It’s worth mentioning that Stratos is not an investor in EigenLayer, we simply find it to be a compelling new crypto primitive which is worth spending some time thinking about.
EigenLayer is a protocol built on Ethereum that introduces restaking, a new crypto-economic primitive for decentralized networks. Restaking allows users to re-use their staked ETH to secure multiple networks and earn rewards on their extended capital.
EigenLayer addresses the challenge of fragmentation in security across Actively Validated Services (AVS) - layer 1 blockchains, layer 2s, oracle networks, etc. In proof of stake systems, the security of the system is highly dependent on the value of the staked capital. To date, each AVS has had to bootstrap their own staking system in isolation. Bootstrapping a proof of stake system is quite challenging. Capital will tend to go to networks which are more proven, leading to less potential stake for new networks. As a result, networks compete directly for the scarce set of capital looking to be staked. This leads to capital and thus security being fragmented across many networks.
EigenLayer’s key breakthrough is in consolidating this fragmented capital by allowing users to grant EigenLayer additional enforcement rights on their staked ETH, enabling it to be effectively restaked on other networks. Now the same amount of capital can be reused across many networks - solving the scarcity problem in bootstrapping new networks. An AVS will still need to incentivize stakers, but because the staked capital can now be used across more than one network, there is a larger pool available.
One example where EigenLayer could be appealing is for decentralized sequencer networks for rollups. Rollups are a way to scale the Ethereum network by moving computation off-chain, but they require their own security mechanism. Rather than having to bootstrap a brand new sequencer set, they could use EigenLayer to extend the security provided by staked ETH.
For end users (aka ETH stakers), restaking presents a significant improvement in value accrual by allowing users to earn passive rewards on their extended capital. Instead of having to choose between different staking opportunities, users can restake their ETH on multiple networks and earn rewards from multiple sources, all with the same initial investment.
The business model for EigenLayer is quite straightforward. They charge a fee on the rewards that flow from the AVSs to restakers. This revenue is then captured by EigenLayer’s token through a treasury system. Thus the more restakers being paid on the platform, the more value accrual to the EigenLayer token.
The team is led by Sreeram Kannan, a former professor from University of Washington, and PhD in information theory from Berkeley. He is a highly respected figure within the crypto world and has an excellent ability to communicate his vision. His experience researching information theory makes him an ideal person to be building this protocol. The rest of the team consists of other academic researchers along with some experienced crypto builders like Calvin Liu who helped with BD at Compound Finance. Overall, they represent a strong founding team.
How valuable can EigenLayer become?
When considering an investment, it's helpful to understand what the revenue opportunity is and what the valuation might be at various market penetration rates.
The first step for answering this question is the potential size of the market in the future. We’ve approached this by looking at existing AVSs - namely existing L1s outside of Ethereum. In Q4 of 2022, the annualized staking revenue paid out by the top 25 proof of stake networks (excluding Ethereum) was around $3b. This has grown from just over $200m in Q1 2020. This is a compound annual growth rate of nearly 140%. But given that in the last 12 months, the CAGR is down by ~80%, it is more reasonable to use the average CAGR for the past 3 years. This would still imply a 37% CAGR, or over $25bn in staking revenue by 2030, seven years from now. An impressive number considering the past 3 years includes an 80% drawdown. While this high growth rate can be attributed partially to P-o-S systems being in their infancy, it is promising that these systems are becoming the preferred consensus mechanism for decentralized infrastructure
Using a 37% CAGR, we project that non-Ethereum staking revenue may exceed $10bn by 2027 and reach over $25bn by 2030.
To put this in perspective, stakers earned over $3b in tokens last year, and we expect that EigenLayer will take 10% of staking rewards earned on the marketplace, which suggests an addressable market size of $300m in token revenue in 2022. Looking at the future growth potential of staking shown in the chart above, we project that non-ETH AVS staking revenue can exceed $25bn in the next decade, representing an addressable market of $2.5bn. It’s important to note that Eigenlayer is likely to be more attractive to new AVSs looking to bootstrap than to already established networks - at least in the near term. Thus, EigenLayer’s TAM will be whatever fraction of future staking revenue is generated by new systems - which is likely to grow over time.
The next question is - what revenue multiple might EigenLayer trade at? An interesting comp for EigenLayer is Lido Finance, the first mover in the liquid staking derivatives market. As of Jan 2023, Lido sits at an FDV around $2.5b according to Coingecko. Based on the data from Token Terminal, over the last 6 months, the average trailing P/S ratio was 50.6x. To use a more conservative comp for this analysis, we assumed that EigenLayer will trade at a 25x multiple of annualized revenue which was the lower bound for Lido over the last 6 months.
For example, in order for EigenLayer to reach a $5b FDV it would need to generate $200m in annualized revenue. It's worth noting that dYdX, LooksRare, and OpenSea were the only protocols other than Ethereum to take in more than $100m in annualized revenue over the same period according to Token Terminal..
