How much liquidity can be brought by liquidity re-staking?

Original title: "How Liquid Are Liquid Restaking Tokens?"

Original author: Kairos Research

Original translation: Ladyfinger, Blockbeats

Editor's note:

EigenLabs' newly launched data availability AVS, EigenDA, represents the beginning of the re-staking era on the mainnet. This article aims to provide a comprehensive analysis of Liquid Restaking Tokens (LRT), exploring their integration in the DeFi ecosystem and comparison with traditional staking tokens. We pay special attention to the current state of market liquidity and potential opportunities and challenges in the future lending market. Through this report, readers can have a clear understanding of this emerging market and understand how LRT affects staking and restaking strategies on a global scale.

EigenLayer’s First AVS on Mainnet

Recently, EigenLabs released its data availability AVS, and EigenDA officially launched on mainnet, which marks the beginning of the re-staking era. Although the road to the EigenLayer market is still long, one trend is already very clear, that is, Liquid Re-staking Tokens (LRT) will become the main way for re-stakers. More than 73% of all EigenLayer staking is carried out through LRT, but how liquid are these assets? This report delves into this question and discusses the overall details of EigenLayer.

Introduction to EigenLayer and LRT

EigenLayer enables the reuse of ETH on Ethereum’s consensus layer through a new crypto-economic original concept - "re-staking". ETH can be re-staked on EigenLayer in two main ways: through native ETH re-staking or using Liquid Staking Tokens (LST). Re-staked ETH is used to support an additional application called Active Validation Service (AVS), which in turn allows re-stakers to earn additional staking rewards.

The main concern users have about staking and re-staking is the opportunity cost of staking ETH. For native ETH staking, this issue has been addressed through Liquid Staking Tokens (LST), which can be thought of as liquidity receipt tokens that represent the amount of ETH someone has staked. The LST market on Ethereum is currently around $48.65 billion, making it the largest DeFi sector by market size. Today, LST accounts for approximately 44% of all staked ether, and as re-staking continues to gain popularity, we expect the Liquidity Re-staking Token (LRT) industry to follow a similar growth pattern, or perhaps even more aggressively.

While LRTs share some similar features to LSTs, their missions are very different. The end goal of each LST is essentially the same, which is to stake a user’s ETH and provide a liquidity receipt token. However, for LRTs, the end goal is to delegate a user’s stake to one or more operators who will back a number of AVSs. How each operator allocates its delegated stake across these different AVSs is up to the individual operator. Therefore, the operators to whom LRTs delegate their stake have a large impact on the overall liveness, operational performance, and security of re-staked ETH. Finally, they must also ensure that appropriate risk assessments are performed on the unique AVSs supported by each operator, as slashing risk may vary depending on the service being provided. It is important to note that most Active Validation Services (AVSs) have little to no slashing risk at launch, but over time and as the staking market becomes more open and permissionless, we will gradually see these protections removed.

However, despite the different structural risks, LRTs reduce the opportunity cost of re-stacking capital by providing a liquidity receipt token that can be used as productive collateral in DeFi, or used to ease withdrawal periods. This last point is especially important because the main benefit of LRT is bypassing the traditional withdrawal period, which for EigenLayer is 7 days. Given this core principle of LRT, we expect them to naturally face net selling pressure as the barrier to entry into restaking is low, but the barrier to exit is high, so the liquidity of these LRTs will be their lifeline.

Therefore, as EigenLayer's TVL continues to climb, it is important to understand the drivers of the protocol's growth and how these forces may affect inflows/outflows in the coming months. As of the time of writing, 73% of all EigenLayer deposits are made through Liquidity Restaking Tokens (LRT). To provide a context, on December 1, 2023, deposits in LRT were approximately $71.74 million. Today, April 9, 2024, they have grown to approximately $10 billion, an increase of more than 13,800% in less than four months. However, as LRT continues to dominate EigenLayer's re-pledged deposit growth, there are some important factors to consider.

Not all LRTs are composed of the same underlying assets. In the long run, LRT stake delegation to AVS will vary, but will not vary much in the short term. Most importantly, the liquidity characteristics of different LRTs vary greatly.

Given that liquidity is the most critical advantage of LRT, the bulk of this report will focus on the last point.

