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Latest de-peg drama highlights risks of restaking

At its best, Decentralised Finance (DeFi) turns money into composable lego blocks. They can be combined together for different use cases. Players can put other legos on top of each other. The legos have high levels of liquidity, composability and can be used by anyone in a permission-less way. But these advantages come with a high and often still underestimated degree of risk.

Each day, Coinrule will run through the state of the digital assets market for Blockbeat, your home for news, analysis, opinion and commentary on blockchain and digital assets.

At its best, Decentralised Finance (DeFi) turns money into composable lego blocks. They can be combined together for different use cases. Players can put other legos on top of each other. The legos have high levels of liquidity, composability and can be used by anyone in a permission-less way. But these advantages come with a high and often still underestimated degree of risk.

In the latest drama, Renzo-ETH, known as ezETH, suffered a depeg. It normally is pegged to Ethereum at a 1:1 ratio. Renzo is one of the many so-called ‘liquid staking tokens’ (LST) that have received widespread attention in the market. LSTs give users access to Ethereum staking yield without forcing the user to actually stake their ETH. LST providers like Lido, the largest player in this space, take care of the staking for you and net a percentage of the staking yield in return. The user gets an LST token such as StETH (‘Lido-Staked-ETH’) that represents their position. In turn, users can put these LST tokens to work in other DeFi protocols. For example, users can deposit them on lending protocols and earn further yield.

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A few months ago, the LST market took another step towards over-excitement with the launch of Eigenlayer. Eigenlayer allows ETH Stakers to ‘lend’ their economic security to other protocols and get paid for it. Currently, ETH Stakers secure the Ethereum Blockchain and earn a staking reward. With Eigenlayer, they can earn an Ethereum staking reward but also rewards from other projects that would use Ethereum Staker’s ‘services’ as network validators. LST providers can now stake their ETH with Eigenlayer. By holding the LST, users receive ETH staking yield, Eigenlayer ‘re-staking’ yield and potential yield from further depositing their LST in a lending protocol.

But this would not be Crypto if this is where it stops. LST providers like Renzo, Swell, Lido and EtherFi already have or are launching their own governance tokens. By holding LSTs from these providers, users qualify for potential airdrops of the LST’s governance tokens as well as a future airdrop of the Eigenlayer token.

This is where things went wrong for Renzo. Their airdrop announcement revealed a surprisingly low amount of total token supply that would go to LST holders. As a consequence, ezETH holders immediately started to sell. The ezETH price temporarily de-pegged to below $1,000 per token versus Ethereum at over $3,000. Many users who had borrowed against their ezETH positions suffered liquidations overnight. The peg has since mostly recovered.

To traditional finance, this level of money lego blocks appears mind-blowing. On the plus side, it highlights the potential of what can be built with DeFi. Unlike with FTX, observers could follow each step in this cascade in a transparent way on-chain. The peg recovered because each ezETH is 1:1 backed by Ethereum held in a Smart Contract auditable by anyone. The risks may be high, but watching DeFi mechanics play out in real-time can also be a thing of beauty.