Reset Emerges as Ethereum’s Second Largest DeFi Sector: Report

According to a recent report by Coinbase Research, recirculation has emerged as the second largest sector in Ethereum decentralized finance (DeFi).

The study highlights EigenLayer's reconfiguration protocol as an essential component for new services and middleware on the Ethereum network.

EigenLayer's Restaking Protocol

Ethereum's Proof-of-Stake (PoS) consensus mechanism is the largest economic security fund in the crypto space, worth nearly $112 billion. While validators validating the network earn base rewards on locked-in ETH, the introduction of Liquidated Licensing Tokens (LSTs) has paved the way for participants to interact with DeFi by trading or spending their stake-held assets.

The EigenLayer Repository Protocol, launched on the Ethereum mainnet in June 2023, has grown rapidly to become the ecosystem's second largest DeFi protocol by total value locked (TVL), currently valued at $12.4 billion.

This protocol allows validators to earn additional rewards by re-establishing ETH held by acquiring Active Verified Services (AVS) and introducing a new revenue stream known as “security-as-a-service”.

As EigenLayer prepares to launch its first AVS, EigenDA, at the beginning of Q2 24, the Ethereum community anticipates the benefits of the network. EigenDA's role as a data availability layer can impact Layer-2 (L2) transactions, providing a modular solution to reduce overhead and improve efficiency.

The report predicts the initial revenue from EigenDA compared to the costs of Ethereum blob storage. Major Layer-2 solutions currently spend around 10 ETH per day on blob transactions. If EigenDA experiences similar levels of usage, the estimated annual re-rewards of around 3.5k ETH will amount to 0.1% of additional revenue.

Risks and complications

While the introduction of AVSS could strengthen the Ethereum ecosystem, it also has its challenges. Each AVS sets its own conditions of slaughter and claims, which can lead to conflicts if several AVS are involved. EigenLayer's “integrated security” model further complicates matters, allowing AVSs to customize their security “specifically with security,” creating a complex technical landscape for operators.

The introduction of Liquid Recovery Tokens (LRTs) removes much of the complexity from token holders, which can lead to hidden risks. LRT providers may prioritize maximizing efficiency to gain market share, which may increase the risk profile. If payouts are in ETH, LRTs can put downward selling pressure on non-ETH AVS rewards, limiting the value available for rescheduling.

LRTs also carry valuation risks, which can be displaced from their original value when large amounts of cash are withdrawn. Accurate valuation of LRTs' securities becomes critical as shifts in portfolio holdings or AVS returns affect their risk profile. In a worst-case scenario, errors in the recryption mechanism could jeopardize Ethereum's consensus protocol.