Avoiding capital erosion in Ethereum leveraged staking

Yield decay and the Pendle loss

The Pendle YT-ETH event resulted in a 34% loss in principal for many users. Pendle separates the yield of an asset from its principal by wrapping yield-bearing tokens like stETH, sUSDe, aUSDC, and ezETH into Standardized Yield tokens. Users can buy Principal Tokens to lock in a fixed yield, as these tokens function like zero-coupon bonds that redeem 1:1 at maturity. Alternatively, users buy Yield Tokens to receive all streaming yield and rewards, including points and airdrops, until the contract reaches expiry. Because Yield Tokens trade at a fraction of the underlying price, their value decays toward zero as they approach maturity. This decay is a mathematical certainty that can exceed the rewards collected from airdrops or points. If you enter a yield position without calculating the cost of this decay, you risk the same principal erosion seen this month. Pendle operates across 12 networks, including Ethereum, Arbitrum, BNB Chain, Base, Mantle, Optimism, Sonic, HyperEVM, Berachchain, Monad, Katana, and Ink. The protocol also supports cross-chain PT bridging to networks like Avalanche and Unichain. Users can stake PENDLE 1:1 to receive sPENDLE and earn 80% of protocol fees via PENDLE buybacks every two weeks. Users also provide liquidity to earn PT yield, SY yield, swap fees, and PENDLE incentives. Pendle’s Automated Market Maker optimizes pricing for time-decaying assets by dynamically adjusting prices as tokens near maturity and providing liquidity incentives with PENDLE tokens. This protocol aims to bring $400 trillion of traditional finance interest-rate derivative strategies to permissionless DeFi markets.

Restaking risks and the Gearbox cascade

The Gearbox 4x restaking liquidation cascade demonstrates the high risk of leverage relooping. Users deposit Liquid Restaking Tokens into lending protocols to borrow more assets and repeat the staking process. This increases capital efficiency but also expands the surface area for slashing. EigenLayer allows validators to use staked ETH to secure Actively Validated Services, which are protocols that borrow security. The EigenPod smart contract is the withdrawal address and judges the performance of the validator. Restaking methods include Native, where users set a withdrawal credential to the EigenPod, and LST, where users deposit stETH or cbETH directly. LRT methods route through protocols like Ether.fi or Renzo to liquify positions. If an Operator double-signs or provides false data, the protocol can confiscate between 10% and 50% of the restaked ETH. This confiscation reduces the value of the Liquid Restaking Token. When the value of an LRT like ezETH or eETH drops, it triggers liquidations for anyone using those tokens as collateral in a loop. This risk is significant because the total value locked in liquid restaking tokens surged by 3000% this year to approximately $11 billion. When the total value locked in liquid restaking tokens surged by 3000% this year to reach $11 billion, the concentration of risk in these leveraged loops became an undeniable threat to the stability of the broader Ethereum ecosystem. EigenLayer currently has approximately $12 billion locked for restaking. Major players include Ether.fi with $8 billion in eETH and weETH, Renzo with $2.5 billion in ezETH, Kelp DAO with $1.8 billion in rsETH, and Puffer Finance with $1.2 billion in pufETH. Kraken also enables restaking through its subsidiary Staked, which acts as an EigenLayer operator.

The EIP-8361 yield crisis

The growth of staking creates pressure on Ethereum’s economic model. Currently, around 28% of the circulating ETH, or 34 million ETH, is staked by validators. Six Ethereum researchers propose EIP-8361 to increase the validator reward burn to 100% when staking hits 60.25 million ETH. This target is roughly half of the total ETH supply. Supporters claim this will curb dilution and increase ETH scarcity. However, the proposal divides the community because it changes the math for DeFi participants. Stani Kulechov, the CEO of Aave Labs, says that moving staking rewards toward zero makes ETH borrowing strategies mostly unviable. Much of the ETH borrowed on Aave goes toward buying more staked ETH. This trade depends on staking returns staying above borrowing costs. If the network burns all new issuance, the base yield for all stakers will drop. The proposal is designed to curb the economic incentive for further staking and address concerns that rising yields are concentrating ETH in large exchanges and staking providers. The proposal only burns newly issued ETH tied to validator rewards, while transaction fees and tips remain unchanged. Ethereum distributes validator rewards at the end of each epoch, which happens about every 6.4 minutes. Will the Hegota upgrade, planned for the second half of 2026, provide any relief for these yield-dependent strategies?

Risk management and verdict

The convergence of slashing risk and declining rewards makes leveraged staking a dangerous game. Users must evaluate the concentration of operators and the unbonding periods of their chosen tokens. Investors should verify operator distribution, confirm slashing conditions for each participating AVS, and check LRT unbonding periods, which are typically 7 to 14 days. You should avoid concentrating capital in a single operator or a single asset type during periods of high volatility. The verdict is clear: leveraged staking is too volatile for most participants.