Vitalik’s Warning

Ethereum is known to be the most secure layer-1 blockchain.

Part of the reason why it has attracted so much volume and liquidity is due to the security it can provide to applications. Currently, there are many Actively Validated Services (AVS) that benefit from Ethereum’s security and liquidity. An AVS is essentially any blockchain that uses native tokens to validate transactions, making the security of their network reliant on their native tokens. EigenLayer seeks to strip away this security aspect from these token models, delegating their validation directly to Ethereum nodes in a process called “re-staking”.

Re-staking adds an additional layer of leverage that brings Ethereum closer to unlocking maximum capital efficiency. There are potentially massive ramifications of this technology being truly embraced, with the prospects being so alarming that it warranted a blog post by Vitalik Buterin just last week. Naturally, there is a lot to unpack here.

First of all, bootstrapping a network of validators can be extremely challenging. When a network’s security relies on its own token, the economic incentive of validators to secure the network is directly exposed to the token’s price. If a new layer-2 has a market cap of only $100M, and half of it is staked, that is only $50M of economic security for applications deploying on that layer-2. This is why it’s rare to see blue chip DeFi protocols deployed on low market cap (and usage) L2s. For the L2s, is their ultimate hindrance the low market cap or the low usage? Well, you can argue that it’s both.

This native validation model can create a cold-start problem for new chains, potentially leaving them dead on arrival if they can’t amass a certain initial market cap (and the resulting economic security guarantee). With EigenLayer, new (and existing) L2s could suddenly gain the economic security of Ethereum itself for their transaction validation and security. This effectively de-couples the relationship between token price and the security of a network.

If you are an ETH staker, this presents a new source of yield. You will now have the opportunity to “re-stake” your ETH. Applications, oracles, layer-2s, and more will offer ETH stakers yield in their native token to secure their networks, effectively creating a stake market. It’s quite easy to see how ETH staking yield could get boosted, depending on the amount of risk stakers are willing to take. The risk here ultimately has to do with the concept of slashing.

Economic security of blockchains relies on validators being incentivized to behave properly. Validators stake the amount of crypto they are willing to lose for “misbehaving” in the validation process. Losing your tokens for misbehaving is called slashing, with rules for such an event defined by the protocols themselves. Now, stakers will have to weigh slashing risk against yield, increasing risk with each additional layer of security that your ETH is re-staked to provide. It only takes one smart contract bug in a newly hyped chain or application and suddenly your securely staked ETH is gone.

Naturally, ETH staking yield will rise as validation is stripped away from the value proposition of participating protocols and transferred to Ethereum itself. Re-staking poses a new paradigm in Ethereum application deployment, one in which the cost to achieve a robust and economically secure validator set is substantially reduced. While the prospects for innovation are high, so are the risks for Ethereum.

When you take your ETH and re-stake it, you are suddenly introducing a new weakest link towards the safety of your precious ETH. Additionally, if a large percentage of the staked ETH was re-staked towards one protocol, and that protocol had a bug, a large amount of ETH could be slashed and burned. This would leave Ethereum’s validator set with a brand new makeup, one that could pose a threat to the network that results in the weighing of a hard fork.

In a recent blog post published by Ethereum co-founder Vitalik Buterin titled, “Don’t overload Ethereum’s consensus”, Vitalik raises his concerns around the assumptions that the collective conscious could adopt around re-staking. In his view, it’s crucial that Ethereum social consensus always stay neutral in a potential conflict to preserve the chain’s minimalism. Thus, each hard fork presents a risk towards Ethereum’s decentralization.

Ultimately, any potential Ethereum hard fork will be circumstantial. Staking is going up-only and it does seem that risk acts as somewhat of a magnet in permissionless systems. In this writer’s view, Vitalik feels that if stakers operate under the assumption that things can become too big to fail, it likely becomes a self-fulfilling prophecy.

Staking has introduced a new primitive in Ethereum: the pursuit of “risk-free”, on-chain, native yield. As we’ve seen with yield in the past, market participants will trend towards pursuing maximum capital efficiency. Let’s hope that we can be wise enough this time around to listen to Vitalik’s warning.

👨‍🏫 AMA with EigenLayer Founder Sreeram Kannan

Q1. Do you think that EigenLayer will lead to a surge in ethereum app chains?

A1. Some of the important limitations that any developer now faces with deployment of app rollups on Ethereum are:
(a) Lack of cheap DA layer with high throughput,
(b) Low censorship resistance due to centralized sequencing
(c) Bad UX for ORUs due to finalization delay on Ethereum (optimistic challenge period can be overcome with LPs on Ethereum side),
(d) High proof verification cost for ZKRUs.

EigenLayer enables a set of services that remedies these issues. For instance, EigenDA solves problem (a), solutions for decentralized sequencing such as espresso solve (b), new bridge solutions employing restaking can solve (c), and finally one can build fast zk-proof verification off chain using restaking.

Thus, we expect EigenLayer will significantly ease the development process for app chains on Ethereum.

On the other side we think, each app chain having its own fragmented security model leads to users taking the minimal trust assumption of all systems they interact with. EigenLayer with its shared security paradigm and rollups with modular scaling is a systematic solution to these fundamental problems.

Q2. Does removing validation from a token model make it less valuable?

A2. There are 4 complementary economic mechanisms for building on top of Eigenlayer, which can be combined in various ways. a) Have a wallet that collects a portion of fees, b) the fees go to a DAO, c) a native token is used for payment of fees to restakers, d) dual staking: one quorum of ETH staking and one quorum of native staking.

We think reducing staking incentives for native token staking actually increases the economic efficiency as the cost of security goes down significantly.

Q3. Do you believe that hard forks hurt ethereum’s decentralization?

A3. We share the general sentiment that hard forks are an “option of last resort” and should be used sparingly. The reason being hard forks puts a lot of pressure on the social layer. We think hard forks at Ethereum layer should be reserved for consensus layer errors (if any) and consensus layer upgrades which are community driven.

On the latter aspect (upgrades) there is a delicate balance between high decentralization and innovations to make improvement, and Ethereum has managed to keep both going well.

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