This post has been co-authored by Chaos Labs and Renzo.
Introduction
With the activation of restaking rewards in the Renzo Protocol, it is essential to carefully evaluate the most effective ways to distribute these rewards to the community. Renzo has chosen a conservative approach for distributing restaking rewards. Given the current state of restaking—where rewards are primarily in the relatively liquid EIGEN token—and Renzo’s expected short-term rewards profile, the protocol will temporarily compound rewards into ETH while exploring alternative distribution methods.
One of the primary options under review is the LRT² protocol. LRT² functions as a vault, aggregating reward tokens from various AVSs and issuing a new token representing the collective value of all assets within the vault. To ensure the most informed and beneficial decision is made for the Renzo community when choosing the right reward distribution approach, Chaos Labs has thoroughly evaluated the LRT² protocol alongside other potential distribution methods. This post aims to provide a comprehensive overview of these options and explain the rationale behind the Renzo Protocol’s forthcoming decision on reward distribution.
Complexities in LRT Reward Harvesting
Harvesting and distributing LRT rewards introduces complexities absent in standard liquid staking, largely due to the need to handle a diverse basket of native tokens from the underlying AVSs as rewards, rather than simply receiving ETH. While not an issue at present, Chaos Labs and Renzo are studying the optimal rewards harvesting system for the long term.
The process of accounting for these tokens and determining how to distribute their value to ezETH holders presents unprecedented challenges and intricate trade-offs. If the tokens are sold for ETH and added to the total stake, programmatic, immediate selling could negatively impact the price of smaller reward tokens once these start being emitted, creating a potential “death spiral” effect. This outcome would be detrimental to ezETH holders, the underlying AVS, and Renzo, and should therefore be avoided. Additionally, there are practical concerns about how to conduct the selling in an efficient, transparent, and fair manner.
Alternatively, distributing individual tokens as they are earned could make it impractical for smaller holders to claim rewards due to gas fees. In this scenario, accurate oracle pricing would be essential to reflect each holder’s claimable value over time.
Initial Reward Distribution on Renzo
Given the emerging nature of the market and the uncertainties surrounding reward distribution methods, Renzo will begin by temporarily harvesting and distributing rewards by selling EIGEN rewards for ETH. This interim step allows the time to adequately diligence and gather sufficient data on all potential reward distribution options before making a final decision.
This reward distribution mechanism is expected to be in place for at least a month until the performance of alternate approaches like LRT² can be observed for a satisfactory period of time, and it is shown to perform successfully across a range of tokens. In particular, the smooth functioning where smaller, less liquid tokens are accounted for in the protocol will be closely monitored.
At present, almost all ezETH rewards are in the liquid EIGEN token. To manage these rewards effectively during this transitional period, the Renzo team has implemented a temporary solution: auto-compounding ezETH rewards into ETH on a weekly basis.
The conversion of ezETH rewards from EIGEN to ETH is not expected to impact EIGEN’s market performance, as the amount converted—approximately 60k EIGEN per week—accounting for only 0.03% of EIGEN’s total circulating supply per week. This relatively small amount ensures there is no significant pressure on the EIGEN token over the period. Renzo has partnered with Wintermute for trade execution to ensure efficient and stable execution to further aid price stability.
Chaos Labs and Renzo recognize that as reward distributions increasingly include a diverse basket of smaller AVS tokens and the ezETH supply continues to grow, this approach may no longer remain optimal. By the time this point arrives, there will be more clarity on how different reward mechanics perform and Renzo will be in a good position to adopt the optimal solution.
This temporary strategy allows Renzo to maintain control over reward distribution while providing flexibility and sufficient time to make informed decisions based on evolving market dynamics.
An a priori Evaluation of LRT²
LRT² functions as a vault, aggregating reward tokens from multiple AVSs and issuing a new token representing the collective value of all assets within the vault. Deposits are made by the restaking protocol, which in return issues and redistributes the LRT² token. Users can either utilize the LRT² token on other protocols, sell them for their preferred token on DEXs, or redeem them for a corresponding portion of the underlying AVS tokens.
