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Coinbase: Restaking Can Be a Game-Changer in Validator Incentives, But at What Cost?


Leading cryptocurrency exchange, Coinbase has released a new report delving into the restaking trends in Ethereum. The report, authored by analysts David Han and David Duong, explores how restaking could reshape validator incentives, potentially unlocking new opportunities and introducing complex risks.

Coinbase analysts explain why restaking has emerged as a major theme within the crypto industry. Ethereum’s switch to proof-of-stake (PoS) has created a vast pool of staked ETH, far outpacing the requirements for network security.

However, the introduction of restaking, particularly through liquid restaking tokens (LRTs), brings to the forefront both opportunities and risks for validators and the broader decentralized finance (DeFi) ecosystem.

Restaking’s Growth and the Rise of LRTs

Restaking lets Ethereum validators earn extra rewards by securing additional services on top of the network’s base layer. This concept has taken hold with the rise of EigenLayer, a restaking protocol that has become the second-largest Ethereum DeFi platform with $12.4 billion in total value locked (TVL).

EigenLayer vs. Lido TVL Growth Comparison.
EigenLayer vs. Lido TVL Growth Comparison. Source: Coinbase Research

EigenLayer has seen explosive growth despite a lack of live actively validated services (AVS) – the additional protocols validators can secure to boost rewards. This suggests short-term farming opportunities might drive some interest. Coinbase analysts predict a short-term drop in EigenLayer’s TVL when farming ends or if initial AVS yields disappoint.

The Complexities and Uncertain Rewards

While restaking’s potential is clear, Coinbase’s analysis highlights financial and security risks. The involvement in various AVSs may complicate the understanding of financial and security repercussions, raising the stakes more than before.

Coinbase’s concerns echoed what Vitalik Buterin, the co-founder of Ethereum, stated in May 2023.

“In some cases, if they misbehave according to the other protocol’s rules, their deposit also gets slashed. In other cases, there are no in-protocol incentives and stake is simply used to vote,” Buterin wrote

Furthermore, it remains to be seen how lucrative the initially available AVSs will be. Some LRT platforms could face unsustainable fee structures if the returns from AVS are insufficient to cover costs.

Additionally, deciding which AVSs to back introduces another degree of complexity for those engaging in restaking. This decision-making process creates a murky environment where accurately assessing risks becomes challenging.

Providers of LRT may be tempted to chase the highest possible yields, potentially exposing their users to higher levels of risk without a comprehensive understanding of the implications.

Despite these concerns, restaking is paving the way for innovative DeFi protocols and may significantly influence Ethereum’s economic model. With the DeFi sector’s TVL in LRTs nearing $8.5 billion and platforms like CoinGecko categorizing restaking tokens as a significant growth area, the trajectory of restaking in Ethereum’s ecosystem is set for substantial evolution.

Top crypto platforms | April 2024


Conclusion

In conclusion, the report from Coinbase highlights the growing trend of restaking in Ethereum and its potential to reshape validator incentives within the crypto industry. The shift to proof-of-stake in Ethereum has led to a surplus of staked ETH, creating opportunities for restaking. However, the introduction of liquid restaking tokens (LRTs) brings both opportunities and risks for validators and the DeFi ecosystem. While restaking offers additional rewards, it also introduces financial and security risks, especially with the involvement of various protocols. The complexity of choosing which AVSs to back and the pursuit of high yields may expose users to increased levels of risk. Despite these concerns, restaking is driving innovation in DeFi protocols and is expected to have a significant impact on Ethereum’s economic model, signaling substantial evolution in the ecosystem.

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