On The Brink with Castle Island - David Hoffman (Bankless) on Eigenlayer (EP.515)

Episode Date: April 3, 2024

David Hoffman of Bankless and Bankless Ventures returns to the show. In this episode we discuss: What Bankless Ventures has been focusing on, including Bitcoin Layer Twos. Eigenlayer – what originally attracted David to the project.   The Eigenlayer value chain and the emerging categories of projects building in this ecosystem. Liquid Restaking Tokens, Actively Validated Services and how these primitives work in the Eigenlayer ecosystem. Views on risk management and leverage in the context of Eigenlayer. To learn more: Bankless Bankless Ventures Eigenlayer Risk FAQ  

Today on the podcast, I sat down with David Hoffman of Bankless and Bankless Venturers. I wanted to have David on the podcast today to talk about eigenlayer in some of the new categories of startups that are emerging in this ecosystem. And I appreciate David coming on and talking through some of the questions that I had about risk and some of the ways that eigen layer primitives might be used in the coming years. So without further ado, here's my conversation with David Hoffman of Bankless. Matt Walsh and Nick Carter are partners at Castle Island Ventures. All of these expressed by them where the guests on this podcast are solely their opinions and do not reflect the ability. of Castle Island Ventures. Guests and host may maintain positions in the assets discussed in this podcast.

You should not treat any opinion expressed by anyone on this podcast as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of their personal opinion. This podcast is for informational purposes only. Brought down by bad mortgage investments, Lehman, which has 25,000 employees, will be liquidated. The federal government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie.

May and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more to Britain's ailing economy with a new round of quantitative easing. And print a couple trillion dollars and all of a sudden people start to worry. So out of this worry, we have something called the Bitcoin. Bitcoin. All right, David, welcome back to On the Brink. Matt, it's good to be back.

It's one of my favorite podcasts. So I don't know if you've been on since you guys started the fund. So how are things going? Really good. I love looking at deals. Looking at deals, really, really fun. So we raised $35 million fund, really started off focusing on Ethereum, the ecosystem dominantly.

But since this whole Bitcoin Renaissance thing, our eyes have been compelled to look over there. We haven't announced it yet. So I guess we won't blow it, but we're working on a deal together right now in the Bitcoin L2 space. I'm excited about it. I think we're working on a couple of them, actually. Yeah. It's fascinating.

So where are you guys spending most of your time these days? In the fund. The topic of this episode is going to be eigenlayer. We're like some sort of pseudo-Igen-layer ecosystem fund, not. completely, but it's one of our biggest categories. And then there's just the surrounding typical DFI categories that you would find on Ethereum, layer twos, and then like the Bitcoin ecosystem and Bitcoin expressivity is the most new category that has captured our attention. But definitely by and large, the biggest category is the surrounding eigenlayer ecosystem.

I've been trying to explain a little bit about what's going on in this Bitcoin D5, Bitcoin L2 ecosystem to folks. What are the reasons why you got so excited about that as a category? And why do you think now is the time we're starting to see all these great projects launch? For me, it just comes back to this word expressivity. One of the reasons why Ryan and I and banklets have been associated heavily with Ethereum is that, well, you can actually do bankless banking on Ethereum in ways that you would never have been able to do on Bitcoin because Bitcoin just doesn't have expressivity, doesn't have smart contracts.

So you need to go off chain to find trust. And that's just what a bank is. We've always just been focused on Ethereum because you get that full, complete level of trustlessness with on-chain EVM smart contracts. You need a virtual machine. Now it seems, it appears, that there have been meaningful technical breakthroughs that allows for more expressivity, more trustless banking type services to be done on Bitcoin with fewer to zero trust dependencies. So it fits largely into this thesis that we have been developing over years now. We call it the bankless thesis. And now the moneyness of BTC, which is, in my opinion, the coolest thing about Bitcoin is

its latent power as money is now being unleashed. So there's no coincidence that these new NFT mince on Bitcoin are immediately minting higher, why there's so much demand to build Bitcoin layer too. When there's so much latent power in the moniness of BTC, there's just demand for expressiveness around it. And we've unlocked that and it's all happening at once. It's interesting because if you just look at this through the lens of things that don't require the market for total crypto assets to grow, I don't know what Bitcoin dominance is today, but somewhere between 45 and 55% probably. It's just capital that is not put to work in productive uses, you could argue.

So it doesn't necessarily require net new capital to flow into this system to be exciting as primitive. No, it's very much right. There's dormant power in Bitcoin the asset, especially this cycle. We don't have BlockFi. We don't have Celsius. So where are you going to go get productivity on your Bitcoins? I know there's this meme that Bitcoiners really love cold storage.

