June 23, 2024

Understanding the Risks and Rewards of Re-Staking in Cryptocurrency

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It was reported that more than $18 billion worth of cryptocurrency has recently moved into a new type of platform that offers investors rewards in exchange for locking up their tokens. This complex scheme, known as “re-staking,” has sparked considerable debate among analysts, who warn of potential risks for users and the broader crypto market. As prices rally and traders hunt for yield, the soaring popularity of re-staking reflects the latest wave of risk-taking in the cryptocurrency landscape.

At the heart of the re-staking boom is EigenLayer, a Seattle-based start-up that has seen rapid growth. In February, EigenLayer raised $100 million from Andreessen Horowitz’s crypto arm. Since then, it has attracted $18.8 billion worth of crypto to its platform, up from less than $400 million six months ago.

Blockchains, a type of decentralized database, rely on a network of computers to check and confirm who owns which cryptocurrencies. This validation process often involves staking, where owners of crypto tokens, such as ether, lock up their assets. In return, they earn yields, but lose instant access to their tokens for as long as they participate in staking.

Re-staking takes this a step further. Some platforms issue newly-created cryptocurrencies to represent the staked assets. These new tokens can then be re-staked with different blockchain-based programs and applications, potentially yielding higher returns. This layered staking mechanism aims to multiply the returns for investors by allowing them to earn multiple yields simultaneously.

The main appeal of re-staking for investors lies in the promise of higher yields. While staking on the Ethereum blockchain typically offers returns in the 3%-5% range, analysts suggest that re-staking could generate significantly higher returns by leveraging multiple staking opportunities.

However, this innovative approach is not without its risks. The crypto community is divided on the safety of re-staking. Some insiders believe the practice is too new to fully understand its risks, while others, including analysts, are concerned about its potential to destabilize the broader crypto market. The fear is that if new tokens representing re-staked cryptocurrencies are used as collateral in crypto’s extensive lending markets, it could create an unsustainable loop of borrowing based on a limited number of underlying assets. This scenario could lead to market instability if many investors try to exit simultaneously.

EigenLayer, the platform at the forefront of the re-staking trend, describes itself as a marketplace for validation services, connecting stakers with applications that need staked tokens. The platform has yet to pay out staking rewards directly to users, as the mechanism for doing so is still in development. Currently, users are joining EigenLayer in anticipation of future rewards or other giveaways known as airdrops. The platform has been distributing its own newly-created token, EIGEN, to users, who hope it will gain value in the future.

Following EigenLayer’s model, several new re-staking platforms have emerged, including EtherFi, Renzo, and Kelp DAO. These platforms re-stake clients’ tokens on EigenLayer and generate new tokens to represent those re-staked assets. These tokens can then be used elsewhere, for example, as collateral in borrowing. However, this introduces additional risk. If the crypto markets experience a downturn, it could trigger a cascade of liquidations, as seen in previous market collapses such as Terra, Luna, and FTX.

The Institutional Interest and Future Outlook

Institutions are showing interest in staking because it allows them to earn yield without losing their digital assets. However, re-staking may push the boundaries too far, creating a relatively small but potentially volatile segment of the market. The long-term viability of re-staking will depend on whether it can sustain its promised returns without leading to systemic risks.

The current trend of re-staking is reminiscent of the repackaging of mortgages into complex financial products, which infamously led to the 2008 financial crisis. While the outcomes remain uncertain, the lessons from the past underscore the need for caution and robust risk management in the rapidly evolving world of cryptocurrency.

The reality is that re-staking does present an attractive opportunity for higher yields but it also carries significant risks. So the in the end it is up to the stakeholders to use their best judgement in entering this new environment.

Digital Assets Desk

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