of Native Restaking. Because after restricting LST, if users want to re-stake, they can only turn to the third-party LRT protocol to provide Native Restaking, which also greatly promotes the development of the LRT protocol. The current ETH flowing into EigenLayer through LRT accounts for about 55% of EigenLayer’s total TVL.

In addition, the implicit point is that Native Restaking can provide Ethereum Inclusion Trust, which is also the third trust model provided and advocated by EigenLayer in addition to Economic Trust and Decentralization Trust. That is, in addition to committing to Ethereum through staking, Ethereum validators can also run AVS and make commitments to AVS. Most of these commitments are related to MEV. One of the use cases is "future block space auction". For example, the oracle may need to provide price feeding services within a specific time period; or L2 needs to publish data to Ethereum every few minutes, etc. They can pay the proposer to reserve future block space.

LRT’s competitive landscape

First of all, in order to make the liberated liquidity useful, the integration of DeFi is the main point of competition between LRT protocols.

As mentioned above, although in theory AVS needs to calculate the economic security they require to reach a certain security threshold, the current approach of most AVS is to use a portion of the total supply of Tokens for incentives. Since different AVS rotate in and out, incentives depend on the price of AVS Token, so the uncertainty of LRT assets is much greater than that of LST (LST has a stable "Risk-free rate" and good expectations for ETH price), in mainstream DeFi In terms of protocol integration and compatibility, it is difficult to become a "hard currency" like stETH.

After all, as a pledge agreement, LRT’s liquidity and TVL will be the first criteria that DeFi protocols pay attention to, followed by brand, community, etc. Liquidity is mainly reflected in the time period of exit. Generally speaking, it takes seven days to exit from EigenPod, followed by a certain amount of time to exit from Ethereum staking. Protocols with larger TVL can build better liquidity, such as the Liquidity Pool Reserve operated by Etherfi which offers fast withdrawals (i.e. eETH -> ETH).

But it is too early to discuss the integration of mainstream DeFi before the EigenLayer mainnet is launched, because many things are still unknown.

In other aspects, Ether.fi recently launched the $ETHFIWIFHAT meme token tweet on the official website to build momentum for the token to go online, which made people think a lot. Swell uses Polygon CDK, EigenDA and AltLayer to build zkEVM L2, with its LRT rswETH as the gas token. Renzo focuses on multi-chain integration on Arbitrum, Linea and Blast. I believe that each LRT protocol will launch its own differentiated playstyle in the future.

However, whether it is LST or LRT, the degree of homogeneity is relatively high. Although LRT has more room to display than LST, even if an LRT launches a new idea to the market, competitors are still able to Follow suit. The author believes that the moat still lies in consolidating and improving TVL and liquidity. Etherfi currently has the highest TVL and the best liquidity. Assuming that all LRT protocol airdrop expectations are fulfilled, Etherfi will have a greater advantage in attracting new funds. (The adoption of institutional users cannot be ignored. 30% of Etherfi’s TVL comes from institutional users)

After the airdrop event, it is entirely possible that the LRT pattern will be reshuffled. The competition for users and funds will become more intense (for example, after the Etherfi airdrop is distributed, some funds may immediately flow to other platforms). Until EigenLayer is fully launched on the mainnet and AVS starts to provide revenue, LRT will not be very sticky to users.

The sustainability of LRT

The sustainability of LRT can actually be regarded as the sustainability of the EigenLayer system, because the income from Ethereum staking will always exist, but this may not be the case for AVS. A question that is often asked is: at the current TVL of 11b, how does EigenLayer provide a yield that matches it (e.g. 5% per year)? The author believes that there are the following points:

• Although EigenLayer’s TVL reached 11b before the main network was fully launched, even exceeding AAVE, after the airdrop of a series of related protocols ends, EigenLayer’s TVL will definitely have a period of decline. Correction period for mean reversion. Overall, it doesn't take that much to consider yield in the short term.
• Secondly, each AVS token provides different returns, durability, and volatility. Each pledger’s risk preference and pursuit of returns are also different. In this process, there will be spontaneous market changes. Dynamic regulation (more ETH pledged to a certain AVS will reduce the yield, prompting pledgers to switch to other AVS or other protocols), so it is not possible to simply use the percentage of the entire TVL to directly calculate the income that needs to be provided.
• From a mid- to long-term perspective, the driving force for the sustainable development of the EigenLayer ecosystem lies on the demand side, that is, there needs to be enough AVS to pay for economic security, and it must be sustainable, which is also good for AVS's own business. Related to bad situations. At present, in addition to the 12 early AVS partners such as AltLayer, there are also a series of AVS that have announced cooperation. The author understands that there are dozens of AVSs waiting in line for integration. Of course, this is also related to the project quality of AVS, the performance of Token and the design of the incentive mechanism. There is currently no way to give definite comments.

Summary

Finally, regarding the future pattern of LRT, the author has the following views:

1. Although competition is very fierce, LRT is still the primary market EigenLayer The preferred direction for investment layout in the ecosystem. When investing in AVS in EigenLayer, the investment logic should consider the investment logic of this middleware. This does not differ because EigenLayer is used to start the network, but the way to implement the product is different. There may be dozens or hundreds of AVS built on EigenLayer in the future, so the concept of AVS is not unusual. The direction of node service providers is already firmly occupied by some mature companies. LRT is obviously closer to users. As an abstraction layer between users and EigenLayer, it has the attributes of both Staking and DeFi. As an allocator of assets, it has a greater say in the ecosystem. Throughout EigenLayer's ecological layout, we also focus on areas such as developer tools, Anti-slashing key management, risk management, and public goods.

2. Currently, the proportion of EigenLayer re-staking through LRT and LST is approximately 55% and 45%. We expect that with the gradual development of EigenLayer, the advantages of LRT unlocking liquidity will become apparent, and this ratio may reach about 73% (assuming that some giant whales and institutions that conservatively hold stETH still choose to passively hold stETH). Of course, the risks of LRT cannot be ignored. Due to the nested asset structure, we also need to pay attention to systemic risks such as depeg under extreme market conditions. In the long run, we hope to see AVS in the EigenLayer ecosystem thrive and provide LRT with a relatively stable underlying structure and benefits.

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