Exploring Developments Around Liquid Staking Derivatives
Innovations in the landscape including EigenLayer, Obol, and more
Liquid staking derivatives allow users to earn rewards on their staked crypto while preserving liquidity and improving capital efficiency. As popular liquid staking services like Lido, Rocket Pool, and Frax continue to gain market share, it’s interesting to see how their underlying tech works and its impact on the crypto sphere. In these protocols, tokens staked by a user are delegated to a validator in the set which in turn helps guarantee the protocol’s overall security. In exchange, the user receives a liquid staking derivative token (representing their stake) that they’re able to trade across dapps that support the token. With Lido, for example, when users deposit ETH they receive stETH, which can be traded or collateralized across supported dapps. Additionally, users earn rewards on their staked ETH.
The liquid staking industry is experiencing fast adoption: as of early April 2023, ETH liquid staking balances topped 7.3M ETH – up from 3.3M ETH in early April 2022. With this rapid growth, a brand new industry is developing around liquid staking derivatives: below are exciting new primitives that are emerging to reshape the field.
EigenLayer
An add-on to staking that has drawn attention to the category recently is the launch of EigenLayer, which employs a restaking mechanism to enable shared security across projects. EigenLayer improves efficiency by an enormous amount by leveraging existing staked capital on Ethereum to new secure networks in need of validation. With this technology, new projects outside of the EVM are able to skip the intensive process of bootstrapping their own validatory set. Dapps, rollups, and middleware can harness EigenLayer’s restaking security mechanism to achieve better flexibility and scalability.
In the current landscape, the following problem exists: modules not deployed on the Ethereum Virtual Machine (EVM) are not able to leverage Ethereum’s (strong) validation. Examples of these modules include: sidechains that use a different consensus mechanism than Ethereum, data availability (DA) layers, VMs, keepers, oracles, bridges, threshold cryptography schemes, and more (EigenLayer whitepaper). Each of these modules are hugely important from an innovation standpoint but it’s often difficult to justify building within these categories due to security complexity.
Modules that can leverage Ethereum consensus via EigenLayer, leading to more innovation and security. Source: EigenLayer whitepaper
As the blockchain field grows from a technical sophistication perspective, this is a large limitation in building outside of the EVM. Often, developers have to choose between innovating outside of Ethereum – and not being able to leverage its validator set – versus building on the EVM but having to adhere to the above constraints. As the whitepaper describes, these projects need actively validated services (“AVS”) in order to achieve proper validation. However, building an AVS comes with significant restraints. The four key issues EigenLayer’s whitepaper mentions are the following: bootstrapping an entirely new trust network for a new AVS, value leakage (from Ethereum) since users must pay two fees (one for securing each network), capital cost burden (EigenLayer cites opportunity cost / price risk), and a lower trust model (since the validation may not be sufficiently robust).
EigenLayer proposes a solution to these issues by applying the security Ethereum’s validator set provides to these modules: in their words, pooled security via restaking and free-market governance.
Pooled security via restaking essentially lets modules (like the ones discussed above) use distributed Ethereum security to ensure their own soundness. Validators can opt-in to secure modules and are then rewarded with additional fees for securing the modules’ network. The modules in turn have the ability to slash the staked ETH of validators if they don’t comply with certain rules. This entire process is referred to as “restaking” – using existing stake to secure new networks. The restaking mechanism capitalizes on Ethereum’s robust security which can be distributed across modules that previously weren’t able to benefit from the security of a large and relatively stable network. Additionally, liquid staking tokens such as stETH, rETH, cbETH, and LsETH can all be restaked, enabling better composability and cryptoeconomic security across web3 platforms.
Leveraging existing trust models to secure a new network. Source: EigenLayer whitepaper
There are two types of restaking possible via EigenLayer: restaking already-staked ETH by pointing withdrawal credentials to EigenLayer’s smart contracts, and restaking liquid staking derivatives by transferring them into EigenLayer’s smart contracts.
EigenLayer has also built a mechanism for AVSs to choose which modules they opt into or not depending on their risk appetite: free market governance. This is beneficial for both new modules and validators: validators profit from securing the new module, and the new module is able to grow faster and there are less concerns around security issues. Through this mechanism, home stakers are also able to stack yield from home staking through securing multiple projects. The risk that comes with securing new modules is that a validator could be slashed if certain conditions aren’t met.
Pooled security supercharges validation by leveraging Ethereum’s validator set and AVS’s. Source: EigenLayer whitepaper
EigenLayer has developed a marketplace model in which AVSs can “rent pooled security provided by Ethereum validators.” Security no longer needs to rely on just the network’s native token, but can leverage restaked ETH.
Many questions have already been raised about the paper, specifically around liveness, decentralization, and slashing procedures. Sreeram Kannan, EigenLayer’s founder, addresses some of these issues here:
It will be interesting to see the discourse and implications that result from EigenLayer’s solution.
Other protocols are also designing ways to leverage stake to drive innovation in the industry. In order to mitigate risks of validator centralization as Ethereum scales, it’s crucial to create validation designs that effectively preserve decentralization.
Obol
Obol is developing new technology to build distributed validation for Ethereum. The technology helps to improve liveness and safety by delegating compute across a cluster of nodes versus the validator running on just one node. Obol does this using distributed validator keys, which are groups of BLS private keys that collectively function as a threshold key in order to participate in PoS consensus.
Distributed validator keys group together BLS private keys that then collectively function as a threshold key. Source: Obol
Using this distributed validator technology (DVT), Obol also built a network that operates as a layer on top of the consensus layer and provides access to distributed validators (DVs). If successful, Obol’s pluggable layer will become a widely used primitive and will help guarantee the security, resiliency, and decentralization of the blockchains that integrate it.
On March 10, the first block was proposed by a distributed validator on Mainnet.
Alluvial
Alluvial Finance is focusing on bringing in institutional players to the staking ecosystem in order to better secure PoS chains and improve LST liquidity. Liquid Collective, the liquid staking standard Alluvial is developing, is an on-chain protocol governed by industry participants including Coinbase Cloud, Kiln, Kraken, Staked and more. The solution provides enterprise-grade infrastructure that prioritizes compliance and security at scale. Further, Liquid Collective operates across protocols with a focus on liquidity (via industry partners), since liquid staking tokens can be relatively illiquid depending on which protocols support them. The protocol also provides its participants with comprehensive slashing coverage including dealing with network outages and node operator failures.
Ion
Ion Protocol is developing a liquidity product suite and token standard for liquid staking tokens (LSTs). They claim that two core problems – liquidity fragmentation and complex token models – are adding unnecessary complexity to the staking ecosystem. Further, governance friction only adds to the disarray since discussions about liquid token standards are scattered across different platforms. Ion also cites different value accrual methods for different LSTs – e.g. Lido’s rebasing mechanism and Frax’s two-token model – which can be confusing for users to understand and keep track of. By streamlining these processes and introducing one unified token standard, Ion will improve efficiency and liquidity in the LST ecosystem.
As the staking industry develops, new primitives will continue to bring innovation to the space. By addressing issues like stake centralization, lack of institutional infrastructure, and liquidity concerns, these mechanisms will drive ecosystem growth and redefine the way individuals interact with staking protocols.
Nicely done