LONDON: Over Rs 15,01,42,590,000 crore ($18 billion) worth of cryptocurrencies have migrated to a new type of platform that offers rewards to investors in exchange for locking up their tokens, but analysts warn that the complex setup poses risks to users and the crypto market.
The growing popularity of so-called “restaking” is the latest sign of risk-taking in the crypto market as prices rise and traders seek yield. Bitcoin, the largest cryptocurrency, is nearing an all-time high while the second-largest, Ethereum, is up more than 60% this year.
At the center of the restaking boom is Seattle-based startup Eigenlayer, which raised $100 million in February from the crypto arm of U.S. venture capital firm Andreessen Horowitz and has attracted $18.8 billion worth of crypto on its platform, up from less than $400 million six months ago.
Eigenlayer invented re-staking as an expansion of a long-standing cryptocurrency practice called staking, the company's founder Sreeram Kannan told Reuters.
The blockchain is a kind of database where a large number of computers in a network check and verify who owns which cryptocurrency. To do this, owners of cryptocurrency tokens, such as Ethereum, allow their assets to be locked as part of the verification process. While participating in staking, owners lose immediate access to their tokens, but earn a yield in return.
Some staking platforms also provide users with newly minted cryptocurrencies to represent the cryptocurrencies they have staked. Restaking allows holders to obtain new tokens that can then be staked again in various blockchain-based programs and applications in hopes of greater profits.
The crypto community is divided on the risks of restaking, with some participants saying the practice is so early in its development that there is no way to know.
But others, including analysts, are concerned that if the new tokens representing the restaked crypto were used as collateral in crypto's vast lending market, it could create an infinite loop of borrowing based on a small number of underlying assets, which could destabilize the broader crypto market if everyone tried to exit at the same time, they say.
“Having collateral on top of collateral is not ideal and it introduces a new element of risk that wasn’t there before,” said Adam Morgan-McCarthy, research analyst at cryptocurrency data provider Kaiko.
The attraction for investors is the yield: returns from staking on the Ethereum blockchain typically range from 3% to 5%, but analysts say returns from re-staking could be even higher, as investors can earn multiple returns at once.
Restaking is the latest development in the risky world of decentralized finance (DeFi), where crypto holders invest in experimental schemes in the hope of generating big gains without having to sell their holdings.
However, this has not yet been done on the EigenLayer platform as the platform has yet to develop a mechanism to pay staking rewards directly to users. Users join the platform in the hope of receiving future rewards and other giveaways called airdrops.
For now, EigenLayer is distributing its own newly minted token to people using the platform, and users hope that this token, called “EIGEN”, will become valuable in the future.
Silkworm’s Morgan McCarthy said the growth of restaking platforms has been fueled by users seeking such airdrops, calling it “this free money thing that’s really, really speculative.”
“It’s very risky,” said David Duong, head of research at Coinbase, a U.S. cryptocurrency exchange that offers staking but not re-staking.
“Now they are making a preemptive strike in the hope of getting some kind of reward, but they don't know what it is,” Duong said.
Eigenlayer was launched last year by Sreeram Kannan, a former assistant professor at the University of Washington in Seattle and part of the team that launched India's first student-designed microsatellite, according to his academic website.
EigenLayer describes itself as a marketplace for validation services that connects applications that require staked tokens with would-be stakers.
New restake platforms such as EtherFi, Renzo, and Kelp DAO have emerged that restake their clients’ tokens on EigenLayer and generate new tokens representing the restakeed assets. These tokens can then be used for other purposes, such as collateral for borrowing.
Kannan said the aim of the platform is not to further facilitate crypto-backed borrowing, but rather to allow users to choose where to stake their tokens and help grow new blockchain services.
“We don't have any official relationship with these players. This is a new phenomenon,” he said.
Coinbase's Duong wrote in the note that restakaging can come with “hidden risks,” including the possibility of forced liquidations and increased volatility during market downturns if restaked tokens are used for crypto lending.
The 2022 crypto market sell-off was exacerbated by risky lending, as the crypto tokens used as collateral quickly lost value following the collapse of the Terra and Luna tokens.
Kannan keeps EigenLayer away from risk.
“The risk isn’t in restakage, it’s in the lending protocol. The lending protocol is mispricing the risk,” he said.
Some experts aren't concerned about restakage, pointing out that the cash from restak protocols is tiny compared to the global crypto industry's net worth of $2.5 trillion.
Regulators have long been concerned that losses in the cryptocurrency world could spill over into broader financial markets.
“At this point, we do not see a significant risk of contagion to traditional financial markets from re-staking issuance,” said Andrew O’Neill, digital asset analysis lead at SP Global Ratings.
Still, as the cryptocurrency world becomes more connected to mainstream finance, restakng is gaining popularity among institutional investors.
Standard Chartered Bank's crypto arm, Zodia Custody, has seen significant institutional interest in staking, but believes re-staking goes too far because of the difficulty of establishing “documented evidence” of where assets go and how rewards are distributed, said chief risk officer Anoush Alevshatian.
Nomura's cryptocurrency unit Laser Digital has partnered with KelpDAO to restake some of the funds, KelpDAO said in a blog post in April. Laser Digital did not respond to Reuters' requests for comment.
Swiss crypto-focused bank Sygnum said it is staking clients' crypto assets and hopes to “see a new ecosystem emerge around re-staking.”
Published May 31, 2024 09:16 IST
