With 2,600,000 ETH restaked ($7B TVL), EigenLayer is primed to be one of the largest protocol launches in the Ethereum ecosystem.

After operator mainnet launches (soon!), there will be a whole new set of incentives that exist in EigenLayer’s operator and AVS marketplace. In this piece, I investigate what those incentives mean for liquid restaking platforms and where I think value accrues.
‍
Recap on EigenLayer’s Structure:
‍‍
EigenLayer has built a marketplace for open collaboration. Three types of participants manage this marketplace:

1. Restakers: Provide native ETH or liquid-staked ETH variants in exchange for additional yield
2. Services: Middleware applications that want to derive security from EigenLayer. These are commonly referred to as actively validated services (“AVS”)
3. Operators: Those who run the software built on top of EigenLayer. They enable stakers to delegate their responsibilities to them and determine which services they want to secure based on their own risk tolerance and capabilities

Because EigenLayer is fully permissionless, any staker, service, or operator can join the network. Stakers can either directly decide which services to secure or they can delegate their stake to operators who manage their position by committing natively staked ETH or liquid staked ETH such as stETH, cbETH, rETH, LsETH, and other variants. Stakers and operators are at risk of slashing by services if on-chain verifiable offenses are committed. Ultimately, stakers and operators must audit services to decide whether they want to opt-in to that service’s slashing risk - defined by its respective, unique parameters.

One primary risk of EigenLayer called out by many, including Vitalik, is the overloading of Ethereum’s consensus by using one’s stake in multiple protocols. EigenLayer’s value is derived from leveraging Ethereum’s security. As that security is looped, the resulting value of the security decreases. With the emergence of liquid restaking platforms such as Rio, Renzo, and others, the looping risk becomes significantly more material.

Let’s use an example.

Alice has 1,000 ETH. She stakes that 1,000 ETH through Lido for stETH. She restakes 1,000 stETH into liquid restaking platform, Renzo, to receive 1,000 ezETH. She takes 1,000 ezETH to a lending protocol to exchange ezETH for ETH. Currently, Aave has a Max LTV on rETH of 75%. Let’s assume liquid restaking tokens (“LRTs”) have a 50% Max LTV. Alice then receives 500 ETH for her ezETH. She cycles back to Lido for 500 stETH then back to Renzo for ezETH. She continues looping until she can no longer achieve any additional yield.

‍

Assuming a 50% Max LTV and every restaker maximizing yield, for every 1 native ETH, there are 2 ETH worth of shared security. As Max LTV approaches 75%, the leverage gets exacerbated to the point where 1 native ETH becomes 3.8 ETH worth of security.

Why does this matter?

If slashing occurs, there will be a cascading wipeout of inflated security. For every 1 ETH harmed via slashing, 3.8 ETH of shared security evaporates.

‍

Additionally, smart contract risk compounds everytime ETH is looped. Maybe there is a bug in the staking platform, restaking platform, or lending protocol. Maybe the user or protocol falls victim to a phishing attack. Any of these risks will result in a cascade of shared security.

To prevent compounded smart contract risk, some liquid restaking platforms are only accepting native ETH as opposed to all liquid staked ETH tokens. Rio, another Hash3 portfolio company, is going this route after some AVS’ made it clear that they prefer native ETH. However, without tracking wallets, stakers can still loop their stake as long as they receive ETH for their liquid restaked token.

If stakers’ incentives are to maximize yield and AVS’ incentives are to make sure that the shared security they’re paying for is in fact…secure, how can these two diverging incentives be aligned?

Operators!

While initially operators will be largely homogenous, over time they will start to specialize either on a risk vector, a vertical vector, an AVS friendliness vector, a combination of vectors, or vectors I haven’t even thought about:‍
‍

Risk Level:

• ‍AAA-rated Operators: These operators will provide the least risky shared security. The restaked ETH will ideally be native ETH with no looping. This also reduces the amount of smart contract / hacking risk. These Operators might also be verticalized (i.e. they are a staker and an operator combined, proving that their native ETH hasn’t been looped).
  
  A AAA-rated Operator will attract AVSs that are running very important protocols that cannot risk a loss of shared security
  ‍
• ‍Junk Bond Operators: These operators will provide the most risky shared security. The ETH will be looped as much as possible, maximizing yield, but also increasing smart contract risk. AVSs will know this because the shared security will be as cheap as possible.A Junk Bond Operator will attract AVSs that are running a testnet or a protocol (memecoins, low-level games, etc.) where they just want the cheapest security.
  
  A Junk Bond Operator will attract AVSs that are running a testnet or a protocol (memecoins, low-level games, etc.) where they just want the cheapest security.

In this overly simplistic scenario, AVSs who want the least amount of shared security risk would be willing to pay more for AAA-rated Operators. AVSs that are willing to pay more are likely going to be higher quality AVSs with more valuable native AVS tokens (how operators are rewarded). Receiving more reward, but taking less risk goes against the old adage “risk follows reward.” However, we must remember that AAA-rated Operators cannot lever their risk in the same way that Junk Bond Operators can. After looping, my guess is that Junk Bond Operators will have the same or higher levered yields (but with more risk!).
‍

Vertical Specific:

Operators could optimize the ideal grouping of stakers and nodes to achieve a threshold security for specific verticals such as gaming, socialfi, defi, payments, etc.
‍

AVS Friendliness:

Since operators will largely be paid in native AVS tokens, some operators might be AVS friendly and hold/stake those tokens. Some can even participate in the network or governance. Other operators will not be so nice; they will auto dump tokens as soon as they receive them. AVSs probably won’t like that - but, hey, the security is cheap.

‍

‍

One potential solution to help automate operator-AVS partnerships is Anzen Protocol. Anzen allows for a more efficient economic security marketplace by actively managing operator payments for AVSs, ensuring they only pay for the amount of security they need. Anzen introduces the Safety Factor (“SF”) metric to measure the economic security of an AVS via the ratio of Cost of Corruption to Profit from Corruption. AVSs choose their desired SF, and the Anzen Protocol economic security oracle calculates the current SF and delivers the data on-chain. The SF data is then consumed by the AVS reserves manager contract to dynamically adjust an AVS’ economic security budget to the optimal level.

EigenLayer is poised to be a monumental upgrade to the Ethereum landscape. As early investors, we believe that EigenLayer’s product will provide numerous benefits to AVSs. Fundamentally novel incentives and new “marketplaces” - the operator landscape being one of those - will flourish and evolve with more market participants.

If you are thinking deeply about the EigenLayer ecosystem or building at the weird edges, I’d love to connect!

Thanks to Sreeram Kannan (EigenLayer), Viktor Bunin (Credibly Neutral), Meir Bank (Hydrogen Labs), Alan Curtis (Rio Network), Jasper (Rocket Pool), Nick Steinhilber (NodeSet) for feedback and comments. Thanks to Alana Levin (Variant) for the push to type this up.

--

Disclaimer: Hash3 Capital Fund LP is an investor in Layr Labs Inc. (“EigenLayer”) and Rio Development Inc. (“Rio Network”). Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by Hash3 LLC. While taken from sources believed to be reliable, Hash3 LLC has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation.

This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities, digital assets, tokens, and/or cryptocurrencies are for illustrative purposes only and do not constitute a recommendation to invest in any such instrument nor do such references constitute an offer to provide investment advisory services.

‍