Quick overview of Restaking leader EigenLayer’s business logic and valuation inference
Overview of EigenLayer's business logic and valuation inference
With the completion of the Ethereum Shanghai upgrade, many LSD projects have experienced rapid growth in their business. The number of users and net worth of LSD assets have also increased significantly. On the other hand, with the upcoming Cancun upgrade at the end of the year and the opening of the OP stack, today is also a big year for Rollup. Various services related to the Rollup module, such as the DA layer, shared sequencer, and RaaS service, are also emerging. Based on the concept of Restaking for LSD assets, EigenLayer aims to provide services for various Rollups and middlewares. This year, it has continued to gain attention. Not only did it complete a financing of $50 million with an estimated valuation of $500 million in March, but the OTC price of its token is rumored to have reached an astonishing $2 billion recently, comparable to the valuation level of public chain projects.
In this article, I will clarify EigenLayer’s business logic and calculate the estimated valuation of EigenLayer’s project, attempting to answer the following questions:
What is Restaking service, who is the target customer group, and what problem does it attempt to solve?
What are the obstacles to promoting the Restaking model?
Is EigenLayer’s valuation of $500 million or even $2 billion expensive?
The following content of this article reflects the author’s interim views at the time of publication, with more emphasis on business evaluation and less on technical details of the project. This article may contain factual errors and biases, and is only for discussion purposes. Corrections from other investment research peers are also welcome.
EigenLayer’s Business Logic
Before formally clarifying EigenLayer’s business, let me introduce several frequently mentioned terms that will appear in the text:
Middleware: Refers to the services between the underlying blockchain and Dapps. In the Web3 field, typical middlewares include oracles, cross-chain bridges, indexers, DID, and DA layer.
LSD: Liquid Staking Derivatives, such as stETH from Lido.
AVS: Actively Validated Services, which provide decentralized security and guarantees for projects. The most typical example is the PoS system of public chains.
DA: Abbreviation for Data Availability, mainly referring to the ability of other projects (such as Rollups) to back up their transaction data on the DA layer, ensuring that all historical transaction records can be accessed and restored from the DA layer when needed.
EigenLayer provides a token economy security leasing market.
The so-called token economy security refers to various Web3 projects that, in order to ensure smooth operation and possess the characteristics of permissionless and decentralized, require the main service providers (validators) of the network to participate in the project by staking tokens. If the validators fail to fulfill their obligations, their staked tokens will be confiscated.
EigenLayer, as a platform, on one hand, raises assets from holders of LSD, and on the other hand, uses the raised LSD assets as collateral to provide convenient and low-cost AVS services to middleware or sidechains/Rollups with AVS demands. It provides demand matching services between LSD providers and AVS demanders, and the specific security guarantee services for collateral are provided by specialized pledging service providers.
In addition, the parent company behind EigenLayer has also created a DA layer to provide data availability services to Rollups or application chains that need DA layer services. This product is called “EigenDA”, and EigenDA will have business synergy with EigenLayer.
The pain points that EigenLayer hopes to solve are:
1. For various project parties: reduce the high cost of independently building their own trust networks and directly purchase collateral assets + node operators on the EigenLayer platform without the need to build them themselves.
Source: EigenLayer Whitepaper
2. For Ethereum: expand the use cases of Ethereum LSD and make ETH a network security collateral for more projects, increasing the demand for ETH.
3. For LSD users: further enhance the capital efficiency and returns of LSD assets.
The users of EigenLayer services involve three parties, and their corresponding demands are as follows:
1. LSD asset providers: The main demand of these users is to obtain additional income from Ethereum LSD assets in addition to the basic PoS rewards and to be willing to provide their LSD assets as collateral assets to node operators, facing the possibility of penalty risks.
2. Node operators: Obtain LSD assets through EigenLayer and provide node services to project parties in need of AVS services, extracting income from the node rewards and fees provided by project parties.
3. AVS demanders: Refers to project parties (such as a Rollup or cross-chain bridge using LSD assets as collateral for node operators) that need AVS to provide security for themselves but hope to reduce costs. They can purchase such services through EigenLayer without the need to build their own AVS.
The main demand for EigenDA comes from various Rollups or application chains.
EigenLayer Business Details
Users can stake tokens on the Ethereum network, including stETH, rETH, and cbETH tokens, to the EigenLayer market. Pledging service providers are responsible for matching users’ tokens with corresponding security network demanders and providing AVS services to these project parties. The underlying assets of AVS are the tokens that users pledge on EigenLayer, and the project parties need to distribute a certain “security fee” to users.
