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Welcome to Crypto Long & Short! This week, Jean-Philippe Aumasson, of Taurus, says DeFi needs to improve its security procedures in order to win more institutional adoption. Then, Marcin Kazmierczak, co-founder of RedStone & Warp, explains why Liquid Restaking Tokens (LRTs) are key to building Ethereum’s financial ecosystem. As always, get the latest crypto news and data from CoinDeskMarkets.com. – Benjamin Schiller, head of opinion and features at CoinDesk |
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Digital Assets Innovation Needs to Balance Decentralization and Security |
Recent forecasts point unmistakably to accelerating finance digitalization. The Bank of International Settlements, a central bank association, predicts rapid proliferation of national digitial currencies (CBDCs) over the coming years, while surveys reveal institutional investors are planning to allocate billions to asset tokenization. But the immaturity of security controls is a major challenge for institutional demand. The technology underlying decentralized finance can be securely used to provide tremendous liquidity potential for asset tokenization and myriad other use cases. But, as it currently stands, there are risks stemming from the full dependency on software security and accountability issues. Smart contract vulnerabilities have led to huge financial losses for some prominent DeFi platforms in the past. For example, in 2021, lending protocol Compound suffered a serious coding glitch where customers were accidentally sent millions of dollars of crypto. For institutions with a large customer base, such a glitch could result in substantial financial, reputational, and reputational damage. That’s why we need to strike a balance between decentralization and institutional needs. Banks and financial institutions will provide the regulatory "shock absorbers" needed to bring stability and regulatory transparency to the ecosystem. Decentralization vs. security dilemma While stablecoins, tokenized securities, and cross-border payments are all promising areas for digital asset innovation, risks lurk under the surface. The sparse landscape of banking partners willing to work with crypto companies, especially in the U.S., is one issue. Market volatility also heightens contagion risks between over-leveraged crypto industry players. As large institutions wade deeper into the space, conflicting international regulations could pose adoption challenges without coordination. We will likely see more digital bond issuance but contained within regulatory sandboxes at first. Meanwhile, boundaries between digitized finance and traditional finance will blur. The development of regulatory frameworks should eventually allow incumbent institutions to participate in DeFi-like ecosystems. Without central intermediaries, transactions occur through distributed consensus between peers. This brings some advantages — no single point of failure, censorship resistance, and enhanced resilience against attacks. But decentralization isn't easy, especially from a governance and accountability standpoint for regulated institutions where security is paramount. It's worth noting that much of the network's security, to some extent, depends on the technical savvy of pseudonymous participants rather than dedicated experts. This security gap inherent in many decentralized networks was highlighted this year when South Korea’s Orbit Chain lost more than $80 million due to a hack linked to compromised multisig signers or when the wallets of Ripple’s CEO were hacked. If professionals routinely fail at security, we can imagine the risk for casual users. Regulatory and institutional challenges Permissioned, or private, blockchains offer a solution. They limit participation to vetted entities and incorporate security protocols akin to traditional centralized systems. Tight access control, consistent implementation, quick threat response, and compliance with regulations — that’s the promise, at least. Contracts between participants can define responsibilities and ensure service guarantees — with penalties in case of a contract breach. But permissioned systems aren’t a panacea either and generally have underperformed permissionless, public blockchains like Ethereum. In a regulated, institutional context, permissioned ledger networks must employ distributed trust and IT systems across the entities involved. The technology must be reliable, maintained by trained personnel, and properly documented. It must also play well with a financial institution’s needs, from audit trail and banking network connectivity to role-based access control, for example. On permissioned networks, trust and technology usage should be distributed across approved entities. DeFi shows how hard this balancing act can be. Right now, speculation dwarfs real economy use. With strategic decisions and consensus mechanisms often centralizing power, decentralization can be an DeFi “illusion.” These chokepoints are opportunities for regulation before systemic risks emerge. Shaping the future of blockchain in finance As blockchain permeates finance over the coming years, we'll see diverse technical architectures emerge across the centralization spectrum, trying to strike the right balance between openness and security. If we get the formula right, blockchain could unlock immense positives for institutions, consumers, and society — efficiency, transparency, scalability, and more. They may not even look like the blockchains we’re used to. The burden is on providers to offer customizable solutions adaptable to each institution’s unique security needs and regulations. |
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Liquid Restaking Tokens: What Are They and Why Do They Matter? |
As of February 29 2024, the total value locked (TVL) in EigenLayer, an LRT leader, amounts to $9.67 billion, while TVL in the liquid restaking category has reached more than $5 billion. In distributed systems like blockchains, addressing the Cold Start Problem — gaining enough incentive and network effect for security — is crucial. Restaking offers a way forward. It repurposes staked ether to support external systems (e.g., rollups, oracles) with an economic security layer. EigenLayer leads this effort to improve the efficiency of staked assets. However, careful, phased implementation is vital due to the heightened risks and responsibilities involved. The EigenLayer system consists of Actively Validated Services (AVSes), Operators that validate AVSes tasks and restakers that lock tokens used for the validation process. So, starting from the first principles, let's delve into the arguments that underscore the importance of liquid restaking protocols and, by extension, liquid restaking tokens: A safety buffer: Liquid Restaking Tokens (LRTs) act as a protective buffer for Ethereum Mainnet. By selectively choosing AVSes to validate, they ensure against the potential for the spiral of slashing, if there were widespread slashing events across non-blue chip AVSes. Since users can freely exchange their LRTs like eETH back to ETH, they don’t need to withdraw it from the Beacon Chain (the Ethereum PoS chain since the Merge in September 2022).
