Today's topic is a requested one, inspired by a comment from a reader named Wu.

Indeed, the halo surrounding restaking is too much, and we need to demystify restaking. To save you time, here are a few important conclusions first, then you can decide whether to read the entire article.

• Restaking is not a new track, AVS is;

• AVS is for businesses (B2B), not for consumers (B2C). It has potential but limited growth space;

• The risks of restaking can be divided into systemic risks and non-systemic risks. For systemic risks, we are powerless if we participate. But for liquidity, which is a non-systemic risk, we have ways to manage it.

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The core appeal of Restaking is that it offers additional returns.

As a result, restaking has quickly become a hot topic in the blockchain and cryptocurrency fields, attracting a lot of attention and investment.

Traditional staking has already provided users with a way to earn returns by holding and staking cryptocurrencies. Restaking, however, further expands this model, allowing users to earn more returns through multiple layers of staking.

For example, users can first stake ETH to get stETH, and then restake stETH to get eETH, with each layer of staking bringing new returns. stETH is a liquid staking token from Lido, and eETH is a restaking token from ether.fi, which will be introduced in detail later.

This "stacking of returns" approach is akin to handing out free money—who wouldn't like it?

However, you must understand that restaking itself is not a new track.

Restaking itself does not generate returns; what gives you money is AVS (Actively Validated Services).

Restaking is like the fur, while AVS is the skin; without the skin, there is no place for the fur to attach. Without AVS, restaking could not exist, let alone generate returns.

Therefore, your attention should not be on restaking, but on AVS behind restaking.

1. What is AVS

AVS, short for Actively Validated Services, is a service integrated with the Ethereum consensus layer using the EigenLayer protocol.

Just like having a high-level security system as a model, AVS builds a brand-new security system that can be rented out, promising the same level of safety as the model.

This model system is Ethereum's PoS mechanism. AVS can promise the same level of security as Ethereum because it restakes ETH.

So, what are the similarities and differences between PoS and AVS? Let's take a closer look.

1.1 Similarities and Differences Between PoS and AVS

1.1.1 Similarities

• Security Dependence

Both rely on the cryptoeconomic security of the Ethereum network. AVS borrows Ethereum’s security by restaking ETH, similar to borrowing Ethereum’s security system for its own safety. Ethereum’s PoS directly depends on the staked ETH to maintain security.

• Validator Network

Both rely on a distributed validator network to ensure the system's normal operation and security. Ethereum validators are responsible for producing and validating blocks to ensure transaction validity; AVS validators ensure the reliability of AVS operations.

1.1.2 Differences

For better understanding, you can think of PoS as Ethereum’s own security department, while AVS is a security company offering external security services. Their differences mainly lie in:

• Purpose

Ethereum’s PoS is used to maintain the entire Ethereum blockchain network, ensuring its security and operation. AVS provides independent services like data availability, oracles, and computation, leveraging Ethereum’s security for these services’ reliability.

• Operation

Ethereum’s PoS is built into the Ethereum protocol, like an internal security system all Ethereum participants must follow. AVS operates independently through smart contracts interacting with EigenLayer and the Ethereum network.

• Verification Object

Ethereum validators verify block validity to ensure every transaction is correctly recorded on the blockchain. AVS validators verify the correctness and reliability of AVS services, ensuring data availability, oracle services, etc., are functioning properly.

• Incentive Mechanism

Ethereum validators' rewards come from block rewards and transaction fees, motivating them to keep the network secure. AVS validators' rewards come from AVS's economic model, earning through providing quality services.

1.2 From PoS to AVS: Another Remarkable Progress

The first remarkable progress was Ethereum's shift from Proof of Work (PoW) to Proof of Stake (PoS), a revolutionary advancement in blockchain technology. The PoS mechanism significantly reduced energy consumption and increased network security and decentralization.

This time, from PoS to AVS, turning security verification into a service opens a new channel for reducing ecosystem security costs.

AVS, through the EigenLayer protocol integrated with Ethereum's consensus layer, brings a new service model. By restaking ETH, AVS borrows Ethereum's security to ensure its service reliability and safety. This design not only inherits the advantages of Ethereum’s PoS but also achieves breakthroughs in several areas:

Diverse Services: AVS is not limited to basic blockchain functions but can provide data availability, oracles, computation, and other services. These services can meet the needs of different application scenarios, promoting the development of decentralized applications (dApps).

Flexible Economic Model: AVS validators earn rewards through providing quality services, encouraging them to continuously improve service quality. The AVS economic model also offers more choices and flexibility for developers and users.

Enhanced Security: By restaking ETH, AVS borrows the security of the Ethereum network, meaning AVS's security is comparable to Ethereum's. Users can use these services without worrying about security issues.

