A Deep Dive into the LRT Landscape: Risks, Depegs and Potential Growth

If you've been keeping an eye on the crypto industry, particularly within the DeFi space, you've likely seen discussions around Liquid Staking, Restaking, LSTs, LRTs, and more.

While these concepts are undeniably important for the growth of DeFi, and Zaros holds a strong belief in their potential, the majority of people don’t understand their mechanisms and, more critically, their associated risks.

An example of this lack of understanding was the recent incident involving Renzo’s ezETH depeg. If you're unfamiliar with this event, don't worry, we'll divPe into it shortly.

The goal of this article is to educate people about the LRT landscape, including its definition, risks, and potential.

Here's a breakdown of what we'll explore:

  • What are LRTs?

  • Different types of LRTs

  • Liquid Restaking Protocols

  • What happened to Renzo’s ezETH?

  • Mitigating Risks

  • Final Notes: Zaros’perspective on LRTs

Let’s go!

What are LRTs?

To understand LRTs, you need to grasp the concept of restaking.

Restaking is one of the biggest innovations in the crypto space, first introduced by Eigenlayer.

This practice allows staked ETH on Ethereum to be used for validating other blockchain protocols and networks, leveraging Ethereum's strong security features.

Restaking holds importance as it bypasses the need for protocols to bootstrap their security. Without restaking, these protocols would have to invest significant capital to attract validators. By utilizing Ethereum's security, they can establish a safe network and allocate capital to other areas of development.

Users have the option to deposit ETH or Liquid Staking Tokens (LSTs) on EigenLayer to secure other networks known as AVSs. This approach enables them to earn higher yields compared to securing Ethereum alone.

However, when restaking on EigenLayer, these assets get locked, hence becoming illiquid. This is where Liquid Restaking Tokens (LRTs) come into play. Similar to LSTs, LRTs provide liquidity to restaked tokens on EigenLayer.

For further insights into Restaking, feel free to download our comprehensive eBook using this link!

Different types of LRTs

While LRTs share similarities with LSTs, there are differences as well.

LSTs rely exclusively on native ETH, whereas LRTs can draw support from ETH, LSTs, or a diversified basket of assets. This nature of LRTs brings some complexities to the industry.

There are three types of LRTs, let’s explore them:

  • Native LRTs: Users deposit PoS tokens (e.g., ETH) and receive a native LRT in return.

  • Basket-based LRTs: Multiple LSTs are combined into a single LRT.

  • Isolated LRTs: Each LST is matched with its distinct, separate LRT.

While accepting all types of LSTs and providing the same LRT as a "receipt" may facilitate growth, it also aggregates risks from every accepted asset. For instance, if one underlying LST depegs, its impact on the price of the LRT may be significant depending on its percentage in the basket-based LRT.

Isolated LRTs offer exposure to only one LST, simplifying risk management. However, their growth potential and liquidity may vary based on the asset type.

For example, depositing stETH from Lido and receiving a corresponding LRT is likely to attract more attention and liquidity compared to a less adopted LST.

Liquid Restaking Protocols

The staking industry currently dominates DeFi, representing its largest sub-sector. It's no surprise that numerous protocols are emerging around the restaking concept, trying to get their piece of the pie in this market.

Here’s a list of the main Liquid Restaking protocols and their respective TVL, as of May 5th, 2024, according to DeFiLlama:

1. EtherFi: $4.02B

2. Renzo: $3.24B

3. Puffer Finance: $1.4B

4. Kelp DAO: $828.87M

5. Eigenpie: $663.69M

6. Swell: $383.66M

7. Bedrock: $149.76M

8. PrimeStaked: $36.07M

9. ClayStack: $7.45M

10. Euclid Finance: $4.37M

What happened to Renzo’s ezETH?

On April 24th, Renzo's LRT, known as ezETH, saw a significant depeg event, affecting thousands of holders.

Originally, 1 ezETH was intended to hold the same value as 1 ETH. However, during the depeg incident, its value plummeted to approximately 0.2 ETH!

The depeg of ezETH resulted from intense selling pressure and the inability to exchange ezETH for ETH, which prevented arbitrage opportunities to uphold its peg.

The sell-off was triggered by Renzo's announcement about their token allocation, but why is that?

