Making Sense of LRTs

A high level overview of LRTs and why they are important

Brief Market Thoughts

Lots happening in the market! Currently spurred on by rumors of the ETH ETF being expedited by none other than the SEC? My assumption in this mess is that the SEC has been acting as a political arm of the democratic party, and maybe the Dems are realizing that alienating the crypto community may not be a strong tactic with the upcoming election.

Another note: in the EtherFi and New Pastures article I laid out a strategy to move ETH into a new rollup (Linea) as well as a few different LRT and Defi protocols. Thus far Renzo and Zerolend have distributed their initial (and largest %) airdrop. Unfortunately these returns did not come close to the returns seen by Athena and Etherfi earlier this year. Market timing surely had something to do with it, but the main issue I saw was execution and communication by both teams. There might be some significant opportunity yet as the Linea surge just began and should distribute some value later this year.

As far as LRTs go, it feels like EtherFi is the king similar to how Uniswap is the king of decentralized marketplaces. That said, I have decided to add value to KelpDAO and hold rsETH in a few different Defi and ZK rollup positions. If anyone decides to do the same make sure to join Turtle DAO to reap a bonus 50% on the points you're earning in Kelp! There's no smart contract risk involved with signing up. Add my referral code when you do (OKDUNC)!

Ok, onto understanding LRTs at a high level...

What are LRTs?

One of the more novel technical innovations this cycle involves liquid re-staking tokens (LRTs). These tokens provide a way for staked cryptocurrencies to be re-staked on other systems that require economic security (think: proof of stake systems). In return, the LRTs given to those systems generate additional yield. This is all made possible by Eigenlayer – a protocol built to facilitate the commoditization of economic security. Today, the LRT ecosystem focuses on re-staking ETH but could move on to include other networks in the future.

What is economic security?

Economic security in a Proof of Stake consensus system refers to the robustness of defense against attacks. Essentially, the more value that is staked to validate and secure the network, the more resilient the network becomes to hostile takeover. Read more about attacks here.

What systems need economic security?

Ethereum provides the most robust and immutable foundation for smart contracts to run on a blockchain. At the same time, the Ethereum network has limitations around transaction speed and cost, making applications expensive. 

Improving network scalability and reducing transaction costs requires a significant amount of middleware (rollups, bridges, oracles, transaction execution and computation). Eventually these transaction states move to the mainchain for final verification.

This infrastructure is well on its way to being a critical resource for decentralized applications to function in a more accessible and cost efficient way, at the same time the rollup ecosystem developing alongside Ethereum has some challenges:

  1. Rollups and sidechains today are unable to share liquidity, Defi apps are forced to choose which rollups to deploy on top of and are limited to the liquidity available in those specific environments.

  2. Rollup and some sidechains verification today uses centralized transaction sequencing that has a higher chance of manipulation and corruption than a decentralized system.

  3. Adding liquidity to rollups and sidechains requires bridges that also rely on systems that have a high degree of centralization in order to act quickly.

Liquid re-staking tokens provide a way for new, decentralized middleware systems to leverage the economic security of the Ethereum network to handle transaction execution in a more efficient and decentralized way. The extra yield generated for holders of LRTs comes from these new forms of middleware infrastructure.

There’s a LOT of jargon and detail I’m glossing over in here, much of which I am still learning myself. The big takeaway tho: LRTs and Eigenlayer help leverage Ethereum’s economic security to develop scalable and secure environments for smart contracts to function. 

Risks and Outstanding Questions

The risks involved with any software project (especially large scale decentralized systems) bring a combination of known and unknown factors. Ultimately, some problems will not show themselves until the system is live and in action. 

The highest risk noted by Vitalik Buterin and Justin Drake (who recently joined as an advisor to Eigenlayer) last year generally revolve around the event a significant portion of restaked ETH is slashed (ie. re-staked ETH is burned due to malicious activity). If a new system emerges via LRT economic security relies on a similar Proof of Stake system as Ethereum, there could be a massive loss of fund on the mainchain. The core worry stated by Vitalik and others is to prevent another DAO hack situation where the community leverages social consensus to perform a hard fork of the chain (read here).

Today, this risk is relatively mitigated due to Eigenlayer’s focus on low risk applications “based on either objective attributability or no slashing.” Despite that point, just like in Defi, smart contract risk will always present a concern for new decentralized software. This technology is still in an early stage of life and standard development and auditing practices continue to mature with time.

Another outstanding question for Eigenlayer and LRTs: will the additional yield be worth the compounding smart contract risk? Ultimately this ecosystem is nascent and many speculate that additional yields will be lower than projected, indicating that the $15B in value staked today might be bloated for the needs of the few systems providing yield to Eigenlayer stakers.


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