Leveraged Restaking of Leveraged Staking: What are the Risks?

During the first few months of 2024, the rapid growth of total value locked in EigenLayer to about $19.5 billion belies the fact that its total value redeemable within the leveraged staking-restaking ecosystem is only about two-thirds of the reported amount, and that this protocol is vulnerable to potentially serious market and technological risks associated with liquid restaking protocols. Leveraged restaking on the EigenLayer of liquid staking tokens (LRTs) can more than double returns relative to leveraged staking alone. However, the leverage necessitates loans collateralized by liquid restaking tokens (LSTs) that are highly susceptible to liquidation consequent to a depeg of the LRT. LRTs are more easily depegged from the native token than LSTs. Mechanisms include inflating supply via manipulation of the LRT oracle price and/or effecting a dump or rug pull on a decentralized exchange (DEX) where LRT pools are less liquid than LST pools. Professional liquidators operate on lending platforms using bots to track vulnerable loans and acquire the LST and/or LRT collateral in return for attractive bonuses. A depeg may lead to a cascade of more serious depegs followed by further liquidations of the leveraged staking-restaking traders. These already-high credit risks for liquid staking and restaking protocols are augmented by a new type of stablecoin, Ethena, whose pegging mechanism is also vulnerable to depeg risks. The vast majority of staking is on Ethereum whose native token ether is the de facto numèraire for DeFi protocols, so the key takeaway for blockchain regulators is that any stress events arising from depegs of liquid staking or restaking tokens could disrupt all protocols involved with staking and restaking on Ethereum and EigenLayer. This has the potential to spread credit contagion throughout the DeFi ecosystem, thus precipitating another DeFi winter.