Staking has become one of the most popular options for cryptocurrency users to invest their digital assets and secure a passive income. When staking, users send funds to a smart contract to participate in validating transactions on proof-of-stake blockchains, earning that network’s native token as a reward for doing so.
There are a number of PoS blockchains that support staking, including Solana, BNB, Cardano and Avalanche, but none are more popular than Ethereum, the world’s top smart contract network, which currently boasts more than $45.5 billion in total value locked.
That number highlights the strong attraction of staking, which offers perhaps the easiest way of all for cryptocurrency users to generate a passive income. But as the popularity of the concept expanded, it quickly became clear to more advanced decentralized finance practitioners that it’s also fairly limited.
After all, staking involves “locking up” your tokens in a smart contract for a specified period, and that means they cannot be removed until a specified period of time is up. Even then, the process of “unstaking” involves a waiting period of up to two weeks on some networks. Worse, during the time the tokens are staked, the investor effectively becomes “illiquid”.
This has proven to be a cause of frustration for many investors in the fast-moving world of crypto, as it means they don’t have the opportunity to capitalize on other DeFi plays as and when they emerge.
Restaking tokens
It was this frustration that gave birth to the concept of “restaking”, which introduces more flexibility to staking so investors can reuse their staked tokens to obtain further rewards via other protocols. Restaking also provides a mechanism for other decentralized applications to inherit Ethereum’s security.
With restaking, the user still locks their ETH tokens into a smart contract as before, but instead of being left with empty hands, they receive a different token that represents the funds they have locked up. Digital assets such as “Staked ETH”, or stETH, are essentially a kind of deposit receipt, and they provide investors with the opportunity to stake elsewhere or participate in liquidity pools for decentralized exchange platforms and lending and borrowing protocols. In this way, they can effectively two-times their rewards.
The best known example of a restaking platform is EigenLayer, which makes it possible to secure Actively Validated Services (AVS) built on Ethereum.
Restaking provides multiple benefits for the crypto ecosystem, enabling developers to improve the security of their dApps and investors to utilize their staked capital, maximizing the efficiency of those deposits. It’s a win-win for everyone concerned, but even so, DeFi investors were still not satisfied with stopping there.
Liquid restaking tokens
Building on restaking, the DeFi industry came up with yet another innovation in “liquid restaking”, which confusingly enables those who restake to receive a third kind of asset, namely a liquid restaking token or LRT.
So users who stake, then restake their assets, can take their LRTs and use those tokens for a third time to enhance their potential rewards further.
By staking an ETH derivative such as stETH on platforms such as KelpDAO, Ether.Fi or Puffer, investors receive an LRT that can once again be reinvested into other DeFi protocols, maximizing their yield even further.
Liquid restaking provides additional benefits to users too, such as automatically choosing which AVS to stake their restaking tokens on. In addition, they eliminate the cooling off period for those who want to unstake and restake elsewhere, ensuring that investors have the flexibility to exit and enter news positions at lightning speed.
The nascent liquid restaking industry is currently dominated by Ether.fi and its eETH LRT, with over a 50% market share, but it’s far from the only option investors have. Alternatives include Puffer Finance’s pufETH, Swell’s rswETH and Lido’s stETH tokens
A fourth of token
You might think that most DeFi investors would already be satisfied with potentially being able to triple their rewards via staking, restaking and liquid restaking, but the DeFi game is all about exploring opportunities, and there’s always room for yet more innovation.
Enter Kelp DAO, which builds on liquid restaking to give investors a fourth kind of token. Only this time, it’s not a staked LRT or anything like that. Instead, Kelp DAO provides users with KEP tokens representing the EigenLayer points that are awarded to users for restaking their ETH derivative tokens.
For those who are confused, it’s time for a backpedal. One advantage of restaking oN EigneLayer (which comes after initially staking but before liquid staking) is that the user can also receive so-called “EigenLayer points”. Points are issued in lieu of crypto-based rewards, because EigenLayer has not yet launched its own rewards token. Users will eventually be able to cash in those points for EigenLayer’s native token when it finally launches, but in the meantime they are just “points” and so they’re not really very useful. So it brings us back to the old problem of illiquidity, which is a no-no for anyone involved in the increasingly confusing world of DeFi staking.
With its KEP tokens, Kelp DAO is essentially tokenizing the EigenLayer points early, making them liquid so they can be used in other DeFi protocols. As such, users can restake tokens such as ETHx, stETH and wBETH on EigenLayer and receive both the LRT and KEP tokens.
Once again, this opens the door to investors who want to further maximize their earnings potential. The moment they receive their KEP tokens, investors can either trade them on a DEX for something else, or find another DeFi protocol that supports them in some way, such as through liquidity tools.
Can anything go wrong?
The rise of restaking and liquid restaking followed by Kelp DAOs new initiative has caused some alarm. Many critics have warned that liquid restaking is extremely speculative and that the entire market could yet come tumbling down, crashing the value of every LRT.
EigenLayer may also be a disappointment. The entire setup is based on the idea of promised rewards, but if these fail to be as lucrative as many investors hope, it might lead to a wave of users withdrawing their tokens and depositing their funds in other restaking protocols. Considering that every liquid restaking protocol is built atop of EigenLayer, it’s not hard to see the possible implications if its rewards fail to meet expectations.
Worse yet, there’s a chance that EigenLayer itself might never actually launch a token. The project appears to be sound and built by an honest, experienced team, but you can never say never in the crypto industry. One notable risk is that EigenLayer points aren’t even distributed on a blockchain, so there’s no transparency regarding how many have been issued.
Final Thoughts
Despite these risks, the enthusiasm for liquid restaking has ignited interest in the potential of DeFi to deliver some seriously lucrative rewards, and it’s a great example of the nonstop innovation seen in the crypto industry.
It’s also worth reiterating the benefits restaking and liquid restaking bring to the broader Ethereum ecosystem, delivering much greater security to dApps and deepening their integration with the blockchains they run on.
Liquid restaking enhances liquidity and expands capital efficiency for investors while boosting security for dApp developers, and those benefits may well be enough to support this increasingly convoluted ecosystem.