What risks are there to staking Ethereum? Slashing, inactivity, and ancillary risks explained
Risk is an inherent nature of staking Ether. The core of Ethereum’s PoS consensus mechanism puts the validator under the risk of incurring ETH loss. But this is worth it because you get rewarded as long as you don't break the rules (with a delicious 4% APY at the time of this writing). When you stake your ETH, you want to minimize potential losses by protecting yourself from the risks. Whether you’re liquid staking or solo staking, you should learn the risks of staking ETH so that you can calculate its downsides against its rewards.
Source: Ethereum Foundation
What is an Ethereum validator?
On Ethereum's beacon chain (PoS chain), validators are nodes that audit transactions, confirm activity, keep records and vote on outcomes. To stand a chance to become a validator, ETH holders must stake at least 32 ETH into Ethereum's staking contract. There are two distinct types of validators:
Block creators (proposers): Validator that is chosen at random to create blocks.
Block verifiers (attesters): Validators that do not get chosen to confirm a block and thus, check and confirm newly created blocks. This process of attesters confirming new blocks is called "attesting".
Attesters essentially "proof-read" the proposer's work and give it a stamp of approval if it is accurate. If a validator creates new blocks or checks (attests) a proposer's blocks, they get rewarded with ETH. In contrast, if a validator proposes or attests bad blocks, their ETH is confiscated.
Apart from proposers and attesters, here are 3 keywords you need to learn to understand how penalties work.
Committee: A group of at least 128 validators that must attest to every proposed block. Slot: Set time-frame for a committee to validate a block. Epoch: A total of 32 slots. After every epoch, the committee of at least 128 validators are disbanded and reformed with a new mix of participants.
Source: James Zaki
Penalties imposed by Ethereum
Generally, as long as you engage in good behavior, which facilitates smooth running of the Ethereum PoS network, you will not be penalized.
Running well designed clients
Complying with the Beacon chain specs
Proposing or voting for inaccurate blocks
There are 2 categories of penalties imposed by the Ethereum network for bad behavior. Let's explore each category.
What is slashing?
Slashing occurs when the Ethereum network slasher confiscates some or all of a validator's staked ETH for proposing or confirming fraudulent blocks.
Source: Daniel Hwang
The reason validators stake their ETH in the first place is so that the Ethereum network can confiscate them when the validator acts maliciously. According to the Ethereum Foundation, slashing has two effects:
Makes it prohibitively expensive to attack the network.
Stops validators from being lazy by checking that they actually perform their duties.
The slashed validator loses ETH over time till it is forcefully ejected and irreversibly labeled ‘SLASHED’, preventing it from rejoining the network.
What malicious behaviors cause slashing?
There are 3 distinct instances that cause slashing:
Proposing conflicting blocks in one slot: Validator proposes two different blocks for the same slot with a different root (hash of the inner data).
Attesting to contradictory blocks in one epoch: Validator signs two different attestations for the same target in the same epoch.
Surround Vote Violation: Validator casts a vote which is “surrounded” by a previous vote, meaning the validator is trying to vote against history, which is a slashable offense.
Resource: Original paper about the Ethereum Casper Proof of Stake protocol
Among the rare slashing events that have happened thus far, the biggest slashing event occurred in Feb 2021, when a validator lost 75 ETH for incorrectly signing a second version of a previously-signed block. However, slashing is a rare event. Out of 400,000+ validators, less than 0.038% of validators have been slashed.
How much ETH does slashing destroy?
The amount of ETH slashed depends on the number of validators being slashed around the same time in the network. The minimum amount that can be slashed is 1 ETH, which then increases when more validators are being slashed at the same time. The idea behind this is to minimize the losses from honest mistakes, but strongly disincentivize coordinated attacks.
Further Reading: Consensys - Rewards and Penalties
What happens to Ether when it is slashed?