Currently, the bullish case for EigenLayer deposits is primarily motivated by the speculative nature of Eigen Points, which we can assume will translate into some form of airdrop allocation of potential EIGEN tokens. There are currently no AVS rewards live, which means there is currently no additional incremental yield on these LRTs. In order to drive and maintain over $13.35 billion in TVL, the AVS market must naturally find a balance between the incremental yield required by re-stakers and the price that AVS are willing to pay for security.

For LRT depositors, we have seen the huge success of EtherFi with its ETHFI governance token airdrop at the beginning, with a fully diluted valuation of ~$6 billion as of now. Combined with all of the above, it becomes increasingly likely that some funds may gradually flow out of re-staking after the launch of EIGEN and other expected LRT airdrops.

However, in terms of reasonable yield, users will be hard-pressed to find higher yields in the Ethereum ecosystem that do not involve EigenLayer. There are several interesting yield opportunities in the Ethereum ecosystem. For example, Ethena is a synthetic stablecoin backed by staked ETH and hedged via ETH futures. The protocol currently offers an annualized yield of ~30% on its sUSDe product. Furthermore, as users become more comfortable with interoperability and bridging to new chains, yield-seeking users may look elsewhere, potentially driving a massive outflow of capital from Ethereum.

Nevertheless, we think it is reasonable to assume that there will not be any incremental staking yield events larger than a potential EIGEN token airdrop to re-stakers, and that large, blue-chip AVS with nine-figure valuations in the private market may also issue their tokens to re-stakers. Therefore, it is reasonable to assume that a certain percentage of ETH will flow out of the EigenLayer deposit contract via withdrawals following these events.

Given that EigenLayer withdrawals have a seven-day cooldown period, and the vast majority of capital is re-collateralized via LRT, the quickest exit path would be to swap your LRT for ETH. However, the liquidity characteristics of these different LRTs vary widely, and many LRTs are not accessible for mass exits at market prices. Additionally, as of writing, EtherFi is the only LRT provider that has enabled withdrawals.

LRT trading at a lower value than its underlying asset could lead to painful arbitrage cycles in re-collateralization protocols, imagine an LRT trading at 90% of its underlying ETH value, a market maker arbitrageur could step in to buy this LRT and push for a redemption process, hoping to make a ~11.1% profit while hedging against the ETH price. From a supply and demand perspective, LRT is more likely to face net selling pressure as sellers may avoid the 7-day withdrawal queue. On the other hand, users who wish to re-stake may deposit their ETH immediately, and purchasing LRT from the open market will provide little benefit to the staked ETH already owned.

Tracking the Data

The data section of this month’s report starts below and will track the growth, adoption, and liquidity of LRT, as well as any notable news we think should be reported.

Top 5 LRT Overview and Growth:

LRT Liquidity Total

Staking via LST and LRT has several key advantages over traditional staking, but these advantages are almost completely negated if the LRT itself is not liquid. Liquidity refers to “the efficiency or ease with which an asset can be quickly converted into cash without affecting its market price.” It is critical to ensure that LRT issuers provide large holders with sufficient on-chain liquidity to enable them to redeem receipt tokens at a near 1:1 value.

Each existing LRT has very unique liquidity characteristics. We expect these conditions to persist for several reasons:

1. Some protocols may be lucky enough to get investors and users to provide liquidity for their LRT in the early stages;

2. There are many ways to incentivize liquidity through grants, token distributions, on-chain bribery systems, or through the anticipation of events such as "points";

3. Some protocols will have more complex and concentrated liquidity providers who will keep their LRT close to the peg of the underlying asset, with less total USD liquidity. It should be noted that concentrated liquidity only works within a tight price range, and any price movement outside of the selected range will result in significant price impact.

Below is a very simple breakdown of the on-chain pool liquidity of the top five LRTs on Ethereum mainnet (plus Arbitrum). Exit liquidity refers to the USD value of the cash-like side of the LRT liquidity pool.

The five largest LRT cohorts have over $136M in ready-to-pool liquidity across platforms Curve, Balancer, and Uniswap, an impressive number considering the nascent nature of the re-staking industry. However, to provide a clearer picture of the liquidity of each LRT, we will apply a liquidity/market cap ratio to each asset.