I actually think that's less true of a meme than what people lead on. I think that's culturally a good thing to rally around just as a learning lesson. But no, people like productivity, people want yield, people want to get more money on their money. Bitcoin is powered by greed. And so this is where this is going to go. And people sell options. There's a lot of proxies for demand here where capital is going. OG Bitcoiners are more than happy to use centralized options desks and things like that. So let's talk a little bit about eigenlayer. We're not investors in eigen layer. You're deeper in that ecosystem. system than we are. But what got you excited about this platform, the whole project, and then maybe talk a

little bit about how you guys are playing this theme? Yeah, I first met Sri Ram right at DevCon in October of 2022, and I immediately got nerd sniped by it. I think it was one of the many nerd snipes that Dan elites are from Nason really got me on. And really the simple version of this is a continuation of the evolution of the arc of ETH as a monetary asset. So ETH as money is now being used to secure things beyond Ethereum. And so if this is something that is extra protocol to the Ethereum protocol that is actually tapping into something very deep in the Ethereum protocol, which is the economic security of ETH. So economic security, many people that I respect inside of the EF, like Justin Drake, for example, Justin Drake will say that he is on a mission to provide World War III

resistant block space for the world. And a large part of that story comes from the crypto economic security of ETH, the asset, and the proof of stake. And Eigenlayer is a good one. And EGenlayer is a is really harnessing that same power, cryptoeconomic trust. But now we are commoditizing trust and making trust cheaper for more people to have. And it's all funneling back into ETHI asset. So it fits into ETH the internet bond, which is this idea that me and Ryan have developed a bank list where proof of stake is this yield-bearing structure for ETH. But now we have even more bond-like things coming out of the Eager ecosystem that is also going into ETH. So ETH has been just a core theme of my journey through crypto, and EigenLayer as an ecosystem is just continuing the arc.

So as soon as I put these puzzle pieces together, I was just immediately nerd-sniped. And that was my first relationship with EigenLayer back in early 2022. So it sounds like it was a lot of the financial side that got you excited about in terms of what this could do for Ethereum. I'm curious how you would think about describing this to maybe a layperson on what EigenLair unlocks in terms of what you can actually build on blockchains. What is the reason for existing from a technical perspective? I think you can even expand and extend eigenlayer to use cases so far out of crypto that it gets really interesting from even just the typical Web2 Silicon Valley Software as a Service perspective, where all eigenlayer does is allows for trust to become a service inside of general Web2 software as a service businesses. So you can have your regular old contracts, your regular relationships between businesses and business and that you can put inject trust into that relationship.

via eigenlayer. So maybe just stating it very simply, what does eigenlayer do? We have Ethereum proof of stake. You stake your ether to the Ethereum network. With eigenlayer, eigenlayer has its contracts as a middleman between you, the depositor into Ethereum proof of stake, the beacon chain. So you do the same thing where you go and stake your eith to the beacon chain of Ethereum to do normal proof of stake consensus for Ethereum. You just do it through eigenlayer. So eigenlayer has this ability to inject extra slashing conditions that are beyond the Ethereum protocol, extra to the Ethereum protocol. And these extra slashing conditions can be coded up to be any service that you want. So any fault that you want to throw into the conditions of a contract can be

added on as like extra slashing conditions. One very simple example for this would be like an Oracle network. You as an Oracle respond with what is the price of ETH, what's the price of Bitcoin, what is the binary outcome of an event? And then if you lie, then because your duty as an oracle is to not lie, but if you do lie, you will get slashed per the extra slashing conditions of this one particular service of which the eigenlayer slashing contracts manages. So it's pretty boundless about what eigenlayer can really do, which is why it takes time, I think it oftenly frequently takes time for people to really wrap their heads around. But it's very simply extra slashing conditions on crypto economic trust. So it extends pretty broad.

broadly. So if you think about that from the perspective of, okay, maybe if eigenlayer existed three, four years ago, do you think that we would have L2s that shows a different path to market where they could rely on this shared security? And the contours of what's possible here, are we talking about net new L2s flourishing? How do you actually see this playing out commercially? So layer twos, I think, are more or less untouched on their core base because they're still going to be blockchains. They're still going to have the same old sequencer. But there are AVS. So what we call these extra slashing conditions, these extra networks are actively validated services, which is another crazy term that the crypto industry produces.

