A brief analysis of the liquidity war in the re-pledge market

Original author: Larry Sukernik, Myles ONeil

Original translation: Frost, BlockBeats

At Reverie, we spend a lot of time researching restaking protocols. It’s an exciting investment category for us because everything is fuzzy (opportunities exist in fuzzy markets) and there’s a lot happening (dozens of projects will launch in the restaking space in the next 12 months).

In our work studying re-pledge mechanisms, we have gained some insights, so we wanted to predict how the re-pledge market will develop in the next few years.

A lot of this is new, so what works today may not work tomorrow. Nonetheless, we wanted to share some initial observations about the business dynamics of the re-pledge market.

LRT as a leverage point

Today, LRTs like Etherfi and Renzo hold a powerful position in the re-staking supply chain: due to their proximity to both the supply side (stakers) and the demand side (AVs), they are in a privileged position on both sides of the transaction. If operated in this way, LRTs are able to determine their commissions, as well as influence the commissions of underlying markets (e.g. EigenLayer, Symbiotic). Given their powerful position, you can expect to see the re-staking market launch first-party LRTs to control third-party LRTs.

AVS and re-staking users as leverage points

The best markets in the world have two characteristics: decentralized supply and decentralized demand. So what happens if a not-so-good market appears, where one or both of the supply and demand sides are relatively concentrated?

Imagine a simple apple trading thương trường where the largest apple seller controls more than 50% of the apple supply. In this case, if the marketplace operator decides to increase the marketplace commission from 5% to 10%, the largest apple supplier has the ability to threaten to stop trading on the platform.

Similarly, on the demand side, if the largest buyer of apples controls more than 50% of apple demand, then buyers also have the ability to threaten to stop trading on the platform (or potentially contact apple suppliers directly) if the marketplace operator increases the marketplace commission.

Back to the re-pledge market, if the final market structure of the re-pledge market is concentrated on the AVS side (the top 10% of AVS account for more than 50% of the income) or the re-pledger side (the top 10% of re-pledgers account for more than 50% of the deposits), then the natural result will be that such trading platforms will be restricted in extracting their own service fees (commissions) (so their value pricing should also be relatively low).

Although there is not enough data to prove it, our intuition tells us that this industry may also see some monopoly laws among key players: large AVS accounts are likely to account for the majority of transaction volume, thereby creating a certain negotiation advantage in the service fees that may be charged in the future market.

Compete for exclusive AVS

From the perspective of every re-pledge market platform, anything that can be done that competitors cannot is worth doing. As the easiest differentiation strategy for re-pledge market platforms, it is to provide users with exclusive access to AVS, whether it is developing first-tier AVS such as EigenDA, or providing third-party AVS through exclusive partnerships. In concept, this is similar to Sony launching exclusive games only on the PlayStation platform, and the purpose is to drive user growth on the platform.

Based on this information, we expect the re-staking market to take some measures, such as launching more first-party AVS or reaching exclusive agreements with third-party AVS. In short, in the coming months, we expect a round of competition among platforms for more AVS resources, and we may see AVS become the focus of competition among platforms.

AVS Subsidy

AVS needs to pay service fees to operators and re-stakeholders, which essentially means that AVS needs to pay with its own ether and stablecoins, or possible points and future airdrops. However, considering that most AVS are still in the early stages, lack tokens, have small balance sheets, and have imperfect point plans and airdrop designs, it is cumbersome to attract operators and re-stakeholders to sign contracts (most EigenLayer collaborations use customized contracts negotiated privately). In short, this is a situation where a customer wants to buy a service and has sufficient payment ability in theory, but actually lacks funds at present.

To help this market run, the re-pledge market will likely “advance” initial payments to operators and re-pledgers, either through its native tokens, on-balance sheet assets, or possibly by issuing “cloud credits” for AVS to spend with operators and re-pledgers. In return for the advance funding, we expect AVS to commit to airdrops and token distributions to the re-pledge market. Alternatively, the re-pledge market could advance this money to AVS to encourage AVS to choose to work with you instead of other competitors.

In short, we expect that over the next 12-24 months, various restaking markets will compete with each other by subsidizing the spending of AVS. Similar to the market dynamics of Uber and Lyft, the restaking market with the most USD and tokens to spend will likely be the ultimate winner.

White glove user onboarding

It is more difficult than it seems to go from I want to deploy an AVS to actually putting it into operation, especially for a small team with limited RD capabilities. There is currently no standard answer to how to determine security configuration, deadlines, operator compensation amounts, penalty items and standards, etc.

Best practices will eventually emerge, but for now the restaking market needs to help the AVS team solve these problems (it’s worth noting that EigenLayer does not yet offer payment or slashing functionality).

Therefore, we expect that a successful re-pledge market will have a certain corporate sales business color, similar to the corporate sales business to provide new customers with white glove integration and service support to help new customers quickly complete the user settlement in the product.

Graduating from the Market

The most successful AVS projects will likely “graduate” from the re-staking market.

