Ethereum restaking: Blockchain innovation or dangerous house of cards?

Ethereum restaking — proposed by middleware protocol EigenLayer — is a controversial innovation over the past year that has some of the brightest minds worried about the potential ramifications.

Restaking involves reusing staked or locked-up Ether tokens to earn fees and rewards. The restaked tokens can then help secure and validate other protocols. 

Proponents believe restaking can squeeze additional security and rewards from already staked ETH and grow the crypto ecosystem in a healthier way based on Ethereum’s existing trust mechanisms. Restaking could serve as a security primitive for exporting Ethereum’s trust generated by its validators to other projects.

Yet Ethereum co-founder Vitalik Buterin and a number of key devs worry that restaking is a house of cards that will inevitably tumble. Some of those Ethereum devs have even proposed a fork to head off restaking platform EigenLayer. 

Why the project’s founders promote “trust as a service” from Ethereum without the Ethereum founder and others’ willingness to participate is still to play out. Will the whole concept result in an Ethereum fork to protect the network from catastrophic failure? 

Staking and restaking

Staking is a crypto-native concept. On Ethereum, it means putting up a security bond in ETH so that the validator (validators of new transactions who maintain the security of the blockchain) will behave honestly in verifying transactions rather than lose their staked tokens. Stakers are then paid rewards for locking up this ETH. 

In essence, stakers lock up their tokens to commit to producing Ethereum blocks — an on-chain way of supporting development, regardless of fluctuations in highly volatile token prices. 

So what is restaking?

In short, restaking works in that already staked Ethereum tokens can be rehypothecated (when a lender re-uses collateral posted from one loan to take out a new loan) to secure a wider variety of applications and accrue additional rewards.

But restakers also get penalized or slashed for non-performance of their staking tasks. (More on that below).

So restaking is a crypto primitive for generating economic security from Ethereum’s nine years of concerted developer activity and project track record. 

“It’s an extension protocol to extend what Ethereum can do, scaling out Ethereum stakers beyond Ethereum to other bridges and oracles that need to be secured,” EigenLayer founder Sreeram Kannan tells Magazine.

He says EigenLayer is commoditizing ETH staking to make it more general purpose, as, in crypto parlance, “staking is the root of trust.” 

Kannan is an academic on leave from the University of Washington, and EigenLayer began as academic research into “exported trust” as a consensus protocol. Basically, he sought to piggyback the trust generated by Ethereum to other ecosystems. 

Kannan essentially seeks to export the “trust” generated by Ethereum for other projects across the ecosystem and other chains. “In crypto, mechanisms for trust mean that investors need skin in the game. The pseudonymous world needs carrots and sticks whereby validators are distributed.” He calls it “permissionless innovation.” 

The best each chain has to offer

The big idea for EigenLayer is to bridge blockchains and create super applications, taking the best each chain has to offer. Kannan says “every ecosystem is better in some dimension, but not all dimensions,” and EigenLayer enhancing decentralized tech stacks will actually benefit the industry. 

Kannan said that what can be built with EigenLayer fits roughly into two categories.

Firstly, EigenLayer allows for the construction of bridges from chain to chain, say Ethereum to Avalanche. EigenLayer acts as a marketplace for “decentralized trust,” connecting stakers seeking yields, projects built on EigenLayer offering risk-reward structures for yields, and operators acting as bridges between stakers and projects.

Secondly, a set of smart contracts on Ethereum’s chain lets ETH stakers opt to run other software. EigenLayer could, for example, improve Ethereum transaction finality speeds. ETH stakers can now take the layer-1 blockchain Fantom chain (for better transaction finality times) and fork it on EigenLayer, thereby running a layer as a super fast finalization layer with an EigenLayer trust layer.

But it’s all still theoretical.  

The idea of restaking makes sense theoretically, helping projects build off Ethereum’s security layer — but the problems worry many. 

In theory, “it’s like the NATO security alliance; each country is still a sovereign country, but their mutual defense pact is secured by the sum of their military power,” Sunny Aggarwal, co-founder of Osmosis Labs and creator of a similar restaking system — Mesh, on Cosmos’ chain — told Magazine. 