I think it as software as a service, but with economic trust, take software as a service, add trust, you get an AVS. So there are layer twos that are AVS enhanced. So eigenDA is an AVS out of eigenlayer. It's the only one that they are incubating internally. And layer twos can leverage eigenDA to have cheaper DA for their layer twos, meaning faster transactions, cheaper transactions. There are just many other Aveses that can be built, and many layer twos can tap into the power of

these Aveses. I think of them as little modules that you slap onto your layer two to make it that much better. But these are just Aveses for these layer twos. There are Aveses that can be completely unrelated to layer twos, can be completely unrelated to crypto in general. It's pretty boundless. Okay. So you see this is more of a modules, microservice type of an architecture as opposed to

enabling something like the next arbitram could be built on this primitive, for instance. Yes, I see AVSs as Legos and of themselves. Microservice, I think, is a great way to describe it. There can be blue chip AVSs, there can be long tail Aveses, there can be Aveses that actually service other Aveses, and very much in the way that software as a service and just AWS services can just be useful for other startups. I think AVS is both useful to some defy apps, some actual crypto networks, completely standalone services. Oracle is actually a great example. You can take this conversation anywhere. So when we talk about AVS's, it stands for actively validated services. These are external to the eigenlayer contracts. So there are other projects, basically. There's probably

some exceptions where eigenlayer itself is building ABSs. But how do we think about these in relation to the actual core of eigenlayer? So we have this core eigenlayer slashing conditions contract that was talking about earlier. And AVS has just tap into this base. So eigenlayer is just these core set of slashing contracts on the Ethereum layer one, which, which is a core layer layer, which is a lot of is what we call eigenlayer. And then Aveses will just code up what their slashing conditions are. So what are the rules of this particular AVS? It's very simple to what are we doing with smart contracts. We are eliminating pen and paper contracts and we're just writing them up into Ethereum. AVS is to do something very, very similar where we just remove the rules of a pen and paper contract,

and we just code them up into the eigenlayer slashing contracts. And then people who stake their eth, restake their ETH to this AVS have to abide by the rules of these extra slashing conditions. and Extra is always in reference to, well, we're starting with the Ethereum Protocol, proof of stake slashing conditions. So AVS has extra slashing conditions, and they are writing the rules for their terms of service. They are literally their terms of service, except they're inside, codify the Egonayer-staking slashing contracts. So there's been critiques of Eigenlayer around re-hypothication. I think the team does a good job of coming out and dispelling some of these things around,

okay, we're not talking about using a prime broker. So some of this maybe is definitional, but let's talk a little bit about that. And when some of these things are launched, they have a look and feel that makes some people are uncomfortable. But how would you classify this re-hypothecation argument? I think this is the first concern that people have when they understand restaking, because the point of restaking isn't to just restake your eth to just one AVS. The whole incentive as to why you would restake your eth in the first place is that you

get extra yields. The AVS is that are using, that are renting your security, your trust, your crypto economic security, your ETH, are paying you some yield. But you're not beholden to any one AVS. You can resake your ETH to potentially all of the ABSs. So you can sign up for every single slashing condition that comes online to eigenlayer. And that starts to get people's hair to stand on then because we've seen what happens when the crypto G gens will leverage up on risk as much as possible.

This is going to happen. People are going to test the limits of the system. People are going to seek as much yield as possible. So naturally, the system is going to get stressed. tested. And then when you see people re-saking their eth and signing up for as many extra slashing conditions as possible, people start to just draw analogies of house of cards. We're going to have some cascading risk. And it's a very normal reaction to have. And there are conditions in which some systemic risk might be developed. But it's important to lay a pretty firm line in the sand

of that there is no actual inherent leverage in the base eigenlayer system itself. You're not borrowing more capital to leverage up and wind up any trade. You are simply taking taking on in a very linear fashion, more or less risk by signing up for more or less slashing conditions from AVS's. So it's a pretty linear, non-exponential relationship with risk, the more AVS is that you sign up for. And then there are also systems, these organizations around the Eugenler ecosystem, call them LRTs, that are doing a lot of the risk management. So it's their job to make sure that no slashing conditions happen. And it's one of the main core philosophies of eigenlayer, that if you are a functional, well-operating entity who is operating

AVS networks, it should be well within your reason to never be slashed. The only time that you will be slashed is if you were careless about your physical hardware and your actual operating of these AVSs or you were malicious. By design of how these AVS is are going to be built, there is no such thing as accidental slashing. You are totally within your control to not be slashed. so long as you are a good proficient operator, if that makes sense. I get that by nature, eigenlayers, just code. So it's not installing leverage by virtue of the code. I guess in the same way that credit default swap is just a piece of code too.

