PoS on Ethereum: Understanding Staking Requirements and Validator Penalties

10 Jul 2024

SEC v. Consensys Software Inc. Court Filing, retrieved on June 28, 2024, is part of HackerNoon’s Legal PDF Series. You can jump to any part in this filing here. This part is 18 of 26.

A. Background: Staking

224. “Proof of Stake” (“PoS”) refers to a consensus mechanism used by some blockchain networks to reach agreement about which transactions are valid, to add transactions in new blocks to the blockchain, and to reward participants with additional crypto assets.

225. A blockchain network using a PoS consensus mechanism typically selects a “validator” from a group of blockchain participants who have agreed to certain requirements necessary to maintain the blockchain and add new blocks.

226. To be considered for selection into the group or pool of validators, a potential validator must among other things commit, or “stake,” a pre-established minimum set amount of the blockchain’s native asset (e.g., ETH for the Ethereum blockchain).

227. On Ethereum, a validator must stake 32 ETH, and these staked assets are “locked up” while staked in the blockchain’s PoS consensus mechanism, in part to incentivize validators to faithfully perform required functions.

228. A “correction penalty” is deducted from the staked crypto assets of validators who do not meet a variety of standards including server uptime, consistency, and accuracy.

229. “Slashing”— forced removal of a validator’s node from the network and an associated gradual loss of all of its staked ETH—occurs when a validator engages in affirmatively malicious activity.

230. Conversely, validators earn rewards for their efforts, in the form of additional amounts of ETH—for example, by timely voting on proposed blocks, proposing new blocks, and participating in other consensus-related activities.

231. To create a new block to add to the chain of blocks, the protocol chooses a validator from among those that have staked. The more the holder stakes, and the less server downtime a potential validator exhibits, the more likely that holder is to be selected as a validator and receive the maximum staking reward. Thus, the most successful staking operations maximize the chances of being selected by staking a large number of assets across nodes and having better computer resources to minimize server downtime.

232. Since September 2022, the Ethereum network has employed the PoS mechanism described above.

233. To serve as an Ethereum validator and potentially earn rewards, a validator must stake at least 32 ETH (worth more than $100,000 as of June 25, 2024) and run an Ethereum node.

234. The ETH used for staking is held in a smart contract called the “Beacon Deposit Contract” (referred to herein as the “Ethereum validator deposit contract,” which is part of the Ethereum staking and validation system).

235. For those staking ETH, “rewards” are paid out in the form of additional ETH. The amount of rewards that each validator earns depends on the validator’s performance.

236. For example, a validator earns rewards for keeping its node online and participating in various blockchain maintenance activities, including but not limited to timely voting and proposing new blocks.

237. Conversely, validators can be penalized for poor performance or slashed for malicious activity.

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