In practice, EigenLayer provides two ways to restake: whitelisted liquid staking derivatives can be restaked with EigenLayer or an EigenPod (a smart contract can be created to run a validator while restaking). But most restakers won’t run their own validator, so new networks can build projects without their own communities of validators. 

EigenLayer isn’t live yet, and it’s impact is still highly speculative, according to Anthony “0xSassal” Sassano, a full-time Ethereuem educator, founder of YouTube channel The Daily Gwei and an early investor in EigenLayer.

To date, there’s only a smart contract for staked ETH to bootstrap the EigenLayer network, and perhaps given EigenLayer’s hype, people are depositing their ETH into that network, expecting to farm an unconfirmed airdrop of native EigenLayer tokens. 

A force for good or evil?

To be successful, new consensus protocols need a balanced alignment of incentives. Trust is like a scale weighing competing interests. And trying to export Ethereum security layers to different blockchain ecosystems worries some. Many are still trying to understand if it’s a force for good or evil — or both.

“There are two camps: those excited by broadening the use case of ETH staking, and then there are those that worry about potential attack vectors on Ethereum and potential negative consequences for Ethereum if something goes wrong with EigenLayer. My view is in the middle; I understand the concerns and the excitement.” Sassano says.

“Inherently, all of this is complex; it depends which rabbit hole you want to go down. The simple answer is that Ethereum, as a network, currently has over 25 million ETH at stake — that’s tens of billions of dollars. So restaking is asking, what if we could harness that economic security for other purposes than just securing the Ethereum chain?”

Sassano continues: “That’s exactly what EigenLayer is trying to do, to generalize the security that Ethereum has with its stakers and expand that to other things like an oracle network or a data availability network. It’s inherently more technical and complex than that, but that’s the gist of it.” 

There are two types of danger that restaking could pose: first for “restakers” and then for Ethereum itself. 

Restaking creates too much leverage

Restaking is controversial as it is akin to leveraged investing through borrowing. Some argue that the danger here is that the hunger for “real yields” or actual revenue that emerged in crypto in 2022 leads to unsavory developments, like restaking. 

Jae Sik Choi, portfolio manager at Greythorn Asset Management, told Magazine that securing networks through restaking could work, but restaking is akin to leverage:

“Just like how Terra’s over-leveraged ‘safe’ collateralization of Luna was, there would always be a risk of participants over-leveraging into this new concept, and such a risk won’t be quantifiable until we see more data sets throughout the emergence of this new restaking narrative.”

Dan Bar, chief investment officer at Bitfwd Capital — a boutique crypto assets hedge fund — agreed that restaking amounts to leverage, telling Magazine: “While moderate schemes of restaking could be beneficial for capital efficiency purposes, any crypto assets manager and finance professional worth their salt knows too well how easily and quickly leverage can turn into a slew of synthetic toxic financial instruments that bring disasters into even the most healthy of ecosystems.”

And maybe that’s the first major problem. Investors will only see restaking as quick, easily leveraged financial products. EigenLayer building an open-source, decentralized network security may fail to convince doubters.

Risks to Ethereum itself

One fear is that slashing on EigenLayer will affect Ethereum itself.

Ethereum’s proof-of-stake trust system keeps everyone in check with slashing conditions — essentially non-performance penalties. Programmable slashing means restakers have additional computational responsibilities and face consequences for non-execution.

Ethereum co-founder Vitalik Buterin fears an overload of the chain’s consensus, basically, computational overloads, if the blockchain’s computational power is suddenly redirected elsewhere. 

Kannan admits that Vitalik’s concerns are valid. “We don’t want to shard Ethereum’s trust layer, and we don’t want contagion of nefarious actors leveraging Ethereum’s trust system.”

Sassano also notes that the functionality of Ethereum proof-of-stake was designed to make sure that there won’t be a sudden influx or outflux of validators, which would affect the core properties of Ethereum’s consensus mechanism. 