And it's really what people do with the credit default swap that could get them in trouble. It's an interesting new primitive in the context of crypto, though, because if you think about these Aveses and you have the ability to take, let's say you put in 10Eath and you want to sign up for a bunch of these things, is there some similarity here to having multiple mortgages on your homes, who actually gets the claim on the eth if and when things start to go bad at the AVS layer? How should people think about that risk? Maybe we can lay out the supply chain around eigenlayer, and we can talk about all these parties in relationship with each other. So you have the main eigenlayer-based contracts, and that's the spawn of the whole system. Then you have three

more parties that are all relevant. You have the Avess, which are the many, many, many, call them eigen apps. There's the applications that are spawned out of eigenlayer, it's the main purpose of wagon layer. And these are the people who are renting your eth, your restaked eth and paying you some reward. Then you have operators who are, think of them as just the people running the hardware, actually doing the service that AVS is require. And then you have these liquid restaking tokens, which are the actual collection of the capital. So they are actually putting up the capital at stake. They are putting up the capital at stake inside of the operators. And then the operators are going out and doing the service for the Aveses. Aveses pay the

operators, operators pay back their accrued yield minus some fees back to the LRT projects. The LRT projects pay it back to whoever is depositing the ETH, which is the end user. So this is the supply chain here. The risk comes from outside of this system, which is why I said there's no actual base leverage in the eigenlayer system itself. The risk comes from if you, as a user, come to some LRT project and you deposit your ETH and you get, we'll just use etherfi, they're the first ones to launch their token. You get the ETH. You get the ETH token in return. So you put in vanilla eth, you get eeth in return. Eeth is a synthetic version of ether that has the proof of stake yield of Ethereum, because this is always hooked into Ethereum

itself, and then also all of the yield from all the AVSs that Etherfi has determined to they want to validate. So then all of that yield is baked inside of the ETH token. So just thinking of some numbers here, you get 4%. If you do native vanilla ETH staking in Ethereum proof of stake, maybe you at 5% to 15%. We don't really know what these numbers are going to be at the end of the day with Ethereum, with restaking yield. The risk comes from when somebody takes that E.E. And they put it into some money market or just some relationship with someone where they put

their ETH up for collateral. And then they borrow more ether. And then they put it back into Etherfy. And then they wind that up. So that is a layer of leverage that is above the eigenlayer protocol. It's now we're now just talking about the DFI app space of Ethereum. or you could also do this with some private off-chain agreement. So it is leverage, it is risk, but it's happening above the eigenlayer ecosystem.

And there's many buffers, there's many circuit breakers throughout this eigenlayer supply chain. Igen layer has a buffer itself where it takes seven days to unstake ether from the eigenlayer-staking contracts. Each LRT will have its own security buffer. So there's a set of security buffers and circuit breakers inside of the eigenlayer system to prevent the D-Gen volatility, chaotic nature from working its way back down the stack. So that is one level of protection. And then the other one is just, well, all of these LRTs are also supposed to be managing risk.

And all of these LRTs are going for some version of money. Lido, stake teeth on Ethereum, competing to be money. So are all of these LRTs. Managing risk and managing slashing conditions is something that they need to be good at. So there's a lot of parties inside of this eigenlayer supply chain that are highly incented to manage the risk. So structurally, we'll see what happens when the DGEN start to wind up, but I think there's more than enough stop gaps to really prevent those shockwights from working its way down to the core. All right. I'm glad you set that up with the value chain because I think

that was well articulated in terms of how the Aveses work and the LRTs and the potential looping. And I definitely want to get into some of the edge cases on how this breaks. But how do you think about this from the perspective of ultimately still have the same unit of collateral at the base? You have Ethereum that goes into this thing. So if what you're saying, let's just say it goes wrong, some of these things start to blow up and plow. There's off-chain agreements. There's credit.

The next big hedge fund blows up. Who has the claim on the one unit of ETH? My core worry here is how does this work from a lean perspective? There's no concept of first lien loss, second lien loss, junior credit. And maybe the answer is that won't happen. But I'm just curious what the rainy day scenario looks like. Okay. So if we start with this initial claim that there.

There's no inherent leverage in the eigenlayer ecosystem. Say we just have 1 million ETH in the eigenlayer ecosystem just as a number. The way that that would become bubbled is that off-chain or defy layer leverage. So you put it inside the money market and then you borrow ETH against that and then you wrap that back into the eigenlayer ecosystem and then you loop that. So what starts off as 1 million ends up as 3 million. And then the risk is that some AVS has a slashing condition and then the collateral that is inside of some LRT goes from 1 to 0.9. we're only 90% collateralized. And then that sensitivity at that leverage layer, that's where that liquidation cascade happens.

I think that liquidation cascade stays more on that defy application layer, wherever people are seeking the leverage. And people who are just depositing ETH into the LRT that was responsible for the slashing condition inside of the AVS, they take a 0.9 or 0.1 haircut. And then a lot of the ETH that people have bonded inside of the defy app, they take the bulk of the slashing condition because they were the ones. taking the leverage, but it would also depend, they are taking leverage in some particular LRT. So like etherfi, puffer, renzo, swell, there are different flavors of LRTs.

