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Multi-Factor Dangers of Crypto's Billion-Dollar "Restaking" Bet

Restaking is drawing significant attention, with platforms like EigenLayer drawing over $3 billion in ETH and token derivatives from speculators, alongside millions from investors chasing early adopter airdrops. However, the resurgence of speculative investment chasing high rewards raises concerns.

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The uncharted territory of cryptocurrency is once again decentralized finance (DeFi), and in particular "restaking."

DeFi has been at the forefront of cryptocurrency since its inventors set out to build a decentralized marketplace that would eliminate the need for banks and other middlemen by automating procedures on the blockchain.

After being the crypto market's darling in 2018, the sector crashed in 2022, along with the broader digital assets market. Since then, the industry has battled to recover from many hacks and questionable initiatives.

Now, the second-largest cryptocurrency, ETH, is making its way to the EigenLayer platform, a decentralized marketplace that allows Ethereum holders to use their tokens to provide security for crypto applications, giving them rewards in the form of yield.

The Ethereum protocol is based on this idea; users deposit tokens, or "stake" them, into the network so that the blockchain can verify transactions, and are rewarded when making successful blocks. This became feasible when the 2022 upgrade of Ethereum converted the blockchain to a proof-of-stake consensus mechanism. Liquid staking builds on this by allowing users to “unlock” their staked tokens while also receiving yield from the underlying staked asset.

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With buzz over a potential large airdrop from EigenLayer, the hype train for "restaking summer" is just starting. Since lifting its deposit cap on February 5, it's attracted almost $2 billion in ETH and token derivatives from speculators, bringing its TVL (total value locked) to over $3.75 billion. According to the company, EigenLayer "allows developers to create decentralized networks while allowing them to circumvent the difficulties associated with bootstrapping and operating their own trust network."

A lack of activity on most new networks' blockchains makes it hard for them to gain staking support, so restaking is necessary.

Because of this, they have little choice but to create solutions that lack the infrastructure and security features of more well-established networks.

Therefore, projects will probably be completed sooner if holders are compensated to restake their tokens.

Apart from (re)staking rewards paid out by the platform, users are hoping for incentive payouts from protocols using EigenLayer's service. Commonly known as airdrops and distributed to early adopters, this can reach tens of thousands of dollars for just a small upfront investment.

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However, experts are worried that DeFi speculators are returning to an old strategy of seeking the best rewards before they are paid out, as money pours into the sector focused on a project that still needs to be operating.

Another issue associated with restaking is the potential for network centralization. Validators who have more significant amounts of cryptocurrency staked can earn more rewards, which they can then restake to further increase their holdings and influence on the network. Over time, this can lead to a small number of validators controlling a large portion of the staked assets, undermining the decentralized nature of the network.

Increased centralization can also pose security risks. If a few validators control a significant portion of the staked assets, the network could become more vulnerable to attacks.

Moreover, restaking poses additional concerns beyond the centralization risk. Liquidity issues can emerge as a significant amount of the cryptocurrency gets locked up in staking, reducing the available supply for trading and potentially increasing volatility. The complexity of managing staking and restaking strategies may also deter participation from less technically savvy users, and the continuous lock-up of assets can restrict validators' ability to respond to market dynamics.

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The allure of compounded returns through platforms offering restaking mechanisms can be compelling, yet it's critical to approach these opportunities with caution. Vigilance becomes paramount as the sector matures. The emergence of platforms promising extraordinary yields signals a cautionary phase reminiscent of past speculative bubbles.

The lesson from the DeFi summer, marred by significant fraud and loss, looms large as a reminder. As restaking gains traction, the underlying security implications and the sustainability of high yields on single assets must not be underestimated. In restaking summer, the potential for a precipitous downfall exists, not from outright fraud, but from a collective oversight of the intricate security dynamics at play.