Introduction
LRT² was created through a collaboration between various restaking protocols. At its core is a vault where reward tokens received from different AVSs are aggregated. In return, a token is issued that represents the collective value of the assets within the vault.
LRT² aims to economically align the supply side of economic security with the demand side of AVS through the creation of a reward supply sink. By acting as an emission dampener, AVS are able to experience less direct selling pressure and heightened reward efficiency. Reward tokens also have the ability to be added in their ‘restaked’ version, enabling auto-compounding & auto-yield generation for tokenholders.
LRT² enhances the experience for recipients of restaking rewards by eliminating the need to collect multiple fragmented payouts. By consolidating rewards into a single asset, it reduces costly gas fees and potential trading costs that would otherwise occur when collecting each reward separately. This approach also simplifies the management of reward distribution for ether.fi and other protocols integrating it. Furthermore, LRT² offers a versatile asset that can be integrated into external DeFi applications without the need to harvest or liquidate the underlying tokens.
LRT tokenholders can choose to hold their LRT², use it in DeFi for activities such as DEX LP’ing, or sell it for their preferred tokens in a gas efficient manner.
Technical Analysis
To be eligible for inclusion in the vault, a reward token must first be registered, a process that includes verifying its legitimacy and setting up its price feed oracle. Additionally, a maximum position limit must be established, determining the portion of the vault’s total value that the token can represent. Once the token is whitelisted through this process, it becomes eligible for deposit into the vault.
The registration, whitelisting, and rebalancing parameters are intended to be governed by decentralized on-chain governance. However, initially, these decisions will be made by the members of the LRT² protocol.
Deposits are made by the restaking protocol, which in return issues and redistributes the LRT² token.
The number of new LRT² shares minted for the depositor is proportional to how much value they add to the vault relative to the vault’s existing value. To manage value dilution rate limits are put on new deposits and the number of new LRT² tokens that can be minted within a certain time period.
LRT² holders can redeem their tokens at any time, in a permissionless manner, for their proportional share of the underlying assets.
Risk Considerations
Pricing and Rebalancing
- LRT² diversifies reward token volatility: AVS tokens are nascent and, as such, carry certain risks similar to many long-tail tokens. LRT² reduces price risk by diversifying the assets that reward recipients depend on. Instead of relying on a single asset—which could experience significant volatility—recipients receive a proportional share of the total value of all rewards in the vault. By spreading the risk across multiple assets, LRT² enhances the overall stability and security of the rewards.
- LRT² Accounting Oracles: The functionality of AVS tokens relies on oracles that provide data for the underlying assets, with specific contingencies on the asset providers. These oracles ensure that each token represents a proportionate share of the underlying asset, even though AVS tokens may often be illiquid. To account for this, a deviation threshold and a heartbeat are carefully parameterized. The implied market value of the LRT² token, in turn, reflects the true effective price of the underlying assets. A manipulator cannot exploit the illiquidity of AVS tokens by minting shares at a discounted price, as only whitelisted LRT protocols are permitted to mint new shares. Any attempt to manipulate the oracle price of a specific AVS token within the LRT² structure would simply result in a proportional adjustment of the underlying assets upon redemption. The market price would continue to align with the actual price of the underlying asset, as dictated by atomic arbitrage principles.
- Exposure to Short-Term Underlying Token Volatility: If the deposit value of a reward asset fluctuates dramatically between the time of deposit and when shares are calculated, this could result in large swings in the number of minted tokens. However, this effect is self-correcting ****because the minted tokens represent a fraction of the vault, not a fixed number, volatility would generally be neutralized by the proportional change in the value of the LRT² token.
- Minting Underserved Tokens: A manipulator cannot attempt to exploit the system by taking advantage of illiquidity or manipulated valuations to receive more LRT² shares than they deserve since minting of new LRT² tokens is exclusively for whitelisted restaking protocols, the system safeguards against such price manipulation.