1.3 The Future of AVS

AVS introduces new hope and broad application prospects for blockchain technology. Here are some possible application scenarios:

• Decentralized Finance (DeFi): AVS can provide high-reliability oracle services for DeFi applications, ensuring price data accuracy and real-time, crucial for DeFi protocols' secure and stable operation.

• Data Storage and Sharing: AVS can offer high-availability data storage and sharing services, ensuring data integrity and security. This is significant for applications requiring extensive data processing and storage, like decentralized social networks and content distribution platforms.

• Computation Services: AVS can provide distributed computation services to meet high-performance computing needs, valuable for applications requiring extensive computing resources, like artificial intelligence and big data analysis.

Overall, the emergence of AVS marks a new phase in blockchain technology. By borrowing Ethereum’s security, AVS provides diversified services and a flexible economic model, opening new prospects for blockchain technology applications. This innovation not only enhances blockchain technology's utility and scalability but also lays a solid foundation for future technological developments.

However, we must also be clear that no matter how good AVS is, it is still an infrastructure application. As a basic "security service," it supports other applications by providing reliable infrastructure.

Since AVS itself does not directly face end-users, it cannot become a killer application that attracts the masses to use blockchain technology. Just as we cannot see security companies among the Fortune 500 companies.

Although AVS itself is not a killer application, it makes an indispensable contribution to the development of blockchain technology. It is precisely because of infrastructure support like AVS that blockchain technology can achieve large-scale application landing, ultimately producing truly killer applications.

But whether it's PoS or AVS, the market size will inevitably be limited by the input-output ratio. For example, around 2022, the highest annualized yield of ETH staking could reach over 16%.

However, currently, the APR of stETH is only 3.3%, less than a quarter of its historical peak.

Why is the current Ethereum staking yield so low?

The reason is simple: too many stakers and too few rewards. With the PoS reward unchanged, an increase in the total amount of staked ETH will inevitably reduce the rewards distributed to each staked ETH.

The appearance of AVS will change all this.

2. AVS: The Game Changer

AVS changes the rules of the game from the supply side.

A single stake can yield not only Ethereum PoS rewards but also AVS rewards, and even token airdrops from various protocol projects. Technically, restaking can also achieve dual staking with a single operation.

For example, in the top restaking protocol ether.fi, users can stake to receive staking APR and restaking rewards, as well as token airdrops from ether.fi and Eigenlayer.

Although Lido attempts to make stETH the center of restaking through the Lido Alliance framework, it faces significant challenges. Fortunately, only 12.29% of staked ETH has been restaked, so Lido’s opportunity window is not completely closed.

However, we must admit: in a sense, restaking is a dimensionality reduction attack on liquid staking.

Or, you can understand it this way: AVS is Eigenlayer’s secret weapon to compete with Lido for the staking market. Restaking is merely to change the service and interest entities of staking.

Therefore, when we find that Eigenlayer has achieved $18.7 billion in TVL within a little over a year, becoming the second-largest protocol after Lido, it is surprising yet reasonable.

The battle between Lido and Eigenlayer is far from over. Karak, Symbiotic, and Pell are also participants.

It is worth noting that Symbotic should be a participant from Lido’s camp. Symbiotic has close ties with Lido founder Konstantin Lomashuk. Lomashuk is not only an investor in Symbiotic but also serves as its advisor.

No matter the outcome of this market share battle, one thing is certain: the innovation of AVS will benefit all other participants, not just Eigenlayer. This is because blockchain is an open-source world. Without open-source, no one would dare to use your protocol due to concerns about backdoors.

Open-source is a byproduct of decentralization. This byproduct will accelerate blockchain innovation.

Moreover, the rapid attention to restaking is largely due to the airdrop profit model. Airdrops have played a significant role in Eigenlayer becoming the second-largest protocol. For more on the topic of airdrops as a profit model, you can read the article "The Business Transformation in the Web3.0 Era: The Rise of the Airdrop Model."

Of course, having a model is not enough. The foundation of restaking is AVS. Without the new benefits brought by AVS, there would be no hot topic of restaking.

Interests and risks coexist. There are no risk-free returns in this world, so what are the risks of restaking?

3. Risks of Restaking

Similarly, the risks of restaking can also be divided into systemic risks and non-systemic risks.

3.1 Systemic Risks

Systemic risks are shared by the entire restaking ecosystem, and it is difficult to completely avoid them through individual efforts. These risks originate from the restaking protocol itself, underlying economic environment, infrastructure, etc., and have certain uncontrollable and uncertain factors.

For example, protocol risk belongs to systemic risk. If the restaking protocol has design flaws or code vulnerabilities, once exploited by hackers, it will bring devastating damage to the entire system.

Another example is economic risk. If the overall cryptocurrency market enters a bear market, restaking yields will inevitably decline. Such macroeconomic changes are beyond the control of individual investors.

