Chaos Labs’ risk assessment evaluates only the suitability of the CAP protocol for receiving stake from ether.fi from a mechanism design perspective. We are not qualified to assess the creditworthiness of underlying operators taking loans backed by this stake or the legal agreements protecting ether.fi. We strongly recommend consulting specialists in credit risk and legal matters before making any allocation decisions.
With slashing now active on restaking platforms like EigenLayer and Symbiotic, the risk landscape for LRTs is undergoing significant change. Chaos Labs actively analyzes and monitors these emerging risks to help build a safer and more resilient restaking ecosystem. Our latest analysis focuses on the Covered Agent Protocol, examining its revenue model, the integration of slashing mechanisms, and the resulting implications for ether.fi’s risk-reward profile.
Summary
The Covered Agent Protocol (Cap) introduces a novel stablecoin system that leverages restaking to enable yield-bearing stablecoins. Accredited financial entities borrow the underlying reserve of the asset for their yield strategies and receive backing from restakers for their loans. They then pay fixed interest rates to restakers, who underwrite their loans. Yields are paid in trusted stablecoins, and fees can be accessed periodically. Slashing remains a core enforcement tool in the case of credit default. It allows the protocol to seize a proportional share of the restaker’s collateral and redirect it to the stablecoin vault to cover losses.
At Chaos Labs, we endorse Cap as suitable for onboarding to ether.fi due to its innovative model and the potential to deliver significantly higher and more sustainable yields. However, these returns come with heightened slashing and duration risks that are distinct from those associated with more traditional Networks or AVSs. We strongly recommend obtaining specialized credit-risk assessments to ensure comprehensive due diligence on all underwriting activities before proceeding with any stake allocation. Additionally, we advise Chaos Labs to perform a future stake allocation assessment that incorporates the credit assessment results and legal agreement details as key inputs into the recommended allocation mix.
How the Covered Agent Protocol works
The Covered Agent Protocol is a stablecoin protocol built on Ethereum mainnet that leverages restaking to create yield-bearing stablecoins. The protocol currently operates on testnet with a USDC-backed stablecoin. Users can mint cUSD by depositing USDC into a vault. cUSD is always fully redeemable for the underlying USDC reserve at a 1:1 rate. Users can then stake their cUSD to receive stcUSD, which generates yield.
Yield is generated by operators, also referred to as agents. These are not node operators in the traditional restaking sense, but rather financial entities such as high-frequency trading firms, market makers, and similar institutions. They borrow USDC from the vault and deploy it into yield-generating strategies. In return, they pay interest on the borrowed capital, which funds the yield earned by holders of stcUSD. The interest rate is determined by a combination of a minimum base rate, closely aligned with Aave’s stablecoin deposit rate, and a utilization-based rate. Read more about the lending mechanism here.
To access capital from the vault, an operator must first secure loan coverage through delegation from a restaker, facilitated by restaking protocols such as Symbiotic or EigenLayer. The amount of capital an operator can borrow is determined by the value of the delegated stake provided as collateral. In exchange for underwriting the loan, the restaker earns a fixed restaking fee. If the operator fails to repay, the restaker’s collateral is slashed and redistributed. This mechanism ensures the stablecoin remains fully collateralized and that yield generation continues uninterrupted.
For its stablecoin mechanism, Cap adopts design principles similar to those used in established DeFi lending platforms, utilizing health factors and liquidations to enforce loan safety and repayment. However, unlike traditional platforms where borrowers provide their own collateral, Cap introduces a novel model in which collateral is sourced through restaking. In this structure, restakers serve as both credit underwriters and risk managers for the protocol. They are responsible for vetting and selecting operators, effectively determining who is allowed to access protocol capital. The loan coverage they provide is supported by individual off-chain agreements between each restaker and their chosen operator. These agreements protect the interests of the restakers and agents, and introduce an additional off-chain accounting layer to the protocol. The protocol itself offers a guarantor agreement template, under which operators are legally obligated to return funds to restakers in a slashing event. This provides legal protection to ether.fi as long as the borrower is not insolvent.
Rewards and Slashing
As compensation for underwriting the operator’s borrowing, a fee is paid to restakers. This rate is negotiated off-chain between the restaker and the operator and then configured on-chain through the RateOracle contract. It is a fixed annual rate that accrues over time starting from the moment of delegation. Once the operator repays the full loan, the accrued restaker interest is distributed via the restaking platform. Interest payments are made in the same token as the principal borrowed. Restakers can receive restaking fees on a periodic basis, even before the loan is fully repaid. These fees can be redeemed permissionlessly from the collateral pool. Once the operator completes repayment, the corresponding amount is reimbursed to the pool.
Slashing in Cap is directly tied to the liquidation process, which is triggered when an operator’s collateral-to-debt ratio falls below the defined liquidation threshold. Liquidation thresholds are set by the protocol for each collateral asset type and are expected to follow a model similar to Aave’s. The maximum borrow rate is defined individually through agreements between each restaker and their chosen operator. LTV ratios are calculated on a per-loan basis, rather than aggregated across all of an operator’s positions. When an operator’s health factor falls below 1, liquidators can step in to repay the operator’s outstanding debt to the stablecoin vault and claim a portion of their collateral provided by the restaker.
When a liquidation is triggered, a grace period is introduced, giving the operator a final chance to repay. If full repayment is made within this window, liquidation is canceled. Alternatively, the restaker could potentially increase their delegation to restore the operator’s health factor and avoid liquidation. If neither action is taken, a slashing event is triggered within the restaking platform. The slashed amount includes the repaid value and a liquidation bonus. Slashed funds are drawn from a staking module and retransferred to the liquidator. Cap uses one vault per restaker within Symbiotic, and plans to implement one operator set per restaker in EigenLayer.