- Oracle Risks: There is a residual risk of oracle malfunction or manipulation. Since each asset in the vault relies on its own individual price feed, the overall risk escalates with the number of assets managed within the vault. The compounded complexity associated with multiple oracles makes it challenging to ensure accuracy across all assets. It is crucial to continue monitoring the situation closely and to consider implementing additional safeguards to mitigate potential vulnerabilities as the system evolves.
- Rebalancing: The LRT² white paper mentions dynamic rebalancing for desired asset distribution, both for risk management and returns optimization. Any failure in the oracle system or mismanagement of the vault’s composition could adversely lead to incorrect rebalancing decisions and could adversely affect the token’s market value and stability. This aspect requires further monitoring.
Supply and Liquidity
- Restaking protocols must incentivize and expand liquidity for their LRT² tokens to maintain liquidity at optimal levels. This approach introduces additional operational costs for the ether.fi DAO.
- Arbitrage of LRT² is more exposed to gas prices than non-basket wrapped tokens. This is due to the need to swap multiple underlying assets during arbitrage, which can significantly increase gas costs and make the process far more expensive than for tokens like eETH. The result is that LRT² is expected to exhibit a degree of volatility around its true basket price.
- In the event of market fluctuations, only restaking protocols have the ability to increase the supply of LRT², while anyone can decrease it by redeeming. The expansion of LRT² supply depends on LRT protocols depositing additional AVS rewards, a gradual process that may not occur in direct response to changes in market demand. Due to this asymmetric supply adjustment, if demand surges and the supply cannot be increased swiftly, the LRT² token may trade at a significant premium. Combined with previously mentioned arbitrage inefficiencies, this could allow mispricing to persist for an extended period. As the market redeems LRT² tokens, liquidity in secondary markets could decline, further exacerbating price volatility and eroding market confidence in the token.
LRT² Adoption
The design choices of LRT² come with certain trade-offs that can impact the user experience for reward recipients. If these trade-offs become too significant, users may be inclined to switch to other protocols offering alternative designs for reward payouts.
- By consolidating multiple fragmented payouts into a single token, LRT² significantly simplifies the reward experience and enhances user convenience. However, a downside to this approach is that LRT² holders cannot effectively manage individual asset risks because they cannot opt in or out of specific AVS reward tokens. As a result, LRT² holders are exposed to the aggregated risks of all underlying assets, including those they might prefer to avoid, limiting their control over their personal risk exposure.
- Rewards harvesters are inevitable. As users seek to maximize their returns, the desire for solutions that automatically swap and reinvest rewards into restaking becomes increasingly prominent. Given the complexity of managing multiple tokens and the efficiency gains from automating the reinvestment process, we believe that integrating auto-compounding mechanisms is not just beneficial but inevitable in the long term.
- The maximum position limit in the vault determines the proportion of the total value that any single token can represent. If this limit does not align with the amount and frequency of rewards paid out by a particular AVS, it could create a mismatch between the incoming rewards and the vault’s capacity to accommodate them. This misalignment might lead to situations where excess rewards cannot be deposited into the vault due to the position limit, resulting in those rewards being held separately or delayed in distribution. Consequently, users might experience lower total rewards because the surplus cannot be efficiently integrated into the vault’s aggregated asset pool.
- As the number of different reward tokens in the vault increases, the total value of the vault becomes distributed across more assets. When LRT² holders choose to redeem their tokens, the redemption amounts for each underlying asset are smaller. The costs associated with redeeming, such as high gas fees or slippage during asset swaps, can potentially outweigh the value of the assets being redeemed, leading to a delayed realization of rewards.
- Given that LRT² represents a basket of long-tailed and potentially volatile assets, its utility in DeFi applications may be limited. Lending protocols might be hesitant to list it, due to the volatility of the underlying assets, and the reliance on various external oracles for pricing introduces additional complexity.
Conclusion
While there are inherent challenges that need to be addressed as we advance this mechanism, Chaos Labs regards LRT² as a viable solution for distributing restaking rewards from a risk perspective. By consolidating multiple fragmented payouts into a single token, LRT² simplifies the reward experience and enhances user convenience.
We recommend further monitoring of potential risks such as oracle manipulation and liquidity constraints.