Today, the restaking hype is most relevant to small projects that don’t have the time, money, brand, and connections to recruit validators or a high-value token to secure the network. But as projects grow, they will naturally choose to leave the restaking market and recruit their own validators and secure the network with their own tokens.

Conceptually similar to dating apps, where successful users leave the platform (e.g. Hinge, Tinder). However, for the marketplace operator, this churn is bad news because you are losing a customer.

One-stop encryption SaaS shop

To illustrate this observation, lets take a deeper look at history: Cloud service providers (such as AWS) provide developers with efficient access to all the resources they need (such as hosts, storage, and computing power) to develop apps or web services. It significantly reduces the cost and time of software phát triển. This has led to the emergence of a new, highly specialized category of web services. Cloud service providers have become one-stop service providers for developers to access all non-core business logic needs through their own cloud services and a large number of third-party microservices.

The goal of a re-staking market like EigenLayer is to create a group of similar microservices for the blockchain space. For example, before EigenLayer, crypto microservices could either fully centralize their off-chain components (and pass this risk on to their clients), or bear the cost of initializing a group of operators and incentive mechanisms to buy a certain amount of security.

For microservices, the re-staking market has the potential to solve this problem. If it works as expected, microservices can consider security first without having to compromise on cost and speed to market.

Lets say you are developing a cost-effective zk-rollup. If you enter the restaking market like EigenLayer, you will have multiple core service options such as DA and bridge to easily get started. Through this process, you will see dozens of other AVS microservices that can be integrated.

The more microservices the re-pledge market offers, the better the user experience will be. Users no longer have to choose between multiple independent providers, but can buy all the services they need from one re-pledge market. Users come for service X and stay for services Y and Z.

Some AVS will have network effects (e.g. pre-provisioning)

So far, restaking scenarios have focused on exporting validators and economic incentives out of Ethereum. However, there is also a class of “inward” restaking scenarios that may add new features to the Ethereum consensus mechanism without changing the Ethereum protocol.

The idea is simple – allow validators to choose to make additional promises to add something to the blocks they propose in exchange for a reward. If they do not follow through on these promises, they will be held accountable. We expect that demand for only a few types of promises may be sufficient to attract significant participation. Although the types are small, the value flow potential of these promises is huge.

Unlike the “external” restaking use case, the effectiveness of this type of use case is directly tied to validator participation. That is, even if you are willing to pay to be included in blocks, it won’t be of much use if only 1 out of 10 validators choose to honor that commitment.

But if every validator chooses a certain type of commitment, then the guarantee provided by this commitment will be equivalent to the guarantee given by the Ethereum protocol itself (i.e. valid blocks). Following this logic, we can expect such scenarios to have strong network effects: as more validators join a certain commitment market, AVS users will benefit from it.

Considering that this type of AVS scenario is still in its infancy, the most logical channel to promote its application seems to be through sidecar software and plugins (such as Reth) of Ethereum clients. Similar to the separation of proposers and builders, proposers are likely to outsource this work to professional organizations and get rewards through a share.

It is unclear what form such AVS will take. While it is possible that a single entity could establish a general marketplace that could be used by any commitment type, we expect that there could be several players focusing on different sources of demand (e.g., those focused on L2 interoperability vs. those focused on L1 decentralized finance needs).

In summary

For students of business strategy, the business dynamics of the re-hypothecation market are a treasure trove of information that you can delve into. As you can probably tell from the above, we had a lot of fun delving into these projects.

Further, we believe it makes more sense to build first-party infrastructure that allows third parties to build LRTs within the protocol rather than building an authoritative first-party LRT.

An analogy we find helpful is to think of L1s like Ethereum as physical clouds, and protocols like EigenLayer as virtualizations of those physical datacenters. Similar to building datacenters around the world, it is nearly impossible to replicate the number of operators and economic interests that secure Ethereum. Some are trying to do this on a smaller scale (e.g. Cosmos), but similar to cloud vs. on-premises, renting security from an existing network will always win on cost and speed to market. Restaking markets like EigenLayer aim to drive the emergence of similar classes of crypto microservices to accelerate development, just as the cloud did for Web2.

We are already seeing the effects of this unlocking, as there are about 40 microservices in development on EigenLayer alone. For example, if you are a Rollup developer, you can integrate oracles to power your DeFi ecosystem, opt-in privacy services to protect user transactions, integrate off-chain coprocessors to give my application superpowers, integrate policy engines to ensure compliance, and integrate security services to protect users. The result is that your Rollup can provide a more fully featured development platform than anything on the market today. Importantly, everything works as expected, and you will be able to get these features at a fraction of the cost and time required to develop in-house.

Examples might include an L2 wanting to pre-confirm an inclusion to speed up its finalization time, a DEX auctioning the right to be the first transaction in the next block, a lending protocol auctioning liquidation rights (i.e., transactions are placed directly after the next oracle update), or searchers and builders wanting to purchase entire blocks from future proposers.

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