This sensitivity table shows the level of Eigenlayer re-staking revenue assuming a 10% take rate, for various levels of market penetration and overall market size (based on the market size projection shared earlier in this piece, and excluding ETH rewards)
Overall EigenLayer is one of the most unique and interesting opportunities we have seen given the relatively straightforward underwriting exercise to reach over $10b in FDV. It's uncommon to come across early stage opportunities with plausible valuations in that order of magnitude. As a result of this potential scale, it will likely garner much attention going forward.
Key Considerations & Risks
We have spent quite a bit of time thinking about both the economic and technical implications of restaking. After talking in depth with the EigenLayer team, we've come up with what we think are the key considerations and risks to take into account when projecting the future penetration of Eigenlayer.
Will EigenLayer be able to build this restaking mechanism as a “proof of concept”?
From a technical standpoint, we can be quite confident that EigenLayer will be able to deliver functioning re-staking contracts to mainnet. Surprisingly, the core function of restaking is enabled by a relatively simple smart contract on mainnet, rather than a separate piece of infrastructure entirely. We believe that the technical implementation challenges are fairly low as a result. The team is highly skilled and they have already deployed these contracts to testnet.
Will restaking prove to be a viable mechanism for extending cryptoeconomic security?
The area with less certainty is with restaking in general. This mechanism is a new approach to cryptoeconomic security that has never been tested in a real world environment. It is impossible to know for certain whether the restaking mechanism will function as intended. There may be unforeseen risks around unintended slashing or validators colluding to attack certain AVSs. Concern around these risks is also somewhat mitigated by the confidence in the team and the research they’ve done. The whitepaper goes quite in depth into the game theory and economics behind staking. It seems likely that the system they design will prevent any existential threats, but the hostile environment of crypto cannot be underestimated.
Will EigenLayer will be able to bootstrap itself through EigenDA?
The EigenLayer team is building a standalone data availability layer called EigenDA with the intent of using this product to bootstrap their re-staking marketplace. Given the team’s background in scaling wireless networks, which rely on similar data compression technologies, they are well positioned to build a compelling DA layer.
Competition - Celestia, Polygon Avail, Subspace, Laconic, and Ethereum itself are building DA layers.
Execution - both EigenLayer’s re-staking and EigenDA are quite technical undertakings.
Is the Total Addressable Market of AVS large enough?
In order to understand this, it's helpful to look at existing AVSs - namely existing L1s outside of Ethereum. In Q4 of 2022, the annualized staking revenue paid out by the top 25 proof of stake networks (excluding Ethereum) was around $3b. This has grown from just over $200m in Q1 2020. This is a compound annual growth rate of nearly 140%. But given that in the last 12 months, the CAGR is down by ~80%, it is more reasonable to use the average CAGR for the past 3 years. This would still imply a 37% CAGR, or over $25bn in staking revenue by 2030, seven years from now. An impressive number considering the past 3 years includes an 80% drawdown. While this high growth rate can be attributed partially to PoS systems being in their infancy, it is promising that these systems are becoming the preferred consensus mechanism for decentralized infrastructure
Will there be meaningful demand from new and existing AVSs?
While it is technically possible for any AVS to incorporate EigenLayer’s staking, the systems which account for most of the revenue are already secured by billions in staked assets. It's uncertain that they would feel any rush to participate in re-staking.
The most relevant potential customers would seem to be new AVSs. Given our view that the space will continue to move in the modular direction of L2s, L3s, etc, there should be no shortage of potential customers to capture. EigenLayer can provide security for sequencer networks, bridges, DA networks, and other modular infrastructure. There is a fairly believable state of the world in which EigenLayer becomes somewhat of a default step for bootstrapping these new PoS systems.
Will new AVSs capture a significant share of the staking market?
Existing systems are unlikely to go away entirely, at least some of the existing alt L1s will be around in the future. However, our perspective is that numerous existing L1s are redundant and do not possess long-term sustainability. Rollups, on the other hand, are capable of performing all the functions of L1s in a more secure and dependable manner. As a result, new systems may have a good chance of capturing a significant portion of the staking market.
Will EigenLayer’s fees be competed away?
EigenLayer's restaking mechanism is expected to generate meaningful fees through its high take rate. The take rate is the percentage of staking revenue that is retained by the protocol, and it is expected to be ~10% of the yield paid to restakers. In order for EigenLayer to generate meaningful revenue, it is important that they can keep this take rate as high as possible. This leads to the question of defensibility. Are there any moats or network effects which will prevent this take rate from getting competed down?
There is a clear first mover advantage which will provide pricing power for a period of time. While some other protocols have mentioned restaking, to our knowledge, no other company is as far along as EigenLayer. But because these contracts will be mostly open source, it should be fairly trivial for copycats to emerge.
Given that EigenLayer is essentially a marketplace business, it is important that they build out a strong base of ETH restakers to fill out the supply side of the market. This could lead to network effects and enable EigenLayer to build a moat around restaking. Marketplace dynamics could be strong if EigenLayer becomes the best brand in the space - after all, liquid staking, which is the closest comparable to restaking, shows similar dynamics with Lido controlling over 70% of the liquid staking market.