Users are flocking to yield farm staking protocols, but poor risk management and due diligence is a ticking time bomb.
Risk management is rarely included in a crypto entrepreneur’s starter package. Especially when the market is booming and crypto entrepreneurs are struggling to acquire adopters and TVL, they often prioritize innovative technology and aggressive marketing over sustainability.
But a company's attitude toward risk determines whether it will thrive after a bull market or become one of the failures the industry points to leading the next bear market.
The current providers of the rehypothecation industry are at this turning point.
Startups are getting an influx of real user funding. In June, the total value locked in liquidity rehypothecation protocols was $15 billion, up from less than $300 million just a few months ago. Ether.fi, the largest liquidity staking protocol, has over $5 billion in TVL on Ethereum and Arbitrum.
This industry is growing like crazy. However, only a small portion of Ethereum is actually participating, so this is a market built on weak fundamentals. Without proper risk assessment, startups, their users, and entire industries can collapse.
Chasing Re-staking Rewards
If staking is the process by which users secure the blockchain by locking or lending digital assets to earn rewards, then re-staking is staking those digital assets again.
Re-staking allows already staked digital assets to be distributed to other decentralized applications in exchange for other rewards. Re-staking allows a blockchain, application or service to gather the community and capital needed to secure their system without requiring the community to amass a new trove of capital - instead, they can simply use the cryptocurrency they already own.
Moving digital assets to get the best rate of return is called yield farming or liquidity mining. In April, EigenLayer’s mainnet launch sparked a new wave of enthusiasm for yield farming staking protocols. EigenLayer allows users to re-stake their Ethereum and ERC-20 to so-called Active Validation Services (AVS) such as Rollups, oracles and other applications. In turn, users will receive Liquidity Recollateral Tokens (LRT) that can be used to earn additional yields, as well as platform points that measure the user’s contribution to the network. While these points themselves have no value, users believe they will be tied to future airdrops and have begun speculating on them.
Since then, the ecosystem of rehypothecation providers and services has expanded rapidly.
Liquidity re-pledge providers, such as Ether.Fi, Puffer Finance, Renzo, and Mellow, remove the technical barriers to re-pledge and deposit assets on behalf of users through sleek user interfaces. These providers are competing fiercely to attract more liquidity to reach higher Total Value Locked (TVL) levels.
The re-pledge war has begun. The weapon of choice: a more elaborate marketing plan that offers eye-popping rewards.
Earlier this year, Ether.fi and Puffer launched a campaign to offer additional rewards in the form of LRT and points to users who transfer assets through the platform. Pendle, on the other hand, went into full speculative frenzy, declaring on its homepage “Hop on the Points Express!” and offering 100x Points.
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However, this marketing strategy—the prospect of huge token rewards or future token airdrops—is dangerous and unsustainable.
If history is any guide, these incentives are unlikely to last, and even more worryingly, this realization will only be caught after huge consequences, leaving money in the hands of many users completely transformed into a metaphor.
From the ICO craze of 2018 to the first introduction of yield farming in 2020, cryptocurrency users have been madly chasing an economic game that gives their tokens a huge potential advantage. These re-hypothecation protocols allow users to extract more potential returns from their digital assets and extract more utility from the infrastructure they rely on.
The biggest concern in the re-hypothecation market is the quality of the Active Verification Services (AVS) to which these platforms redirect user funds. In order to attract more users, restaking providers are incentivized to engage with more AVS and even accept high-risk services because the rewards are high. But if AVS violates blockchain rules and is penalized, staked user tokens may be confiscated—in crypto, this is called slashing.
At present, the reduction mechanism is not yet live, so the industry can only speculate on how penalties against one provider will affect all other providers related to it.
At this point, the cryptocurrency industry needs to refocus on risk management as restaking providers weigh the incentives to attract new users against the effort required to conduct thorough due diligence on their AVS partners.
Another concern with all these staking and re-staking systems stacked on top of each other is the ripple effect of hacks. If any of these providers were hacked, billions of dollars could be evaporated not only from these services, but also from the Ethereum network. In addition to the monetary impact, hacking can also damage user trust. The whole concept of re-staking to provide economic security to the broader app industry may be questioned.
Competition creates quality
The re-hypothecation battle could harm the entire industry, as it would tempt users to inject large sums of money into the market to purchase projects with unstable fundamentals. But it doesn't have to be this way. Competition is healthy when the competition to build innovative products is matched by the competition to protect those products from risk.
As long as companies find ways to reduce these risks—and even work to lower the expectations of users who sometimes invest frantically in untested new products—the industry will become stronger because of this competition.
Take the growing competition between EigenLayer and Symbiotic, for example. Shortly after Symbiotic announced it would offer a Bitcoin restaking service, EigenLayer expanded its service to include ERC-20 functionality to meet demand for more token options.
Through competition, innovative technologies will drive the industry forward. But more than that, startups will be incentivized to develop better user experiences and user interfaces for interacting with new technologies, making it easier for more users to participate. And more users build a more powerful ecosystem.
The permissionless nature of cryptocurrencies allows for exciting products to be built with the help of a decentralized community and allowing the community to earn rewards. As long as risk management is part of the equation, a healthy re-hypothecation ecosystem will deliver real value.
[Disclaimer] There are risks in the market, so investment needs to be cautious. This article does not constitute investment advice, and users should consider whether any opinions, views or conclusions contained in this article are appropriate for their particular circumstances. Invest accordingly and do so at your own risk.
This article is reproduced with permission from: (MarsBit)
Original article by Amadeo Brands
