Are all of your eggs in one basket? How correlated slashing works, the risks it presents, and the importance of mitigating with diversified operators.
While global participation in staking to secure proof of stake (PoS) networks continues to grow at a rapid pace and liquid staking has taken over the charts as the single largest sector of DeFi, many participants still lack a clear understanding of staking’s core risks and how to mitigate against them.
Slashing, a primary risk of staking on Ethereum, is when a percentage of the ETH staked to a validator is programmatically seized from the validator for misbehavior. If more validators are slashed, the penalty per validator becomes worse.
This means that correlated slashing, or the simultaneous slashing of multiple validators due to a shared point of failure or correlated misbehavior, presents an even steeper risk to stakers—one that can be amplified by staking with single operator staking providers, making it a key consideration for those evaluating options for staking participation.
In this post we’ll cover how correlated slashing works in Ethereum, the risks it presents, how these risks can affect liquid staking protocols, and tactics for mitigating correlated slashing risk.
The Ethereum network relies on validator nodes to propose and attest to blocks. Validators are required to lock-up a certain amount of ETH as collateral to register on the network (currently ≅32 ETH). Slashing is the protocol's way of penalizing validators for malicious behavior or liveness faults.
Correlated slashing can happen in several scenarios, including:
In addition to Ethereum’s base slashing penalty (currently 1/32 of the validator’s effective balance, or ≅1 ETH) and the forced exit of the validator to Ethereum’s exit queue, Ethereum’s slashing calculation also includes a correlation penalty. This is an additional penalty designed to discourage validators from colluding or oversharing the same infrastructure. The more validators that are slashed around the same time, the higher the correlation penalty.
This penalty is calculated based on the proportion of the total validator set that has been slashed within a recent period (currently over the most recent 8192 epochs, or ≅36 days). For example, if about 1% of the total validator set is slashed, the correlation penalty is 1, but if about 3% is slashed, the penalty is 3.
Notably, if 33.4% or more of Ethereum’s validators are slashed the correlation penalty is 32, leading to 100% of the validator’s 32 ETH effective balance being programmatically seized by the network. This is a protection against any one operator putting Ethereum’s security at risk by operating more than 33% of the network’s validators.
As such, staking with an operator who runs more than 33% of the network’s validators puts the staker at a heightened risk of losing up to 100% of their staked funds due to a correlated slashing incident. A correlated incident of this size would also lead to an inactivity leak, a form of emergency state for the network in which rewards and penalties are modified.
Diversifying node operators is crucial to mitigating the risk of correlated slashing. By staking with multiple node operators across different geographic locations and infrastructure providers, stakers can help reduce the risk of simultaneous slashing. Diversification also helps in spreading one’s individual risk across multiple validators to reduce the impact of any single validator's failure.
A technical approach to diversification is essential to mitigate the risk of correlated slashing:
Liquid staking participants receive a liquid staking token (LST) to evidence legal and beneficial ownership of the underlying staked token, along with any network rewards or penalties received. This LST represents a claim on the staked tokens and any rewards earned, comparable to a bailment in commodity law.
However, this also means that LSTs are exposed to the same slashing risks as the underlying staked tokens. If the validators associated with a liquid staking solution experience correlated slashing it can lead to a significant loss of redeemable ETH for the LST holders.
Participating in liquid staking protocols can help to mitigate the risk of correlated slashing when compared to staking with a single node operator. While many staking-as-a-service providers represent centralized node operators, some liquid staking protocols diversify their active set across operators.
It’s important to evaluate liquid staking offerings carefully as not all are designed to mitigate the risk of correlated slashing:
Liquid Collective aims to provide a decentralized approach to enterprise-grade liquid staking, addressing the need for the highest level of security and compliance while promoting diversity, standardization, and composability.
Liquid Collective has an intentional, targeted, and technical approach that aims to mitigate the risk of correlated slashing:
In addition to the protocol’s robust approach to mitigating the risk of slashing, Liquid Collective and Rated Labs announced a partnership to develop the Ethereum ecosystem's first open source validator performance and security standards to define industry-wide benchmarks for evaluating staking providers in July of 2023. This ecosystem-wide shared understanding of how to evaluate staking on a risk-adjusted basis is viewed as a crucial missing piece for the professionalization of the staking ecosystem overall.
Liquid Collective's task group will first align on the key parameters that will be used to objectively measure validator performance and security. The partnership also aims to build robust security management standards that effectively mitigate node operator risks, including:
Liquid Collective will leverage the completed methodology to natively embed programmatic parameters and service level agreements (SLAs) in the protocol's code, regarding validator attestations, missed rewards policies, validator security, validator onboarding management processes, and more, setting Liquid Collective apart as a pioneering protocol in offering such performance requirements and SLAs for stakers.
LsETH users may still be subject to slashing losses. If slashing losses were to occur, they would be socialized pro rata for all LsETH user's starting with earned but unredeemed network rewards.
Liquid staking via the Liquid Collective protocol and using LsETH involves significant risks. You should not enter into any transactions or otherwise engage with the protocol or LsETH unless you fully understand such risks and have independently determined that such transactions are appropriate for you.
Any discussion of the risks contained herein should not be considered to be a disclosure of all risks or a complete discussion of the risks that are mentioned. The material contained herein is not and should not be construed as financial, legal, regulatory, tax, or accounting advice.