It's going to be determined on which LRT had the capital inside of it that had the slashing condition and also the AVS that created the slashing condition. There's also fundamentally inside of the eigenlayer core contracts. There's a technical term for this, and I'm forgetting it, but Sri Ram talks about this frequently, but we can actually allocate the ETH that was slashed to the actual AVS. So even though that many AVSs are commingled inside of the same package from this LRT, because one AVS was the cause of the slashing condition, you can actually attribute the ETH to that one particular AVS. They call it attributable security. We're going to need to see these contracts in prod. We're going to actually

need to see them actually shipped and made viewable to the public in order to really fully unpack these things. But these are very deep questions that the Eiglian team are taking head on. This particular question, I think, is answered by this part that they call attributable security, which technically over my head beyond the name itself. I come at this from the angle of traditional money market funds off chain, real world money funds. I remember when the reserve fund broke the buck. I think it was in 2008 and dip below a dollar for the first time, and it was this huge event.

And in crypto, these things happen all the time. Tether has traded below. USDC has traded below. So I think we're a little bit immune to it. But ultimately, you still have that one unit of collateral. at the base. Do you worry that the behavior in crypto is just not going to be able to restrain itself? We haven't proven to be, as an industry, the most risk-managed people, I would say. Well, so there's two anecdotes that we can compare and contrast here, and we can say which one is

more like eigenlayer and which one's not. There was the incident of, there was an ST-Eth depegging before the Ethereum merged, before our withdrawals were enabled. And people had leveraged up by depositing Lido-Staked Ether into Avey. they borrowed vanilla ether. They swapped vanilla ether for Lido-Staked Ether, deposit that back into Ave, and then wound that up. So some 4.5 to 5% ETH staking rate turned into something like the high 20s e-staking rate because they just wound up the yield.

And because there wasn't the loop, because the merge hadn't happened yet and withdrawals hadn't happened yet, there wasn't a complete loop between the liquidity of ether in defy and the redeemability of staked eth. So this was actually as a result of Three Ro's Capital, now that I'm thinking about this, more three-o's capital was getting liquidated. They were selling Staked Eth into the market. Staked Eth depegged. One steak-death ended up being worth 0.93 or 94 actual Eth. And as a result of that, there were like liquidations in Avey because the peg unwound. So that's one example. The other example of cascading liquidations that we've seen is Terraluna. So these are very different examples.

Why did Terraluna have this massive cascading liquidation, even when so many people had all of our eyeballs looking at Terra Luna and we had half the industry saying, this is totally solvent and it's totally going to work. And the other half of the industry was like, this is totally not solvent. This is hot air. And how is that different from the Lido-staked Eth versus ETH thing? In my opinion, we saw the winding up of Terra Luna, but the industry had confusion as to like whether there was actually collateral there or not, was the actual Luna good collateral and in our completely risk mismanaged part of the bull market euphoria, enough people inside of the crypto industry was like,

oh, Terraluna, totally solvent. Whereas what we have in Ave and the Staked Eath example is everyone's looking at that thing. There ultimately was collateral there. There was ether there. And so people came in to bid up Staked Eaths. So it didn't turn into a cascading leverage event that completely undermined the security of Ethereum because we had full transparency. So one was like completely delusional.

And then the other one was, well, actually, look, there is ETH here at the end of the day. People have leveraged up to the maximum frontier amount of risk to reward, but somebody's going to step in to buy because that ether is there. And that's the same thing with Eager. There is ether there. Some DGens have wound themselves up. But at the end of the day, there is ether there and there will be demand to buy some DGEN's mistake. So there's ether there at the base, but there's not necessarily ether there, depending

on how far out on the branch you're buying it, I suppose you would say. Well, if we're talking about a defy app that is allowing people to wind up a trade, then that defy app, if we're going to extend the Ave compound morpho structure, it's collateralized. The only way that it actually, there isn't ether there if there's non-collateralized leverage happening. And inside of defy, which is where we've seen a lot of the stress tests of the economics of eth happen, it's always been collateralized. In my opinion, so long as there's collateral there, there should be a very good buffer that

prevents any reverberations through this tech stack. You brought up Taraluna, and I want to maybe talk a little bit about just the social side of this industry. If you look back on that, there were people that were calling out, hey, this thing looks like it's not stable and I don't think this is going to work, but not a ton of them. There was actually probably more of an incentive not to say anything. So do you worry about that at all in terms of some of these AVS's and some of the behavior that we have the potential to see here over the next couple of years?

