Ethereum has spent the current bull market living in Bitcoin’s shadow, but two recent developments could put the world’s second-largest blockchain back in the spotlight. The first is the surprise green light from the Securities and Exchange Commission. Ethereum ETF. The second is a popular but controversial new investing feature called Clean diaperwhich received support of 100 million dollars Andreessen Horowitz (a16z) Crypto.

EigenLayer is a new protocol, or set of instructions, located on top of the main Ethereum blockchain. It provides a way for those who have already invested tokens by means of staking– a blockchain feature that rewards those who lock up their tokens to secure the network – the ability to “take back” these tokens. The term is what it sounds like. By reinvesting, users take the Ethereum tokens they have already invested and then invest them again. But instead of receiving a reward from the Ethereum network, as is the case with staking, those who reinvest are paid by other projects that rely on the blockchain’s existing security pool.

Resttaking has been around for a while, but EigenLayer is looking to supercharge the process by adding many more participants. The protocol aspires to resemble a Amazon Web Services for cryptoeconomic security.

The implications of this are “profound,” a16z wrote in a blog post about the company, noting that EigenLayer has the potential to accelerate innovation on Ethereum “100x faster.” While this seems like a promising development for blockchain, EigenLayer has yet to be tested on a large scale. And while this could lead to an explosion of innovation for Ethereum, some point to a major potential downside: a new concentration of risks that, in a worst-case scenario, could harm both users and the broader ecosystem of the blockchain. Should Ethereum users view EigenLayer with excitement, fear, or both?

“Open a wormhole”

The arrival of EigenLayer is a boon both for investors, who can now more easily earn an additional slice of yield, and for developers who can more quickly add a layer of trust in the form of collateral. The problem, however, is that using the same pool of collateral to secure multiple aspects of the blockchain creates new vulnerabilities.

“It opens a wormhole,” Rushi Manche, co-founder of Ethereum layer 2 Movement Labs, told Fortune. Manche raised a troubling hypothesis posed by EigenLayer critics: what happens if there is a hack or a bug in retaking smart contract? How does this affect the broader ecosystem that also depends on this unique deposit?

At the same time, Manche noted that supporters claim that “a whole new design space has opened up” for developers thanks to EigenLayer, allowing the same asset to be extended much further and reach much more. . From this perspective, the rewards far outweigh the risks. It is also worth considering the downsides if tools like EigenLayer are not available.

Specifically, absent restructuring, decentralized applications built on Ethereum must create their own proof of participation token: a high entry bar for any startup. With the re-easing, protocols can tap into the nearly $95 billion in staking on the main blockchain. Ether for the safety. To revisit the cloud computing analogy: if hackers want to attack small businesses, they need to get past vulnerabilities like Google Cloud or AWS that these companies rely on. EigenLayer supporters make the same argument: Hackers must bypass a security system created by Ethereum, which is worth more than three times the market cap of Nike.

But what happens when the same collateral is used over and over again?

“EigenLayer reminds me of the 2008 recession: under-collateralization, over-indebtedness. It’ll be fine,” a X user job…just one of the industry watchers who have drawn a parallel to the financial crash, where banks rehypothecated subprime mortgages.

Austin Campbell, former head of portfolio management at Paxos, told Fortune the comparison was not insignificant. “At the heart of any leveraged system is the simple truth that the more leverage you use, the less stable your system is,” he said.

There is a risk of “cascading failures” if a project fails, he acknowledges. Omid Malekan, assistant professor at Columbia Business School. But he and many experts were quick to qualify the 2008 parallels: reinvestment does not involve repeated borrowing and lending. Instead, it’s about taking a blocked asset and locking it up again. Think of it more like reusing an apartment security deposit to secure other apartments, suggests Jack O’Holleran, CEO of Skale, an Ethereum layer 2.

What if you trashed both apartments?

One so-called flat destruction scenario would be if those operating re-staking services – known as AVS for “actively validated services” – choose to devalue the re-staked tokens. “There could be this house of cards effect, but in reverse,” says O’Holleran.

The debate is analogous to criticism of liquid staking provider Lido, which currently accounts for 28% of all Ethereum staked. In theory, Lido introduces a “centralized point of failure” which is “obviously concerning,” Fortune told Tekin Salimi, founder of dao5 Capital and seed investor in EigenLater. But according to him, rather than banning this innovation, the solution is to diversify liquid staking providers.

Noting these concerns, EigenLayer says on its website that it includes a “veto committee” to contain slashing – the term used in the Ethereum world for destroying the collateral of validators who fail to perform their duties – and to prevent contagion to the main network or others. protocols. It will serve as a “doubly reliable intermediary between AVS and the staker”. Thus, the reduction conditions are the responsibility of each AVS, instead of the discretion of the overall protocol. But it’s unclear what this will actually look like in practice. To this end, risk reduction remains “the most real and yet the most undefined” of all those mentioned, thinks Vance Spencer, co-founder of the crypto venture capital firm Framework Ventures.

“Don’t overload the system,” warns Ethereum founder

EigenLayer gave rise to specific security concerns, but also to a broader existential problem: what fraction of the staked tokens can be concentrated on a separate protocol on Ethereum, which considers decentralization as its primary value? Empowering EigenLayer, according to O’Holleran, amounts to the Ethereum community giving massive leverage and power to another system. Additionally, copy recovery services are also popping up, like Karak, which announced a $48 million Series A raise last month. Additionally, an unnamed but similar version will hit the market soon, sources familiar with the matter told Fortune.

Vitalik Buterin, The Ethereum founder raised concerns about EigenLayer in a blog post last May. “Be wary of application layer projects that take actions that risk expanding the ‘scope’ of blockchain consensus to anything other than verifying the fundamental rules of the Ethereum protocol,” he wrote. Buterin warns of the “slippery slope” of the loss of credibility of the “fragile” social consensus of the underlying network. His message was clear: don’t overload the network consensus.

One of the most concerning focus risks for Buterin is system security overload.

The strength of Ethereum’s security system is directly linked to the economic value of the network: it would be prohibitive for hackers to muster the resources necessary to defeat the consensus system that protects the network. “We agree that Ether is used to secure the mainnet, and that is its sole purpose,” says Campbell. But if you use your staked tokens to secure Ethereum and other networks, the surface area of ​​what Ether is used to secure increases. This increases the value based on a single point, Campbell says, which can provide more attractive incentives for hackers.

The second concentration risk concerns decision-making. Let’s say 40% of Ethereum’s tokens end up being reinvested and EigenLayer’s smart contract suffers a hack or bug. It’s unclear when there will be consensus to cancel Ethereum in order to release it, says Tom Schmidt, a partner at crypto venture capital firm Dragonfly. “I don’t know where that threshold is,” he admits.

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