Well, a great part of Renzo’s TVL comes from airdrop farmers who were expecting to receive a large portion of $REZ. However, after the token distribution was announced, they definitely didn’t like it.

Below you can see the image and the large disparity in the distribution. The percentages don’t match the size of the pie!

OLD allocations of $REZ
OLD allocations of $REZ

We do not know and are not here to judge whether the disparity in the token distribution was intentional or a mistake on the team's part. However, based on the expected allocations, the pie chart below illustrates how the distribution should ideally appear:

Source: https://twitter.com/0xtommy_eth/status/1783018222759055529
Source: https://twitter.com/0xtommy_eth/status/1783018222759055529

Airdrop farmers definitely didn’t like this distribution and decided to leave the protocol. However, to get their assets back, they couldn’t just redeem it from Renzo, since it didn’t have a withdrawal function. Consequently, they resorted to selling ezETH for ETH on Uniswap. This substantial selling pressure caused the token to deviate from its intended 1:1 ratio, as the lack of arbitrage opportunities failed to maintain price equilibrium.

The situation got even worse thanks to liquidations, particularly among airdrop farmers who had leveraged their positions on platforms like Morpho and Gearbox. As the token's value declined, leveraged users faced liquidations from these protocols. This led to a cascade of selling pressure across lending platforms, as they had to forcibly sell ezETH to mitigate risk.

More liquidations = More ezETH selling pressure = lower prices.

Source: Dune Analytics
Source: Dune Analytics

Mitigating risks

The problem here was not with LRTs themselves, but with the absence of a withdrawal function. Without the ability to exchange ezETH for ETH at a 1:1 ratio, holders are forced to sell on the open market, resulting in price depreciation as recently witnessed.

This situation isn't new. Even stETH, the LST offered by Lido Finance, experienced significant depegs, particularly before The Merge era, when stETH couldn't be directly redeemed for ETH but had to be sold on the open market instead.

Fortunately, after this episode with Renzo, Liquid Restaking protocols are already implementing withdrawal functions (EtherFi was the only one that had it at the time).

The image below illustrates the protocols that have already implemented this feature. Others, such as Renzo, have announced plans to do so in the near future.

Source: https://dune.com/hahahash/eigenlayer
Source: https://dune.com/hahahash/eigenlayer

When a withdrawal function is available, arbitrageurs are incentivized to explore the price difference and capitalize on it.

For example:

  • LRT < ETH: Arbitrageurs purchase the LRT at a lower price on the open market and redeem it within the dApp for 1 ETH. This action increases the price as arbitrageurs acquire the LRT, restoring the 1:1 ratio.

  • LRT > ETH: Arbitrageurs exchange 1 ETH for 1 LRT in the dApp and sell the LRT on the open market for a higher price, thereby reducing the price back to 1:1.

Final Notes: Zaros’ perspective on LRTs

The recent ezETH depeg event was regrettable, resulting in tough losses for many holders. However, it's important to highlight our strong belief in the money legos concept and the potential benefits that LRTs can bring to the ecosystem, when approached correctly.

As we’ve covered in this article, LRTs can help make DeFi a better place. For instance, on Zaros, users can deposit LRTs and provide liquidity to a perpetual futures market—a cornerstone product in the crypto space. In return, they receive boosted yields on their LRTs derived from trading fees.

This way, they help the ecosystem with more liquidity and enjoy higher rewards.

The ongoing efforts of Liquid Restaking protocols to integrate withdrawal functionalities show a positive step towards fortifying safety measures in DeFi. At Zaros, we are committed to prioritizing security measures for our users.

About Zaros

Zaros is the first LRTFi perpetuals DEX powered by a CEX-like UX coming to Arbitrum. It enables boosting ETH staking & restaking yield by delegating liquidity to the protocol's ZLP Vaults, while traders on the other side may leverage up to 100x across crypto, FX, and commodities perpetuals.

Notable early angel investors include Fernando Martinelli, founder of Balancer; Kieran Warwick, founder of Illuvium; Danny Wilson, CFO of Illuvium; Antony Sassano, founder of TheDailyGwei; Andy Chen, CTO at Scalene and former Lead Architect at Synthetix, and Kevin Lu, CEO at Scalene and former Growth Lead at Band Protocol.

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