Whats up and welcome to the FT Cryptofinance publication. This week we’re looking at a fast-growing new pattern in decentralised finance.
The thrill over the arrival of inventory market funds investing straight in cryptocurrencies this yr has obscured the fast modifications happening on the planet of decentralised finance, or DeFi.
The most popular factor available in the market in the mean time is the emergence of EigenLayer, a brand new community that lets holders of the ether cryptocurrency concurrently lend out the identical coin a number of occasions.
Underscoring its attraction, its Seattle-based mother or father firm Eigen Labs in February raised $100mn from Andreessen Horowitz’s a16z, one of the vital influential crypto enterprise capitalists.
The idea behind EigenLayer is “restaking”, a brand new idea for the crypto market. At current holders of ether can earn curiosity, within the type of extra tokens, in the event that they deposit or “stake” their ether on ethereum, permitting the system to safe and validate transactions on the blockchain.
They earn a reward for it however that retains their cash locked up and motionless. EigenLayer takes the staked ether and permits it to be reused in different functions which might be additionally constructed on ethereum — incomes them additional yield within the course of.
It might properly sound acquainted. That’s as a result of, essentially, it’s rehypothecation, or the observe of lending the identical asset over and over. It’s one thing world monetary regulators have clamped down on for the reason that 2008 collapse of Lehman Brothers, when it emerged that the US financial institution had used collateral posted by shoppers to assist fund its personal trades. It took years for purchasers to be reunited with their belongings.
On the planet of crypto, this vice is changed into a advantage. Different companies resembling Lido Finance additionally rehypothecate belongings however hand out tokens that characterize the worth of the staked ether.
The twist with EigenLayer is that it’s attempting to increase the safety that underpins the ethereum community to different functions which might be additionally being constructed on ethereum. EigenLayer sits within the center, connecting individuals who wish to use their staked tokens to lend with new functions which might be being constructed. EigenLayer makes use of automated algorithms and sensible contracts to handle the method.
The benefit of EigenLayer is that, not less than in idea, it solves a serious situation for the ethereum community. Each software constructed on ethereum has to type out its personal safety with its personal validation, and that makes it a extremely inefficient, fragmented and dear system that’s troublesome to scale. EigenLayer may help the community develop by piggybacking on the advanced and efficient system that validates it.
From a standing begin in December there are actually slightly below 5mn ether cash, valued at $18.6bn, locked up in EigenLayer, in keeping with knowledge supplier DefiLlama. That makes it the second-largest software within the DeFi market, between longtime gamers Lido on $36bn and AAVE on $13bn.
However in a research paper this week, Carol Alexander, professor of finance on the College of Sussex within the UK, argued that restaking was creating a serious, new danger available in the market.
She stated the $18.6bn determine was “vastly overestimated” as a result of a number of the numbers had been counted a number of occasions. The true determine backing the exercise is nearer to two-thirds of that, she thinks.
That issues as a result of, she stated, every new software must depend on extremely leveraged tokens backed by little or no in a skinny market.
The EigenLayer system is designed to punish dangerous actors resembling hackers by confiscating a portion of staked tokens or deposits as a penalty. It depends on algorithms that unilaterally resolve when malicious exercise is occurring.
That leaves the leveraged staking market uncovered if there are deliberate assaults to steal funds, if costs are manipulated or if lenders merely have poorly coded algorithms, gentle borrowing requirements or poor danger controls. And all constructed on an IOU of ether, she says.
“As a result of the overwhelming majority of staking is on ethereum, any stress occasions . . . have the potential to unfold credit score contagion all through the DeFi ecosystem, and this might precipitate one other DeFi winter,” she concluded.
Already the multiplication of layers is dizzying. Functions resembling Renzo restake staked ether tokens on EigenLayer — and mint one other token to characterize that transaction. Functions resembling Renzo “are taking over a really massive credit score danger”, Alexander warned.
That might result in a cascade of liquidations available in the market and tokens might depeg from different tokens whose worth they’re supposed to trace, she stated.
It has occurred earlier than. The collapse of the terra stablecoin, which triggered the crypto market crash of 2022, started with staked ether tokens within the DeFi market and unfold as a result of larger merchants and lenders had been interlinked with different markets.
Nonetheless some have argued that introducing layers of functions on prime of staked ether is “financialisation” of the ethereum community.
Both it may be a protocol for open innovation, extra akin to a commodity, or it may be an investable asset that may ship a yield for buyers, stated the top of analysis at one staking service who declined to be recognized.
“It’s not likely potential for them to do each. In case you optimise ether because the monetary asset . . . you’re encouraging the creation of this type of layers and going additional out within the danger curve to maximise yield.”
But market demand is doubtlessly pushing ether and ethereum in the direction of it being an investable asset, simply when US lawmakers and monetary regulators are leaning in the direction of ether being a commodity.
If the Commodity Futures Buying and selling Fee turns into the principle US regulator for crypto as anticipated, then the company might discover itself happening a really deep rabbit gap when piecing collectively the aftermath of the following market crash.
What’s your take? E mail me at philip.stafford@ft.com
Weekly highlights
Former FTX senior government Ryan Salame was sentenced to greater than seven years in jail after pleading responsible final yr to election fraud fees and conspiring to function an unlicensed money-transmitting enterprise whereas at Sam Bankman-Fried’s failed cryptocurrency change.
BlackRock’s IBIT became the world’s largest bitcoin exchange traded fund regardless that it solely launched in January. Its holdings of slightly below 300,000 bitcoin pipped these of Grayscale, regardless that its rival held greater than 619,000 firstly of the yr.
Customers of Gemini’s Earn lending programme will get nearly $2bn of their crypto that was caught at Genesis, following the digital asset dealer’s chapter in January 2023.
Soundbite of the week:
Elon Musk dismissed tales that he had talked to Donald Trump about digital belongings. He wrote on his X social media web site:
“Fairly positive I’ve by no means mentioned crypto with Trump, though I’m typically in favor of issues that shift energy from authorities to the individuals, which crypto can do.”
Knowledge mining: the rise of ethena
Among the many indicators of hovering optimism in DeFi is the emergence of a stablecoin referred to as ethena. It’s pegged to the ether cryptocurrency slightly than the US greenback, and gives consumers a yield of 36 per cent. From nothing in January, it’s now the world’s fourth-largest stablecoin with practically $3bn in circulation. Its backers argue that it’s totally decentralised — pegged to the worth of ether so there aren’t any deposited belongings sitting in a financial institution. As an alternative it makes use of derivatives to maintain the worth in stability. This week it overtook First Digital USD, which has $5.29 in circulation and now sits behind Dai, which has $5.3bn in circulation.
Cryptofinance is edited by Laurence Fletcher. To view earlier editions of the publication click on here.
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