Slashed funds are destroyed. In cases where an attester detects and accurately reports fraud, the slashing reward is given to the attester as whistleblower reward. This incentivizes honest validators to step forward and crack down on dishonest validators. However, the rewards are fairly small as the network wants honest validators to practice integrity out of altruistic motives. Furthermore, it only requires one honest validator to identify fraud.
How frequent does slashing occur through the Ethereum network?
So far, 90% of all slashings have been by one staking pool, and all slashings have been because of running the same keys in two places. Solo stakers are more safe from slashing. Even if they do get slashed, the amount of their slashed funds are lower than bigger validators, whose slashing funds are higher as multiple numbers of their validator gets slashed at the same time.
The Proof of Stake Ethereum network also penalizes validators for going offline as inactivity hinders the network from conducting consensus efficiently. However, the network is more forgiving towards inactive validators. This is because validator inactivity usually happens involuntarily due to uncontrollable events like power failures or hardware crashes. As a result, the financial penalty for going offline is lower than for malicious behavior.
Penalty for inactivity
When a validator becomes inactive, it will gradually lose a portion of their staked ETH. When its total ETH balance reaches 16ETH, the validator is ejected off the network. In general, the amount of ETH you would lose from inactivity is similar to the amount that you would have gained had the validator been active. But, if a large proportion of validators are inactive at the same time, then each validator loses a larger portion of their ETH. The amount of ETH an inactive validator loses every epoch is also dependent on the amount of ETH balance it stores. Generally, the penalty rate decreases as the validator’s ETH balance decreases.
Source: Alon Muroch
The risks we have discussed so far are penalties imposed by the Ethereum network for bad behavior. But what about external factors that could affect your staked funds? Consider the risks below.
So far, the Ethereum Foundation members have not confirmed the exact date that validators can withdraw their staked funds. While the risks of not being able to withdraw your staked funds are speculatively minor, you should be aware of them to make informed decisions.
Risk for all stakers: The Proof of Stake Ethereum network has not been battle-tested. Although unlikely, there is a chance that the merge will go haywire due to undiscovered smart contract complications. This could mean that all of your funds are inaccessible forever. But again note that the likelihood of this is low. Additionally, withdrawals from the Beacon Chain will likely be introduced in the first upgrade after The Merge. Specifications for both the consensus and execution layers are in progress.
Risk for solo stakers: Crypto market fluctuations could cause ETH price to fall severely, especially in today's bear market environment, causing you to lose access to your token while its price is plummeting. This would particularly incur loss for solo stakers as their ETH is completely illiquid. On the other hand, since liquid stakers have liquidity over their tokens, this is not as big a problem because they can sell off their token whenever they like.
Risk for liquid stakers: Ethereum recommends a handful of liquid staking services for users to liquid stake, including Lido, the largest liquid staking protocol for ETH. You can stake your ETH through Lido via the Omni app.
in 3 taps. Lido provides stakers with a token, stETH, which represents the user’s staked ETH (pegged 1:1 to one another) and removes the hassle of needing to set up your own node and staking a large sum of ETH. Lido is an added protocol on top of the Ethereum PoS protocol, which means you will be incurring an added smart contract risk on top of the Ethereum contract risk. To ensure this risk is under control, the Lido DAO is driven to mitigate its risks and eliminate them entirely to the largest extent possible.
Further Reading: Lido Risks
Concluding thoughts: Understanding risks in context
The Etherum network has more than 400,000 validators currently staking ETH. And this number is only expected to increase over the next year.
Although having your ETH locked up sounds risky, stakers find the trade-off worth it because they get the opportunity to earn rewards in ETH, the second-highest valued crypto asset in the world. Additionally, many stakers take pride in securing the Ethereum network.
The number of stakers on the beacon chain ETH 2.0 network has shown no signs of slowing over the past year and this number is only projected to grow further. Although it's important to understand the risks, looking at the history of penalization is important as well. So far, less than 0.036% of validators have been penalized and the development of the Ethereum PoS has been generally smooth.