Currently, EigenLayer has only launched the restake function of LSD and has not developed node operation pledging and AVS services based on LSD assets. In the two open deposit activities of LSD assets, the deposits quickly reached the limit (depositors mainly sought potential airdrop rewards from EigenLayer). Users can also directly deposit 32 units of ETH to participate in Restake. Currently, EigenLayer has accumulated about 150,000 staking ETH under the deposit restrictions.
Image source: https://app.eigenlayer.xyz/
According to the official roadmap released by EigenLayer, the main task for the current Q3 quarter is the development of the Operator testnet (node operator testnet), and the development of the AVS service testnet will officially begin in the Q4 quarter.
The first explicit user of EigenDA is the rollup project Mantle, which is based on the OP virtual machine fork. Currently, Mantle is using the test version of EigenDA as its DA.
EigenLayer is a project with tokens, but its token information and token model have not yet been determined and disclosed.
Team and Financing Background of EigenLayer
Founder & CEO: Sreeram Kannan
Associate Professor in the Department of Computer Engineering at the University of Washington, and also the founder and controlling shareholder of Layr Labs, the parent company behind EigenLayer. He has published more than 20 blockchain-related papers. He completed his undergraduate studies in telecommunications at the Indian Institute of Science, obtained a master’s degree in mathematics and a Ph.D. in information theory and wireless communications from the University of Illinois at Urbana-Champaign, and then worked as a postdoctoral researcher at the University of California, Berkeley. He is currently a faculty member at the University of Washington and serves as the head of the University of Washington Blockchain Lab (UW-Blockchain-Lab).
Founder & Chief Strategy Officer: Calvin Liu
Major in Philosophy and Economics at Cornell University. After graduation, he worked for many years in data analysis, corporate consulting, and strategic work. He worked as the Head of Strategy at Compound for nearly 4 years before joining EigenLayer in 2022.
COO: Chris Dury
MBA from the Stern School of Business at New York University. He has extensive experience in project management of cloud service products. Prior to joining EigenLayer, he served as Senior Vice President of Product at Domino Data Lab (a machine learning platform) and held various positions at Amazon AWS, including General Manager and Director, leading multiple cloud service projects for game developers. He joined EigenLayer in early 2022.
Data source: https://www.linkedin.com/comLianGuainy/eigenl/
The team of EigenLayer is growing rapidly, with more than 30 employees, most of whom are based in Seattle, United States.
Layr Labs is the parent company behind EigenLayer, also founded by Sreeram Kannan (established in 2021). In addition to EigenLayer, it has two other projects: EigenDA and Babylon (both are projects that provide encrypted economic security services, but mainly serve the Cosmos ecosystem).
EigenLayer has conducted two public financing rounds, namely a seed round of $14.5 million (valuation unknown) in 2022 and a Series A round of $50 million (valuation $500 million) completed in March 2023.
The following are some well-known investment institutions:
Data source: rootdata.com
In the same period in 2023, its parent company Layr Labs also completed an equity financing of nearly $64.48 million, as detailed in its filing with the SEC.
Market Size, Narrative, and Challenges of Restaking Business
Market Size Forecast
EigenLayer has proposed the novel concept of restaking and provides “cryptoeconomic security as a Service” to its client base, including middleware (oracles, bridges, and Da layers) as well as sidechains, application chains, and rollups. The pain point it aims to address is the reduction of decentralized network security costs for these projects compared to building their own trust networks.
In theory, any project that requires token staking for admission, maintains network consensus through game theory mechanisms, and aims to remain decentralized can be a potential user. The specific size of this market is difficult to accurately estimate at present, but optimistically, it could become a market worth billions of dollars within three years.
Considering that the current staking amount of ETH on the Ethereum network is $42 billion, with a total project market value of around $200 billion (as of August 30, 2023), and the total funds on the Ethereum blockchain are between $300 billion and $400 billion. Taking into account that EigenLayer’s main clients in the future will be relatively small and new projects, the staking business scale of EigenLayer’s service projects should be in the range of $1 billion to $10 billion in the short term, compared to Ethereum’s approximately $40 billion staked in PoS, which is in an absolute leading position.
Narrative Driving the Project’s Business and Expected Growth
The arrival of the Cancun upgrade and the opening of OP Stack have accelerated the development of small and medium-sized rollups and application chains, increasing the overall demand for low-cost AVS.
The modular trend in public chains, rollups, and application chains has increased the demand for cheaper DA layers outside of Ethereum. The expansion of EigenDA has increased the demand for EigenLayer, and there is synergy between the businesses.