This mechanism lowers the chance of a liquidation cascade and positions withdrawals from Ethereum (the Beacon Chain to be precise), as a backup defense procedure. Moreover, reduced volatility in EigenLayer security enhances Ethereum's core security stability.
Another chance to strive for the vitality of Ethereum staking: Liquid restaking protocols give Ethereum a new opportunity to invigorate its staking ecosystem. As an advancement over traditional liquid staking, these protocols aim to engage in Ethereum's consensus process, thereby democratizing the staking landscape and challenging the hegemony of established liquid staking leaders. The traditional Liquid Staking Protocols put ETH deposited by users into securing the PoS chain, whereas the Liquid Restaking Protocols use funds to validate AVSes, which validates various systems, i.e. rollups, oracles, bridges, etc. |
Liquid Staking vs Restaking Tokens (Source: RedStone’s LRT report) |
Simplicity: Running a validator involves complex tasks like managing infrastructure, monitoring status, and addressing downtime, requiring technical expertise. Similarly, LRT protocols manage restaking complexities behind the scenes, simplifying the process for users. Risk Management: LRT Protocols, add complexity to Ethereum's staking ecosystem. Unlike standard LSTs that solely validate consensus, LRTs can undertake various market-driven tasks, each carrying unique risk profiles and yields due to diverse restaking combinations. This variation necessitates a deeper understanding of each token's technical and financial risks, making the staking landscape significantly more intricate than traditional liquid staking methods. |
Applying Modern Portfolio Theory to Ethereum Restaking Source: Idan Levin |
Appetite for higher ETH Yield: Given the steady, 120% yearly, increase of ETH staked in the post-Merge era, the yield from native staking is correspondingly decreasing, a trend showing no signs of abating. It makes sense, users who have ETH exposure can simply stake it for additional yield with relatively low slashing risk. Hence Liqueid Staked ETH is often referred to as the 'internet bond'. Aware of this, there's a substantial demand for enhanced yields. The LRT market is best positioned to capitalize on this growing demand, keeping risks within the reasonable spectrum. Availability: The LSTs deposits into EigenLayer are capped and set by the EigenLayer team to ensure the system is not overheated. This restriction doesn't apply to native restaking.
Native restaking, essentially solo staking involving a 32 ETH deposit into the Beacon Chain, operating an Ethereum client node, and notably includes using EigenPods—a personalized contract designed for native restaking. LRT Protocols that utilize native restaking have the advantage of unlimited growth potential.
Gas Efficiency: Since restaking can be used to validate various services, rewards to AVS operators (so indirectly restakers) are set to distribute enhanced rewards in comparison to simple staking – not only in ETH but also in a variety of other tokens. This could turn into a highly gas-intensive task on the resource-limited Ethereum L1. In contrast, LRTs have the capability to batch-collect rewards for the entire pool collectively and then distribute them among protocol holders in various efficient ways, thereby conserving user resources.
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Ethereum’s staking distribution Source: Hildobby’s Ethereum Staking Dashboard |
We can't conclude a discussion about EigenLayer without addressing some of the criticisms it faces, such as concerns about what occurs during a cascade liquidation event, or the potential risk of restaking overloading the Ethereum consensus. There are compelling points for and against these concerns, and the prevailing view is that only time and practical observation will reveal the true impact. Want to learn more? Read the LRT Report. |
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From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading: |
| THAT BITCOIN RECORD: Bitcoin just set a record high. But what the hell is it? Amid all the excitement around bitcoin setting a new all-time high Tuesday, there's oddness surrounding the auspicious event: little agreement on the new peak price bitcoin got to, or the prior pinnacle that got beat. On Coinbase, the U.S.-based cryptocurrency exchange popular with retail traders, bitcoin got to a new high of $69,325. But Bloomberg says the fresh record is $69,191.94, Reuters says $69,202 and the CoinDesk Bitcoin Index (XBX) says $69,208.79. CoinGecko reports that bitcoin only reached $68,912.84 on Tuesday, which is not a new record, according to its tally. Unsurprisingly, they also don't agree on what the prior all-time high was back in November 2021, ranging from $68,990.90 on the low end from CoinDesk, to $69,044.77 on the high end from CoinGecko. In the end, it probably doesn't really matter very much. Bitcoin is soaring, and whales and small-fry investors alike are getting rich. And, yet, the disparity does underscore that the crypto market is a little rougher around the edges than the conventional financial system it seeks to replace. Arguably, the Coinbase record is the purest of them all: $69,325 is unquestionably a price bitcoin just traded for on that large exchange. The Bloomberg, Reuters, CoinDesk and CoinGecko figures are a blend of data from multiple venues. When the Dow Jones Industrial Average hits a record high, there's zero debate over what the new number is or what the old one was. Whereas one company calculates the Dow, there's no central authority in crypto collecting data and calculating The One True Number. So, the chaos around sorting this important milestone does represent success, in a sense, of a core crypto goal: decentralizing money, markets and finance. |
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