I don't worry about that in any specific relationship to eigenlayer. I worry about that as just a characterization of the industry that I work and live in. In the peak of bull markets, sobriety is penalized. Get with the DGens or stay silent. And post-Theraluna, a lot of these people came out with their receipt saying, hey, not only was I right, but I was right, and I said it, and I said it loudly. But no one wanted to listen to that person in that moment of time. So, like, there's nothing unique about AgenLayer that I think will incentivize any of this.

I think actually the Agenlayer team are very risk-averse people who are, building a very risk-averse structure. And Sri Ram couldn't be any more different than Do-Quan. And a lot of the fault of Terraluna came, in my opinion, from the ego of Do-Quan. And again, this is just my character assessment of Sri Ram, one of the most kind-hearted, respectable founders that I think has emboldened and brought a lot of faith in him from the team that works around him. Really just fantastic leader. And I think if we're just leaders imbue culture inside of the organization that they have, so if there is any room for any crazy bubbling to happen, in eigenlayer as a structure, I don't think Sri Rom is the leader who would inspire that

bubble to actually inflate, if that makes sense. I totally agree with that. I'm more worried about something really catching fire at the ABS level that is just not risk manage or the looping of these LRTs, having the next Celsius emerge and raise a lot of money in a centralized way and start playing this game. Those are the vectors I worry most about. And I just wonder if, as an industry, we're going to be able to identify those things. because definition some of these risks that we're talking about,

they only happen when this thing is massively successful and the asset prices are ripping. And that's really where historically, I'd say, the bad risk management incidents in this industry have happened. I do agree that that is where it would happen. If there's going to be any cascading liquidation, it's going to be because one AVS had a slashing condition and it dominoed down the supply chain.

One thing I'll say about that is there are many LRTs in competition with each other who are all highly incentivized to manage risk. What are LRTs doing is they are trying to find some efficient frontier between maximizing yield for their depositors who are restaking their ETH with these LRTs and minimizing risk. So there's going to be some efficient frontier between minimizing risk and maximizing yield. But going back to this philosophy around what does it mean to be an AVS and having slashing conditions is that any well-functioning operator should never just be unexpectedly slashed. The only times you are slashed is if you are negligent or you are malicious.

And now you have the seven or eight or nine, decently two very competent LRT teams who is their job to protect their users' capital while also optimizing for risk. So there's just a lot of market forces at play. There's a lot of diversity inside of the Ican layer ecosystem because there's so many LRT teams. There's operators that have learned how to run hardware

since before Ethereum was even online and they were running hardware in the cosmos ecosystem. So like running hardware in crypto is something that we totally know how to do. So that feels like a pretty safe risk factor. And because we have this diversity in the LRT ecosystem, one of the philosophies of eigenlayer is, eigenlayer is like an antitrust buffer.

So it doesn't want any LRT to get too big. Doesn't want any LST to get too big. So just because we have so much diversity on the number of players inside of the eigenlayer supply chain, there's a lot of redundancy and resiliency there. That makes sense. How do you think about what the efficient frontier of LRTs looks like? This feels like it could be a little bit of a winner,

take most type of a market, but how many of these things do you think will have? What's the basis for competition? The fact that there are so many LRTs is actually one of the more interesting things. LSTs seems to have a very strong Pareto distribution curve, as in, well, Lido is the largely dominant LST. And starting an LSC competitor this day seems to be the hardest thing to do. Lido's like, it's penetrated L, saked-Eath into D-Fi. It's hard to disrupt. And there seems to be just a very clear power law to the spoils go to the winner. LRTs seem to be the opposite. There's so many and they all have a pretty mild slope on ETH deposited into these LRTs. The number one, etherfi is something like a little over two billion. The number two is at 1.5 billion. The number three

is at one billion. So there's actually a pretty narrow range of between the number one and the last place of who has all the ETH deposited. And it actually makes sense because as you layer on parts of this tech stack. You have Eth at the bottom, LSTs in the middle, LRTs on top of LSTs. You actually start to branch out in opinionation. And all of these LRTs are going to have to look at all the Aveses and be opinionated as to which AVS is that they want to integrate with and get yield from. So there is, in my opinion, a wide flavor profile for what these LRTs want to optimize for and what risk they want to optimize for and who they want to be. So these things I don't think are competing as money nearly as much as like Lido is. They're competing on more different vectors. They all need to be

