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Written by Elizabeth Howcroft
LONDON (Reuters) – More than $18 billion worth of cryptocurrencies have moved to a new type of platform that offers investors rewards for locking up their digital currencies, in a complex scheme that analysts warn poses a risk to users and the cryptocurrency market.
The growing popularity of so-called “re-staking” is the latest sign of risk in cryptocurrency markets as prices rise and traders look for yield. , the largest cryptocurrency, is approaching all-time highs while Ethereum, the second largest, has risen more than 60% this year.
At the heart of the repurposing boom is Seattle startup EigenLayer. The company, which in February raised $100 million from the cryptocurrency arm of US venture capital firm Andreessen Horowitz, has attracted $18.8 billion worth of cryptocurrencies to its platform — up from less than $400 million six months ago.
EigenLayer invented restaking to expand the long-standing cryptocurrency practice called staking, its founder Sriram Kannan told Reuters.
Blockchains are a type of database, which involves many computers in a network to check and confirm who owns cryptocurrencies. To do this, holders of cryptocurrencies, such as ether, allow their assets to be locked as part of the validation process. Token holders lose immediate access to their tokens as long as they participate in staking but receive a return in return.
Some staking platforms also give users newly created cryptocurrencies to represent the cryptocurrencies they have deposited. Re-staking allows holders to take those new tokens and share them back with different blockchain-based software and applications in hopes of generating greater returns.
The cryptocurrency world is divided on how dangerous restaking is, with some insiders saying the practice is too new to be known.
But others, including analysts, fear that if new tokens representing re-mortgaged cryptocurrencies are used as collateral in vast crypto lending markets, there could be endless loops of borrowing based on a small number of underlying assets. They say it could destabilize the broader cryptocurrency markets if everyone tries to exit at once.
“When anything has collateral, it’s not ideal, it adds a new element of risk that wasn’t there,” said Adam Morgan McCarthy, a research analyst at cryptocurrency data firm Caico.
The appeal for investors is the yield: returns from staking on the blockchain are typically in the 3%-5% range, but analysts say returns could be higher for restaking, as investors can earn multiple returns at once.
Reallocation is the latest development in the risky world of decentralized finance, or DeFi, where cryptocurrency holders invest in experimental schemes in the hope of making significant returns on their holdings without having to sell them.
However, EigenLayer has not yet paid staking rewards directly to users, because the mechanism for doing so has not been developed. Users join the platform in anticipation of future rewards, or other gifts known as airdrops.
Currently, EigenLayer is offering its newly created token to people using the platform. Users hope that this token called “EIGEN” will have great value in the future.
Kaiko’s Morgan McCarthy said the growth of repossession platforms has been driven by users seeking such airdrops, calling them “really speculative, this free money.”
“It’s very risky,” said David Dong, head of research at US cryptocurrency exchange Coinbase (NASDAQ:), which offers staking but not re-staking.
“They are doing it proactively now, (with the expectation) that they will be rewarded with something but they don’t know what it is,” Dong said.
Enter Egginlayer
EigenLayer was launched last year by Sriram Kannan, a former assistant professor at the University of Washington in Seattle and part of the team that launched India’s first student-designed small satellite, according to his academic website.
EigenLayer describes itself as a marketplace for validation services, connecting potential stakeholders with applications that need tokens.
New repossessory platforms have emerged, including EtherFi, Renzo, and Kelp DAO, that repossess customers’ tokens on EigenLayer to them and generate new tokens to represent those repossessed assets. These tokens can be used elsewhere, for example as collateral in borrowing.
Kannan said the goal of his platform is to let users choose where to stake their tokens and help new blockchain services grow, not to stimulate more cryptocurrency-backed borrowing.
He said: “We do not have any official relations with any of these players… This is an emerging phenomenon.”
Coinbase’s Duong says redeposit can come with “hidden risks” — if redeposit tokens are used for cryptocurrency lending, there could be forced liquidations and more volatility during market downturns, he wrote in a note.
The sell-off in cryptocurrency markets in 2022 was exacerbated by high-risk lending, as cryptocurrencies used as collateral quickly lost value after the collapse of the Terra and Luna coins.
Kannan keeps EigenLayer out of danger.
“The risk does not lie in remortgaging, but in the lending protocols. Lending protocols misprice risks,” he said.
Some experts are not interested in restaking, noting that the cash in restaking protocols is minuscule compared to the global cryptocurrency industry’s $2.5 trillion in net assets.
Regulators have long been concerned about losses in the cryptocurrency world spilling over into broader financial markets.
“Currently, we do not see any meaningful risk of contagion from issues being brought back into traditional financial markets,” said Andrew O’Neill, head of digital asset analysis at S&P Global Ratings.
However, the world of cryptocurrencies is becoming increasingly tied to mainstream finance, and remortgaging is attracting institutional investors.
Zodia Custody, the bank arm of Standard Chartered (OTC:), has seen significant institutional interest in staking, but considers re-staking a step too far because it is difficult to create a “paper trail” about where assets go and how rewards are distributed. Anoush Arivchatian, chief risk officer, said:
Nomura’s cryptocurrency arm, Laser Digital, has partnered with Kelp DAO to return a stake of some of its funds, Kelp DAO said in a blog post in April. Laser Digital did not respond to a request for comment from Reuters.
Cryptocurrency-focused Swiss bank Sygnum said it is acquiring its clients’ crypto assets and expects a “new ecosystem around restaking” to emerge.