LRT² offers several key advantages. It helps reduce selling pressure on AVS tokens while still providing users with liquidity options to switch to other assets when needed. Additionally, it allows users to save on gas costs, which would otherwise occur when collecting each reward separately, and eliminates the need for multiple asset swaps. Furthermore, since AVS tokens are still emerging and carry inherent risks, LRT² mitigates price risk by diversifying the assets that reward recipients depend on. LRT² also serves as a flexible financial instrument that can be integrated into external DeFi applications.
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. However, exploit of any whitelisted LRT protocol poses risks to the entire LRT sector. 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 due to potential atomic arbitrage. Arbitrage is also likely to keep the price of the LRT² token relatively close to its basket of constituents.
The protocol’s reliance on external price oracles to determine the value of the vault introduces risks. If an oracle becomes compromised or manipulated, the vault’s value could be inaccurate, potentially leading to incorrect rebalancing decisions or the minting of shares at inappropriate prices. While the rebalancing algorithm is designed to manage these risks, any failure in the oracle system or mismanagement of the vault’s composition could result in adverse outcomes for the token’s market value and stability.
Rewards distributions that require a claim process such as LRT² are exposed to the issue of Ethereum gas costs when claiming. This is inconvenient for users and will result in infrequent harvesting of rewards for smaller holders as they wait for their earned rewards to grow to a point where the gas cost does not dilute them too much.
Monitoring the functioning of the price feeds underlying LRT² will be a major focus over the next few weeks as we work with the Renzo team to determine the right strategy to distribute the rewards going forward.
Other Potential Distribution Methods
In addition to the above approach, several other alternatives have been evaluated. One option under consideration is establishing Renzo’s own reward token. In this approach, the Renzo protocol would autonomously handle whitelisting and depositing reward tokens into the vault, as well as rebalancing, instead of coordinating with various LRT² ecosystem partners. This autonomy allows the selection of reward tokens and the composition of the vault—and consequently the value of LRT²—to be optimized in alignment with the interests of the protocol’s own stakeholders. This strategy would provide greater control, enabling the reward system to operate independently of external influences and safeguarding engagement with new AVSs without the concern of potential reward token sell-offs due to an externally defined rebalancing algorithm. It would however, face similar challenges and operational costs to those previously mentioned. Specifically, the protocol would need to manage external oracles for each reward token, design and maintain a robust rebalancing algorithm and furthermore be challenged with providing liquidity and integration for such asset.
Another alternative that has been evaluated is leveraging existing tools from the Renzo EIGEN airdrop to facilitate reward distribution. In this scenario, the Renzo protocol would track the holdings and accrued rewards of its LRT holders and frequently disburse the rewards accordingly. The advantage of this is that it would not necessarily require any decisions around reward token balances. This approach need continuous tracking of holders and their accrued rewards, however, which is a non-trivial task and imposes an operational burden on the protocol. The complexity increases with the granularity and frequency of the snapshots required for accurate tracking. Furthermore, this method introduces trust assumptions, as the fair tracking of rewards is unverifiable, potentially leading to confusion or centralization concerns.
Next Steps
Chaos Labs and Renzo will closely monitor the functioning of the LRT² protocol to determine its suitability for Renzo’s reward distribution strategy. By observing how LRT² effectively and fairly distributes rewards, the protocol can make informed decisions about whether to adopt this mechanism or explore alternative options.
To further assess LRT², we propose utilizing quantitative analysis to gauge AVS reward tokens’ adoption and market performance. It is essential to assess how the rewards behave, determining whether there is genuine appetite and viable use cases for the reward tokens. Key metrics to monitor include volatility, trading volume, secondary market liquidity, and price performance as well as DeFi integration.