Compared to stETH, the top liquid staking token, LRT’s liquidity ratios are not overly worrisome. However, given the additional risk layer introduced by re-staking, and the seven-day withdrawal cycle added by Eigenlayer that exceeds Ethereum’s unstaking queue, LRT’s liquidity may be more important than LST’s liquidity. In addition, stETH is traded on several large centralized exchanges, and its order books are managed by professional high-frequency trading firms. This means that stETH’s liquidity far exceeds what is seen on-chain. For example, on OKX and Bybit, ±2% of the order book liquidity exceeds $2 million.

Therefore, LRT can also work with centralized exchanges to strengthen integration and educate market makers on the risks and rewards of being a liquidity provider on these centralized venues.

Data from LRT

As shown in the above chart, rsETH, rswETH, and ezETH all trade relatively closely on a 1:1 basis with ETH, with a slight premium. Due to their nature, they should all trade at a "premium" in the future. Since these are all non-rebase tokens, unlike stETH, they automatically compound staking rewards, which is then reflected in the token price. This is also why 1 wstETH currently trades at around 1.16 ETH. In theory, over time, the "fair value" of these tokens should continue to grow due to the factor of time*staking rewards and be reflected in the increased fair value of these tokens.

The anchors of these LRTs are important because they essentially represent the level of trust that market participants have in the project as a whole, which is directly affected by the stake that participants have invested or the willingness of arbitrageurs to trade these premiums and discounts to keep the tokens trading at "fair value".

As can be seen from the trading of the two most liquid LRTs, ezETH and weETH, their trading prices have been relatively stable over time, mostly in line with their fair values. EtherFi's weETH has a slight deviation from fair value, which can be mainly attributed to the launch of its governance token, where opportunistic farmers swapped out tokens and naturally, other market participants stepped in to trade this discount arbitrage. Once Renzo launches its governance token, we can expect to see similar events.

KelpDAO’s rsETH traded at a discount to fair value at launch, but has since slowly but steadily returned to parity.

For rswETH, it has traded slightly below its fair value for most of the time, but appears to have reached parity with its fair value recently. Of all these LRTs, pufETH is the main outlier as it has only ever traded at a discount to fair value. However, this trend appears to be coming to an end as it is trading closer to the fair value of its underlying asset.

Except for EtherFi, none of these LRT providers have enabled withdrawals. We believe that ample liquidity coupled with the ability for users to withdraw funds at will will increase market participants’ confidence in trading at these discounts or premiums.

LRT in the DeFi Ecosystem

Once LRT becomes further integrated within the broader DeFi ecosystem, and specifically within the lending market, its importance will grow significantly. For example, when we look at the current money markets, LSTs in particular such as wstETH/stETH are the largest collateral assets on Aave and Spark, providing approximately $4.8 billion and $2.1 billion respectively. As LRTs gain more and more ground within the DeFi ecosystem, we expect them to eventually surpass LST in terms of volume, especially as they become more Lindy over time as the market becomes more understanding of the risks and product structure. Additionally, there are governance proposals on both Compound and Aave to introduce Renzo’s ezETH.

However, as mentioned previously, liquidity will continue to be the lifeblood of these products to ensure their breadth and depth of DeFi integration and overall durability.

Conclusion

While stETH gained an early lead and dominated due to first-mover advantage, a series of LRTs mentioned in this report were launched at roughly the same time and market momentum was on their side. We expect this to be a winner-takes-most market structure as most liquid assets apply power laws; simply put, liquidity begets liquidity. This is why Binance continues to dominate the centralized exchange market share despite all the negative news and turmoil.

Overall, liquidity re-collateralization tokens are not extremely liquid. Liquidity is decent, but there is greater nuance to each individual LRT, which will only increase as delegation strategies begin to differ in the long run. For first-time users, it may be easier to understand LRTs as collateralized ETFs. Many will compete for the same market share, but allocation strategies and fee structures will likely be the determining factors in who the winners and losers are in the long run. Additionally, as products become more differentiated, liquidity will become more important, considering how long withdrawal cycles are.

In the crypto space, seven days can sometimes feel like a month in normal times, as global markets operate 24/7. Finally, as these LRTs begin to integrate into lending markets, pool liquidity will become more important, as liquidators will only want to take acceptable risks, depending on the different liquidity characteristics of the underlying collateral in question.

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