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The liquid recovery token (LRT) landscape depends on the degree of liquidity of these assets, according to a report by cryptography research firm Kairos Research. Once EigenLayer officially allows LRT withdrawals, the entire ecosystem will depend on how liquidity recovery protocols manage to maintain the liquidity of these tokens.
Liquid restoring involves allocating Ether tokens (ETH) or Liquid Staking Tokens (LST) in a shared security infrastructure, and users receive a proxy token representing the amount deposited to continue operating in the finance ecosystem decentralized (DeFi). In the EigenLayer example, decentralized applications could simply turn to their security infrastructure with millions of ETH staked instead of creating their own set of validators.
The report goes on to explain that the ability to exchange LRT for the underlying asset, i.e. ETH, plays a major role in this sector, especially after EigenLayer is opened for withdrawals, as users could seek alternative return streams. Still, it takes seven days to withdraw staked ETH from EigenLayer, and investors might be looking for ways to find liquidity quickly.
In this case, if an LRT does not have enough liquidity, its peg with ETH will fluctuate, creating usage issues.
“Once LRTs become more integrated into the broader DeFi ecosystem, particularly in lending markets, the importance of pegging will increase significantly. Looking at current money markets for example, LSTs, specifically wstETH/stETH, constitute the largest collateral asset on Aave and Spark, with approximately $4.8 billion and $2.1 billion provided respectively” , emphasized Kairos analysts.
Additionally, an abundance of liquidity makes it more difficult to change LRT prices, and the report uses an article by Coinbase director Conor Grogan to highlight how Sam Bankman-Fried (SBF) managed to create a significant “deindex” of stETH by selling 75 million dollars in the market. The lack of liquidity created a shock that Grogan characterizes as the reason behind a series of events that include the blowup of hedge fund Three Arrows Capital.
Nonetheless, the report highlights that incentives from protocols using EigenLayer's shared security framework and liquid replenishment protocols could play an important role in keeping the LRT ecosystem healthy. “We believe token incentives could potentially play an important role here, and we look forward to diving into the different token models following potential airdrops from other LRT providers.”
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