The increase in Ethereum’s staking rate and the number of staking users provide an abundant supply of LSD assets and holders. They have a strong willingness to improve the capital efficiency and returns of LSD assets. In the future, EigenLayer also hopes to introduce LSD capital other than ETH.
Issues and Challenges
For AVS demanders, it is difficult to determine how much cost can be reduced by purchasing a combination of collateral assets and professional verification node services on the EigenLayer platform. Using LSD assets on Ethereum as collateral does not mean inheriting the security level of Ethereum’s multi-billion-dollar staking. In fact, the economic security of the project is determined by the total scale of LSD assets borrowed and the operational quality of the verification nodes. This may be faster and easier than building AVS from scratch, but the cost savings may not be significant.
If the project uses other assets as collateral for AVS, it may weaken the use cases of its own tokens. Although EigenLayer supports a mixed staking model of the project’s own tokens and EigenLayer, it still poses significant obstacles to adoption.
The project may worry about becoming overly dependent on EigenLayer during long-term development, which may put them in a passive position in the future. Once the project matures, it may switch to using its own tokens as collateral for network security.
When using LSD assets as collateral for security, the project needs to consider the credit and security risks of the LSD platform, adding an additional layer of risk.
Restaking is a relatively new concept pioneered by EigenLayer, with few current followers. However, for EigenLayer, the main comparison for potential customers is whether to build their own secure network or outsource the secure network to EigenLayer. Currently, EigenLayer needs more customer examples to demonstrate the superiority and convenience of its solution.
As a new business project, EigenLayer lacks clear benchmark projects and benchmark market values. Therefore, we calculate the valuation of the project by predicting the annual protocol revenue and PS of the project.
Before making formal estimates, we still need to make several assumptions:
The business model of EigenLayer primarily involves collecting security service fees from AVS service users, with 90% of the service fees going to LSD depositors, 5% going to node operators, and EigenLayer’s commission rate being 5% (consistent with Lido).
AVS service users pay an average security service fee of 10% of the LSD capital they lease each year.
The reason for choosing 10% is that the current mainstream POS projects provide annual rewards for PoS stakers in the range of 3-8%. Considering that most users of EigenLayer are relatively new projects and the initial incentive rate will be higher, the author chooses 10% as the average security service fee rate.
POS reward rates of major L1 chains, data source: https://www.stakingrewards.com/
Based on the above assumptions, the author calculates the following project valuation range based on the amount of LSD assets lent by EigenLayer and the corresponding PS. The colored area of the valuation represents the range with a higher probability according to the author’s judgment, and the greener the color, the more optimistic the prediction.
The reason why the author judges that the “LSD asset annual lending volume of 20-50 billion” and “PS in the range of 20-40 times” have a higher probability of valuation is because:
Currently, the market value of staking tokens of the top ten public chains is about 73 billion US dollars. If we include Aptos and Sui, it is nearly 82 billion. However, most of the staking in these two projects comes from unreleased team and institutional tokens. During the cautious period, I excluded these two outliers. The author assumes that EigenLayer’s LSD share can account for about 2.5%-6.5% of the total staking market (note that this is a rough estimate), corresponding to a market value of 20-50 billion. As for whether a 2.5%-6.5% share is reasonable, that is subject to readers’ opinions.
The PS value of 20-40 times is based on Lido’s current PS of 25 times (data as of August 30th, calculated based on fully diluted market value) as the anchor, while newer narratives may enjoy a higher premium.
According to the above calculation, the reasonable valuation range for EigenLayer might be 200-1,000 million US dollars. Considering the various restrictions on token unlocking, the primary investors who valued the project at 500 million might not have left themselves much safety margin. If there are indeed investors who want to buy EigenLayer tokens over-the-counter at a valuation of 2 billion US dollars, it is even more prudent to be cautious.
Of course, it needs to be clarified that the above valuation is a deduction of the entire EigenLayer project. The specific market value of the token should be determined based on its ability to capture value in the business, such as:
1. What percentage of the protocol’s revenue will be attributed to token holders?
2. Besides buybacks and dividends, are there any rigid use cases for the token in the business to increase demand for it?
3. Will EigenDA share the same token as EigenLayer, providing more scenarios and demand for the token?
If the empowerment of points 1 and 2 is insufficient, it will further weaken the intrinsic value of the EigenLayer token. If there are unexpected surprises with point 3, it will add value to the token.
In addition, the market value of EigenLayer at its debut also depends on the market conditions at that time.
Let us wait patiently for the answer from the market.