Moreover, node operation risk is also a systemic risk. The restaking network relies on a large number of nodes to maintain it. If there is a large-scale node failure or network congestion, it will affect the normal operation of the entire system, causing losses to investors.

For the systemic risks of restaking, the best you can do is self-prevention, minimizing the harm of systemic risks to you. My suggestion is never to invest more than 5% of your total assets in restaking projects, never put all your eggs in one basket, and always leave yourself a chance to start over.

3.2 Liquidity Risks

In stark contrast, liquidity risks are non-systemic risks. The occurrence of these risks largely depends on investors' operational strategies and risk management capabilities.

Let's take the historical stETH liquidity crisis as an example.

stETH is a token launched by Lido representing staked ETH. Users deposit ETH into Lido and receive an equivalent amount of stETH as a certificate. Theoretically, 1 stETH should equal 1 ETH.

However, in June 2022, the cryptocurrency market turmoil led to many investors attempting to redeem stETH for ETH, triggering a liquidity crisis for stETH.

At that time, two main reasons led to the stETH liquidity shortage:

• Institutional Investors Like Celsius Redeeming Large Amounts of stETH: The crypto lending platform Celsius had staked a large amount of ETH in Lido, holding about $1.6 billion in stETH. During the liquidity crisis, Celsius tried to exchange a large amount of stETH for ETH, leading to an oversupply of stETH.

• Insufficient stETH Liquidity in Curve's Liquidity Pool: Most stETH to ETH transactions occur in Curve's liquidity pool. When many investors rushed to redeem, the pool’s ETH liquidity was severely insufficient to meet redemption demands.

Due to the ETH shortage, the price of stETH relative to ETH was discounted, falling to as low as 0.92 ETH, with a discount rate of 8%. This means that an investor holding 1 stETH could only redeem 0.92 ETH.

This directly caused economic losses for stETH holders. For example, an investor holding 100 stETH theoretically valued at 100 ETH could only redeem 92 ETH during the liquidity crisis, losing 8 ETH in value. If you had used stETH for loans, the discount could have led to forced liquidation.

Additionally, the decoupling of stETH and ETH heightened investor panic, further exacerbating the sell-off of stETH, creating a vicious cycle.

This event highlighted potential risks in Lido’s liquid staking model. Such risks are also present in liquidity restaking. How can we mitigate them? Here are three methods for your reference:

• Diversified Investment

Investing funds across multiple restaking protocols is an effective way to reduce liquidity risks. Diversifying investments reduces the impact of liquidity risks in a single protocol, lowering overall risk exposure. For example, you can simultaneously participate in different restaking protocols like ether.fi (eETH), Puffer (puffETH), Renzo (ezETH), etc., to diversify risks.

• Choosing Good Protocols

Choosing restaking protocols with good liquidity management capabilities can effectively reduce liquidity risks. Some protocols consider liquidity management in their design, establishing liquidity reserve pools or introducing liquidity providers to ensure sufficient liquidity even in extreme situations.

• Managing Leverage

This refers to using your restaking tokens to participate in various DeFi protocols. For example, you can use eETH as collateral in AAVE for loans but control the amount of ETH borrowed. Don’t max out your borrow limit; leave a buffer of at least 20% to avoid forced liquidation due to price fluctuations.

In short, controlling your desires, adopting diverse strategies, and using your high awareness can help you avoid most risks in the blockchain world.

Conclusion

In philosophy, "demystification" means liberation from the realm of the mystical or superstitious, returning to a rational and scientific attitude.

This concept was proposed by German sociologist Max Weber, who believed that with the development of modern society, the world gradually becomes "disenchanted" or "demystified," meaning people no longer rely on mystical explanations to understand the world but explore and understand things through rational and scientific means.

After reading the above, I wonder if you have demystified restaking. If I were to put it bluntly, I could simply tell you to participate in ether.fi's restaking and then use eETH in various DeFi projects.

But I wrote "Demystifying Restaking" to help you gradually build your understanding of the entire blockchain ecosystem, achieving demystification of the entire blockchain world.

After demystification, we should view blockchain technology more rationally. Although innovations like restaking and AVS are eye-catching, they essentially serve as infrastructure for the broader blockchain ecosystem. Their importance lies in providing a stable and secure operating environment for decentralized applications, not in being the "star applications" that attract the masses.

After demystification, we should approach blockchain technology more pragmatically. While innovations like restaking will not become "killer applications," they lay the foundation for the continuous development of the blockchain ecosystem. As technology matures and application scenarios expand, blockchain technology will gradually integrate into our daily lives, becoming indispensable.

Finally, if you truly understand the above article, you should applaud yourself. Also, you should be grateful that you are not too late to enter the blockchain world. Because this world is still working on solving the most fundamental security issues:

Bitcoin’s PoW is like this; Ethereum’s PoS is like this; Eigenlayer’s AVS is still like this.

Everything is just beginning.

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