Risk Considerations
Rewards
- We expect restakers to earn significantly higher average restaking yields on Cap than other networks and AVSs currently due to the nature of the economic security provided.
- Restaking fees are paid in the same asset that is borrowed (e.g., USDC or USDT), reducing exposure to volatile governance or utility tokens and helping restakers realize more stable returns.
- Restaker income scales with operator borrowing, which depends on adoption of Cap’s stablecoin. Because Cap uses trusted assets like USDC and USDT as backing, and includes a reliable redemption mechanism and Chainlink-based oracle feeds, it is well-positioned to foster trust and long-term adoption. However, to attract sustained borrowing demand and restaker participation, Cap must also remain competitive with yield offerings from other stablecoins in the market.
- Operators are expected to be accredited institutions with established track records. Off-chain legal agreements between restakers and operators add an additional layer of enforcement for interest payment terms.
- Restakers have full freedom to negotiate delegation premiums and the maximum borrow amounts based on their individual risk assessment of each operator. This allows them to tailor rewards to perceived risk, allowing for more sophisticated risk management strategies.
- Restakers have the option to access fees periodically, but in extreme cases, payouts may be limited by the erosion of collateral value.
- Reward loss can also arise from various edge cases, such as operators repaying loans early due to rising vault interest rates, depletion of stablecoin reserves caused by heavy redemptions, or a depeg in the borrowed assets. We recommend that restakers account for these scenarios in advance and include appropriate protections in individual agreements with operators.
Slashing
- When loans are not repaid, restakers face slashing of up to 100% of the loan value. While this is not expected in cases where the operator is diligently and cautiously selected, it is significantly higher than in other live Networks and AVSs, where slashing only involves foregone rewards.
- Limiting delegations to accredited institutions that pass a professional credit assessment can manage the risk of operator default. Additionally, retakers can enter into off-chain legal agreements with operators, adding another layer of protection for enforcing terms. However, slashing can still occur in cases of operator default. Therefore, Chaos Labs strongly recommends credit risk assessments from a specialist before allocating to an operator.
- Slashing conditions in Cap are clearly defined and enforced on-chain, reducing ambiguity and minimizing the potential for dispute.
- It remains unclear how key slashing parameters such as the liquidation bonus, grace period, and liquidation window are determined or governed. They could be changed in the future without direct input or consent from restakers, potentially increasing the severity of slashing and altering the risk profile.
- In cases of operator misbehavior or poor performance, restakers could theoretically withdraw their delegation via the restaking protocol as a last resort. However, this approach is largely impractical, as it triggers forced liquidation, incurring financial loss, and is subject to a withdrawal lock-up period. Consequently, timely mitigation is limited and relies primarily on strong legal enforcement mechanisms to reimburse losses.
- In the event of an operator default, restakers have the option to intervene by adding more collateral to restore the operator’s health factor. This may buy additional time to renegotiate loan terms or support the operator in meeting their obligations. While this flexibility is valuable, it shifts responsibility onto the restaker to monitor risk and act quickly, which may not always be feasible depending on timing, capital availability, and market conditions.
- The ETH-collateral, stablecoin debt architecture introduces price volatility risk, as a decline in ETH value can increase the liquidation risk for borrowers due to no fault of their own. While Cap’s guarantor agreement designates the operator as responsible for maintaining the LTV, restakers should still be aware of this risk. They may need to actively monitor their positions and maintain a capital buffer to step in if operators fail to respond promptly. This adds operational complexity and increases the need for active risk management. Further, because liquidations create the risk of slashing for stakers, more frequent liquidations due to price moves could increase the risk of irrecoverable slashing.
Liquidity Risk
- On Symbiotic, Cap utilizes the Single Network, Single Operator delegation model, while on EigenLayer it will concurrently adopt Unique Stake. In both cases, the delegated stake is locked for the full duration of the loan and cannot be reused elsewhere. Withdrawing it without financial loss would require the loan period to end plus an additional withdrawal period. Depending on the size of the allocation, this can impact the overall liquidity of the restaking protocol. It’s essential to factor in these constraints and their potential impact on the protocol’s redemption mechanisms and integration across other DeFi protocols, when forming an allocation strategy for Cap. These dynamics warrant a more in-depth assessment to guide informed decision-making and shape a sound allocation strategy.
Conclusion
Cap represents a distinct category of network, where restaker revenue is derived from trading activities. The use case is compelling, offering strong yield potential, particularly due to its new economic model and the fixed nature of the fees, which are paid in stablecoins. Unlike traditional AVSs that provide infrastructure services, Cap involves credit underwriting, introducing a fundamentally different risk and return profile for ether.fi’s LRT product, which extends beyond typical network or AVS exposure.
The relationship between stakeholders and operators relies heavily on off-chain legal agreements, which limit the ability to assess or mitigate risk through a mechanism analysis of Cap without knowledge of the details of the agreements and the outcome of a specialist credit risk assessment. Legal matters are outside Chaos Labs’ expertise, and we recommend external counsel here. We also advise involving a specialized third party with expertise in credit risk to evaluate and manage each borrower’s underwriting risk on an ongoing basis as this function is critical for the success of Cap restaking delegations and requires specialized, deep credit analysis and monitoring.
Chaos Labs recommends additional research into optimally allocating delegation to Cap and its operators to manage the risk of slashing all stake delegated to an operator and the increased duration risk the loan commitments introduce. Despite this, the significantly higher and more sustainable yield opportunity presented by Cap makes it a good candidate to onboard for ether.fi.