The issue is that EigenLayer will decide where to take ETH from, but they can’t slash a validator on Ethereum.

“In Ethereum, there’s also a queue for validators to enter or exit each day. So let’s say, in an extreme example, 30% of all staked ETH begins staking with EigenLayer and say that all 30% gets ‘slashed’ by EigenLayer. While it depends on what the slashing condition was, let’s say all this ETH was lost because they tried to do something really bad. Even if all 30% had to be exited, there’s a limit on how much can exit per day. It would take literally years to exit 30% of ETH stake. So I understand people’s concerns, but at the same time, other things built on top cannot dictate what happens on Ethereum.”

So, restakers should have to play by Ethereum’s rules. 

Yet Sassano’s biggest concern is around the calculus of ETH staking, which may one day become a question of whether stakers get more from staking on EigenLayer than Ethereum itself. This could erode the Ethereum staking model in time.

He is confident, though, that Ethereum’s tech offsets those systemic risks: “It’s not a critical risk to Ethereum if you are slashed on EigenLayer. You are not slashed on Ethereum. EigenLayer cannot cause you to be slashed on Ethereum because Ethereum has its own slashing conditions built into the protocol. And EigenLayer has its own separate slashing conditions built into its protocol as well.”

Anything built on top of Ethereum introduces additional complexity and risk. Juan David Mendieta Villegas, co-founder and chairman at crypto market maker Keyrock, tells Magazine:

“EigenLayer is an interesting development but creates additional attack vectors without providing explicit benefits to the Ethereum ecosystem itself. If we take a step back, it’s important to note that ETH staking has introduced a base benchmark yield for the industry, and that is a good development. You can almost think of it as a ‘risk-free’ rate. Any additional layers, such as liquid staking derivatives and re-staking mechanisms, of course, can carry more concerns such as concentration risk, security and smart contract.”

But Villegas wishes EigenLayer well. “Overall, we’re advocates of the innovations that are happening around staking and want to see multiple protocols win as this will assist in the decentralization and democratization of the network.”

In other words, he wishes for competitors to EigenLayer to create similar products. 

Restaking could make or break new projects

Cosmos’ Aggarwal believes restaking will only benefit those blockchains with existing network effects for those with existing economic alliances or overlapping communities.

He also sees restaking protocols akin to a venture capital arm for layer 1s that might discourage solo stakers and further centralize networks. 

In the end, competing layer-1 blockchains probably won’t engage in restaking across chains. For that reason, he feels that EigenLayer’s design could be improved. 

While EigenLayer is designed as a security system importing trust from Ethereum, builders will create their own tokens and revenue models. This has pluses and minuses. 

In some cases, dodgy new tokens may benefit from Ethereum’s trust layer. Choi thinks “this trust layer benefit could potentially be moot due to the tokenomics that these alt layer 1s would want to try and attain (i.e., the use of their own token — their own agendas) could be problematic and so any supposed trust exported from Ethereum is lost anyway.”

On the other hand, experimental, well-meaning projects may now have a chance at success thanks to EigenLayer. That’s why Choi thinks the ultimate potential benefit EigenLayer is proposing is that other blockchains that do not want to spin up their own validator and staker sets have a chance at scaling to success. 

Aggarwal also notes that with appropriate checks, restaking should be set within parameters to control risk. Restaking primitives need cleverly programmed governance, such as discounted voting power to restaked tokens on another chain. For example, one restaker can’t have more than 20% of the vote for another chain.  

So, is restaking a good thing for Ethereum?

“The purists would say Ethereum should only be securing the Ethereum Beacon Chain and nothing else. [They] shouldn’t be exporting Ethereum security to anything else. But I don’t think that is necessarily a bad thing to get node operators to do other work,” says Sassano. 

“If it can happen on the Ethereum network, it will happen. If the network can’t resist it and Ethreuem’s chain becomes insecure because of it, and there are adverse effects because of it, then Ethereum as a protocol was not designed correctly and needs to be improved.”  

We’ll find out soon enough.