liquid collateral assets in DFI. They all need to compete on that vector. But where they get the yield from and what risks they sign up their depositors for, there's a much larger surface area to be opinionated for. And in my opinion, that means that there's a lot of room for a lot more LRTs to peacefully coexist. And you actually do see that. Usually you would see these are all competitive teams, but they're also doing a lot of partnerships and integrations with each other inside of the defy ecosystem. And so you do see a lot of this extra room being expanded into by collaborations between LRTs. So there's obviously investment happening at multiple layers of this value chain that you laid out here in terms of the Aveses, the LRTs. Obviously, you can invest in ETH and EGEN layer

as well at some point once they publicly launch. How do you think about value accrual? Where is value going to accrue in this stack? What's investable? What's not investable? Is it too early to tell? this is something that we've gone back and forth at bankless ventures for a really long time where this was a conversation that me and Ryan were having where he was concerned that there wasn't as much value accrual to the LRT space because LRTs will always be subdominant to LSTs because LSTs will always have more ether. But then I was on this side, well, it doesn't matter if the units of ether in LRTs are less. LRTs might have larger margins to pull from because they're taking more risk, they're doing more work, they're taking on more responsibility, and there might be

more value captured per unit of ether at the LRT level versus the LST level. I think that's a pretty fair assumption to make, simply just because LRTs are just much more complex, and they're just getting more yield. They literally just have a larger pie to take a percentage off before they pass along that yield onto their depositors. Right now, EtherFi is actually the only LRT that has launched their token with a public valuation, and first-time valuations and of one month is always dubious to extrapolate that further than just the first days. But right now, Etherfi is trading at a fully diluted valuation of $5 billion, with a market cap of $580 million. Comparing that to Lido, Lido's at $2.5 billion. So in this very early time period of LRT valuations,

etherfi is coming in at 2x of Lido. You don't really get any notion of fair valuation until, in my opinion, one full cycle of crypto has happened. We'll see what happens. First, you need to have a market, then you have to have a bear market, and then we'll see. But right now, the market is giving a very strong premium to these LRTs. In the private markets, AVSs are the hot girl at the party, because there's not enough AVSs to go around, because there's only 20 to 30 of them. More are coming online every single day, but they are commanding very high valuations from the venture capital corner of the EigenLER ecosystem, just because all LRTs need to partner with them. It's good for operators because they have more AVSs to choose from. And they are ultimately the source of yield.

from inside of the eigenlayer ecosystem. So we haven't seen any single AVS come online yet because the eigenlayer hasn't come online yet. So there's still a big fog of war over there as well. But at least in terms of the private market, ABSs are the hottest thing since slice bread. It's interesting because how valuable an LRT ought to be is in large part how well they can actually diagnose and understand AVS risk. So in a lot of ways, maybe we don't even know who the best teams are yet because time will just tell in terms of their core competency.

Totally, yeah. It's also going to be a function of how diversified these LRTs can be against each other, which, in my opinion, I think people first looked at all these LRTs, and they were like, these all looked the same, but that came from just a lack of familiarity with the eigenlayer ecosystem. And now people have realized that, no, these actually can be very, very differentiated from each other. So let's talk a little bit just around what this does for Ethereum. Obviously, this is a pretty big deal, the launch of Eugen Layer. It's going to unlock a lot of new things that people are building. Obviously, a lot of net new company formations, probably a lot more developers coming into the ecosystem. But how do you think about the competitiveness of Ethereum as an L1 with this development? I think with the eventual launch of Egan Layer, and then maybe we can zoom forward to say the eventual success of EganLayer, AVS is functional, they are doing real services.

there's a wide variety of them. They are generating yield for these LRTs, which we're putting it back into ETH. This whole system is up and running and functional. Let's make the assumption and jump there into the future of time. In my opinion, it formally enshrines ETH as the native currency of the internet. Because ETH is becoming this trustless collateral for more than just blockchain networks. You already see Ether becoming the unit of account for Ethereum's own layer two blockchains, which are now also, by the way, spawning layer three blockchains.

They're also spawning app chains. So there are all of these fractal of blockchain networks being spawned off the Ethereum main chain. And eth is already the unit of account for these networks. Avess are now also using Ether as a unit of account for all of their services. And this is a shout-out to Roon Chitra from Gauntlet who made this metaphor. But we have Ether, the proof-of-stake internet bond. But now with AVS is we have something that looks like corporate bonds.

And it's all denominated around Ether, the asset. So if you didn't think ETH is money, now or before eigenlayer, now there's even more evidence to suggest that ether is this unit of account for trustless value transfer, trustless collateral inside of this internet economy. So this is what the original nerds night that I had about the eigenlayer is that now there is these additional ways for ether to be money that are extra to Ethereum, extra to blockchains, and now we're just in this boundless space of cryptoeconomic trust applications. It's interesting to think about the L1 versus what's built on top of it.

