By Elizabeth Howcroft
LONDON (Reuters) - More than $18 billion worth of cryptocurrency has moved into a new type of platform which offers investors rewards in exchange for locking up their tokens, in a complex scheme that analysts warn poses a risk for users and the crypto market.
The soaring popularity of so-called "re-staking" is the latest sign of risk-taking in crypto markets as prices rally and traders hunt for yield. Bitcoin, the biggest cryptocurrency, is near all-time highs while ether, the second biggest, is up more than 60% this year.
At the heart of the re-staking boom is Seattle-based start-up EigenLayer. The company, which in February raised $100 million from U.S. venture capital firm Andreessen Horowitz's crypto arm, has attracted $18.8 billion worth of crypto to its platform - up from less than $400 million six months ago.
EigenLayer invented re-staking to expand a long-standing crypto practice called staking, its founder Sreeram Kannan told Reuters.
Blockchains are a kind of database, which involve many computers in a network checking and confirming who owns which cryptocurrencies. To do this, owners of crypto tokens, such as ether, allow their assets to be locked up as part of the validation process. Holders lose instant access to their tokens for as long as they participate in staking but they earn a yield in return.
Some staking platforms also give users newly-created cryptocurrencies to represent the cryptocurrencies they have staked. Re-staking enables owners to take those new tokens and stake them again with different blockchain-based programmes and applications in the hope of bigger returns.
The crypto world is divided as to how risky re-staking is, with some insiders saying the practice is too nascent to know.
But others, including analysts, fear that if new tokens representing the re-staked cryptocurrencies are used as collateral in crypto's vast lending markets, there could be endless loops of borrowing based on a small number of underlying assets. That could destabilise broader crypto markets if everyone tried to exit simultaneously, they say.
"When there’s anything that has collateral on collateral it’s not ideal, it adds a new element of risk that wasn’t there," said Adam Morgan McCarthy, research analyst at crypto data provider Kaiko.
The appeal for investors is the yield: returns from staking on the Ethereum blockchain are typically in the 3%-5% range but analysts say returns could be higher for re-staking, as investors can earn multiple yields at once.
Re-staking is the latest development in the risky world of decentralised finance, or DeFi, in which cryptocurrency holders invest in experimental schemes in the hope of generating large returns on their holdings without having to sell them.
The EigenLayer platform is yet to pay out staking rewards directly to users, however, because the mechanism for doing so has not been developed. Users are joining the platform in anticipation of future rewards, or other giveaways known as airdrops.
For now EigenLayer has been giving out its own newly-created token to people who use the platform. Users hope this token called, "EIGEN", will be worth something in future.
Kaiko's Morgan McCarthy said the growth of re-staking platforms was fuelled by users seeking such airdrops, calling it "really, really speculative, this free money thing."
"It's very risky," said David Duong, head of research at U.S. crypto exchange Coinbase (NASDAQ:COIN), which offers staking but not re-staking.
"They’re doing this pre-emptively right now, (with the) expectation that they will be rewarded with something but they don’t know what," Duong said.
ENTER EIGENLAYER
EigenLayer was launched last year by Sreeram Kannan, a former assistant professor at the University of Washington in Seattle and part of a team that launched the first student-designed micro-satellite in India, according to his academic website.
EigenLayer describes itself as a marketplace for validation services, connecting would-be stakers with applications which need staked tokens.
New re-staking platforms have emerged, including EtherFi, Renzo and Kelp DAO, which re-stake clients' tokens on EigenLayer for them and generate new tokens to represent those re-staked assets. These tokens can be used elsewhere, for example as collateral in borrowing.
Kannan said his platform's aim is to allow users to choose where to stake their tokens and to help new blockchain services grow, not to incentivise ever more crypto-backed borrowing.
“We don’t have any official relationships with any of these players...This is an emergent phenomenon,” he said.
Coinbase’s Duong says re-staking could come with “hidden risks” - if re-staking tokens are used in crypto lending there could be forced liquidations and more volatility during market downturns, he wrote in a note.
The 2022 selloff in crypto markets was exacerbated by high-risk lending, as crypto tokens used as collateral quickly lost their value following the collapse of the Terra and Luna tokens.
Kannan distances EigenLayer from the risks.
"The risk isn’t in re-staking but rather it’s in the lending protocols. The lending protocols are mispricing risk," he said.
Some experts are unconcerned about re-staking, noting that the cash in re-staking protocols is tiny relative to the global crypto industry's $2.5 trillion in net assets.
Regulators have long been concerned about losses in the crypto world spilling over to wider financial markets.
“For now, we do not see any meaningful risk of contagion from restaking issues to traditional financial markets,” said Andrew O’Neill, digital assets analytical lead at S&P Global Ratings.
Still, the crypto world is becoming increasingly connected to mainstream finance, and re-staking is catching on with institutional investors.
Standard Chartered (OTC:SCBFF) crypto’s arm, Zodia Custody, has seen significant institutional interest in staking but considers re-staking a step too far because it is difficult to establish a “paper trail” of where the assets go and how rewards are apportioned, Chief Risk Officer Anoosh Arevshatian said.
Nomura’s crypto arm, Laser Digital, has partnered with Kelp DAO to re-stake some of its funds, Kelp DAO said in an April blog post. Laser Digital did not respond to a Reuters comment request.
Swiss crypto-focused bank Sygnum said it stakes clients’ crypto assets and expects “a new ecosystem around re-staking to emerge”.