When it comes to staking ETH, there are a handful of risks that any prospective validator should be aware of. While many regard becoming a validator as the “risk-free rate”, it’s important to recognize that in practice, there’s some risk associated with depositing your ETH into the network.
A validator node going offline is one of the most recognized risks with staking. If a user is running their own node, and they lose their internet connection for whatever reason resulting in the validator going offline, the node may incur a penalty.
While this seems daunting from the surface, the penalties for going offline are rather minimal.
Offline validators only stand to lose what they would have made as rewards had they participated in the protocol. Expanding on this, validators that are online for >50% of the time will see their rewards increase over time.
In turn, this means that prospective validators don’t have to go to extreme lengths with setting up backup clients and having redundant internet connections (but it’s highly recommended that you have a secure internet connection in order to maximize your rewards).
One of the most well-known risks with becoming a validator is the potential to incur slashing fees. Generally speaking, slashing serves two purposes: (1) to make it expensive to attack the network and (2) to stop validators from being lazy by ensuring that they actually perform their responsibilities.
It’s important to recognize that validators only incur slashing fees when they maliciously attack the network. This could be through double voting, an action where a validator votes on two different blocks during the same epoch, meaning they are trying to support two different versions of the chain at the same time. In broader crypto terms, this is known as the “double-spend attack”.
The second action that can incur a slashing fee is known as “surround voting” where the validator attests to one version of the chain and then later attests to another version, making it unclear which reality they support.
Any validators who correctly follow the protocol will never incur slashing fees, meaning if a user just runs a validator and never intentionally attacks the network (which requires a significant amount of technical knowledge) they’ll never incur this fee. That said, in the rare case that there was some bug or accident that formed a slashable action, the amount of stake destroyed is proportional to the number of other validators slashed at the same time. Given that successfully attacking the network would require a significant amount of validators, slashings that occur in small numbers are assumed to be honest mistakes and only incur a small slashing fee (min 1 ETH).
In the instance that there was a large number of validators being slashed simultaneously, then a large amount of their stake is burnt (up to the full balance) and distributed to the whistleblower.
This then poses the risk of a widespread client bug that could see a huge number of validators slashed. In this unlikely circumstance, there may be a community-wide effort to recover slashed funds. See our closing thoughts below for more detail.
With Ethereum 2.0 being executed on a multi-year roadmap, one of the biggest concerns with becoming a validator is the potential illiquidity during Phases 0-2.
Validator deposits are one-way. They are sent from the current ETH 1 chain to the ETH 2 chain and cannot be returned. ETH 2 will also be an unusable chain for the foreseeable future, with no function other than to validate blocks.
Users who elect to pioneer and become a validator on the new version of Ethereum must recognize that they may have an inability to withdraw their deposited ETH for an undefined period of time. The exact timeline between Phase 0 and the full migration is largely unknown and is subject to change throughout its development.
Therefore, anyone who wants to capitalize on the ability to earn substantial rewards in the early phases of Ethereum 2.0 must be conscious that they’re investment may be inaccessible for years. One workaround for this drawback is to create staking derivatives on the underlying positions on ETH 1, allowing users to gain exposure to the staking position but these are complex designs and may take time to come to fruition (if at all).
Users looking to deposit their ETH into a centralized staking provider should be conscious of the risks that come with such services. If a centralized provider is hacked and funds are stolen, users with deposits on that exchange may be affected by the attack.
While self-custodial alternatives exist, there are tradeoffs on both. Centralized providers can give newer users a more intuitive and seamless experience for earning validator rewards while self-custodial providers can provide a safer experience at large (with the tradeoff being users will require more technical knowledge and an understanding of best practices for safe key storage).
One alternative to running a validator node from a physical location is to use a Virtual Private Server (VPS) that can be scaled up and down with ease. There are numerous advantages to using a VPS, however there are also risks.
Staking nodes must contain private keys for the signing messages. VPS providers have administrative access over all of their hardware and a malicious member of staff with the right privileges could gain access to these private keys.
While validator deposits can only be withdrawn to a specific Ethereum wallet and are therefore safe, there is a risk that a malicious attacker signs blocks in a way that would slash deposits. It is therefore essential that those validating via a VPS use an extremely strong password to encrypt their private key files.
Ethereum 2.0 validators in the early phases are pioneering an entirely new version of the network and should prepare for such.
While client teams, staking providers and other ETH2 builders are taking significant precautions with excessive public audits, testnets, and more, prospective validators must recognize that the Eth2 network is nascent. It’s leveraging a new consensus algorithm without nearly as much history and battle-hardening as Proof of Work and it’s likely that there are other unperceived risks and bugs that can occur unexpectedly.
As with any bleeding-edge technology, measuring the risks of ETH 2 staking is challenging and difficult to quantify. The risk-return ratio of ETH 2 validation is therefore highly subjective and depends largely on an individual’s risk appetite. That said, with ETH 2 validation forming a crucial part of the next stage in Ethereum’s development, it is possible – perhaps likely – that a catastrophic bug would be rectified and validators made whole.
As ever, it is essential to research the topic thoroughly and make your own risk assessment before depositing funds in ETH 2 validation.