And I wonder if there's almost a design consideration to have more parts of eigenlayer integrated into ETH, particularly with an eye towards, what if something really went wrong here? And would you end up in a tension where there's fork proposals? Is that a risk or is that just my fudding the bad side here? I think you're either intentionally or unintentionally referencing Vitalik's blog post, don't overload the Ethereum consensus. So this is why there is this philosophy enshrined inside of eigenlayer, which is completely objective slashing. No subjective slashing. We cannot have two different opinions as to whether some slashing condition should or should not have happened. And as a result of that design choice in eigenlayer, there is no four-choice rule because everything is completely

objective. So we don't want the Ethereum L1 validators to have to choose which version of some AVS slashing condition they want to choose because they never signed up for that. they just signed up to secure the Ethereum protocol. And because eigenlayer as a design choice is not imposing that choice on Ethereum, there ought to be no fork choice rule imposed by eigenlayer on the underlying layer one blockchain. That's interesting.

I was not explicitly referencing Vitalik's post, but almost more of a philosophical question around what happens when application layer things go wrong. So look at the Dow, for instance, there was a hard fork at that. So, yeah, it sounds like you're not worried that if something really bad happens at the AVS layer or the LRT layer that we wouldn't be talking about an Ethereum fork at some point or anything like that. That would require such a strong winding of leverage and connection of dominoes that I don't think exists.

And the reason why I don't think it exists is because so many different parties inside of the eigenlayer ecosystem are incented to manage that risk. Igen layer itself is building in circuit breakers. And that's the seven-day withdrawal buffer. Aveses have attributable of security. and so they can only slash as much security as they are specifically borrowing. There are just so many buffers between all these different parties. And in addition to what I think has always been underrated about smart contract-based finance,

we can see everything. Everyone can see everything. And this is the difference between an Ave-based cascading liquidation versus a Terra-Luna cascading liquidation with Tera-Luna. You couldn't see anything, partly because you don't know how the market is going to respond to collateral being liquidated. And so you literally cannot predict that. But on Ethereum, you can see all.

the collateral in the different places with the different parties, and you can see the supply chain of events. This whole thing is auditable. And every now and then, we like to invoke, what if this causes like 2008? 2008 happened because it was a black box. We didn't know who had the money and what, and it took us decades of litigation and lawyers to like unwind all that stuff. That's why we have smart contracts. Smart contracts will do the unwinding and it will be orderly and efficient. My last maybe I sound like the risk management guy over here, but you just can't know what's happening on the back end of it. So three arrows capital, they built into a 6% holding of GBTC at one point.

And the question we should have been asking is where the hell did all that money come from? Those guys never raised outside capital. At least they never registered with the SEC for it. So they're clearly borrowing it. So everything that was happening there was off chain. That's probably the key risk in all of this. It's just that someone levers up massively off chain and that there's dominoes that start to fall. I believe in the power of degen's.

They might find a way. But I also think too many parties are interested and have the tools to manage that risk for that to work its way that far down the tech stack. Yeah, that makes sense. All right, David, what would you say to people that want to go deeper in EigenLayer? Where are you getting a lot of your information these days? People are going to have a lot of questions, where to play in this stack. Where would you send people?

Depends on what level of technical capacity listeners have. If they still want to get introduced to EigenLayer and learn more about what it means to be an AVS and to have commoditized trust for parts beyond Web3. To listen to the episode Wist FreeROM that we did, I'll send it to you so you can link in the show notes. For people who really want to get into the risk conversation, Turin Chitra, who is just this gigabrain risk modeler at Gauntlet, gave a very good talk about the different risk conditions around Aginlayer.

And that, I think, is one of the most clear articulations of where risk is coming from and how it's managed. I'll send that to you so you can link that in the show notes as well. Other than that, the AgenLayer Research blog has basically every single technical answer you could ever ask for. I'd also echo that. I think Turun's blog post and then the Aginler blog really spell out some of these risks around liquidity, financialization of LRT. So definitely check that out, do your own research. Exciting. It's, it feels like we're coming out of this bear market, though, talking about net new projects and interesting future potential financial

crises, years on the horizon, hopefully. Hey, where's the fun without a bit of risk? Yeah, exactly. All right, David, so where can we send people to listen to the podcast and check out what you guys are up to at Bankless. Bankless.com, wherever you listen to your podcasts, I'm Trustless State on Twitter. Yeah, that'll do it. Appreciate you coming on. Cool. Thanks, Matt.

Thanks for listening to another episode of On the Brink with Castle Island. To find out more about Castle Island, visit castle island. Visit castle island.vc. To listen to all of our podcast episodes, please go to On the Brink dashpodcast.com or just click on the tab in our website. Thanks for listening.