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Coinbase Warns of Potential Hidden Risks in Ethereum Restaking Mechanism

Coinbase analysts delve into the risks of Ethereum's restaking feature.

Wed, 03 Apr 2024, 09:44 am UTC

In a recent research report, Coinbase analysts highlight the potential hidden risks associated with Ethereum's new restaking protocol, Eigenlayer, which aims to bolster yields through liquid restaking tokens (LRTs).

Despite its promise to serve as the foundation for numerous decentralized applications, concerns over risk amplification and validator concentration persist.

Evaluating the Balancing Act: Ethereum's Restaking Promise Versus Emerging Risks

According to Coinbase (via Cointelegraph), Ethereum restaking could serve as the "bedrock" for various new decentralized blockchain applications but may also introduce several new hidden risks.

In an April 2 research report, Coinbase analysts David Han and David Duong identified several risks associated with restaking and issuing liquid restaking tokens (LRTs).

The Ethereum restaking protocol Eigenlayer enables users to earn additional rewards — LRTs — for securing actively validated services (AVS) by staking derivative tokens, which are distributed to those who have already staked Ether via liquid staking protocols such as Lido (LDO).

When introducing the Eigenlayer protocol, the analysts stated that restaking would be "fairly straightforward." Still, one feature of EigenLayer is that staked tokens committed to one AVS can be staked to another AVS.

"While this can increase earnings, it can also compound risks," the analysts stated, as it allocates the same funds to similar validators to increase yield.

Second, with the addition of LRTs, restakers may become more concentrated in higher-risk providers offering the highest yields.

"As such, LRTs may be incentivized to maximize their yields in order to gain market share, but these could come at the cost of a higher (albeit hidden) risk profile," the authors wrote.

Future Frontiers: EigenLayer's Vision Amidst Concerns Over Ethereum's Restaking Landscape

Despite the risks, the analysts believe EigenLayer's restaking protocol is "poised to become the bedrock for a wide range of new services and middleware on Ethereum, which, in turn, could generate a meaningful source of ETH rewards for validators in the future."

Han and Duong also predicted that, while the amount of restaked ETH will continue to grow in the long run, Eigenlayer's TVL may experience a reasonable short-term drop if point farming is discontinued or early AVS rewards are lower than expected.

On March 6, Eigenlayer surpassed lending giant Aave to become the second-largest DeFi protocol, with a total value locked (TVL) of $11.5 billion per DefiLlama, trailing only Ethereum liquid staking protocol Lido.

The market's enthusiasm for restaking has already been criticized, and Ethereum developers warn that it could result in excessive leverage.

Restaking proponents, on the other hand, argue that it provides additional rewards to those who have already staked their Ethereum.

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