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In cryptocurrency networks based on proof of stake (PoS), those willing to stake their assets and participate in block validation are rewarded with a return on their investment. When everything is operating smoothly, this can be a way for cryptocurrency users to easily earn predictable, annual returns and passive income on their holdings.
However, there is no such thing as free money. Staking, like all elements of the crypto industry, carries with it a variety of risks.
One key area comes in the form of slashing. Slashing is the key security mechanism in PoS systems that prevents stakers from abusing their power on these networks, but it can also haunt those who simply are not fully aware of how to properly stake their coins.
This comprehensive guide will get you fully caught up on staking slashing and how to avoid it when navigating the rapidly growing bitcoin DeFi landscape. Let’s dive in.
What Is Slashing?
Slashing is a security mechanism used in PoS cryptocurrency networks that discourages and penalizes bad behavior by the validators on the network. The validators are the nodes on the network entrusted with the responsibility of creating new blocks, similar to the proof-of-work (PoW) miners in bitcoin.
These validators must put up an amount of cryptocurrency as collateral for the right to participate in block creation, and this collateral can be seized in situations where the validator is not acting in the best interest of the network, or has become negligent. This seizure of collateral is known as slashing.
Reasons Why Slashing May Occur
Each PoS cryptocurrency network has its own set of standards when it comes to slashing. However, there are a few common reasons why slashing may occur:
- A validator has signed multiple different blocks at the same block height, which can cause network instability in terms of not knowing which block to follow and when transactions are finalized.
- A validator has not participated in the consensus process for an extended period of time and has gone offline.
- A validator refuses to include specific, individual transactions or certain types of transactions, effectively implementing a form of censorship.
- A validator proposes blocks that contain invalid transactions or break some other consensus rule regularly.
It should be noted that different degrees of slashing can be used to punish different types of malicious or unwanted behavior. For example, a validator that is only offline for a short period is likely to have less of their stake slashed than a validator that was actively trying to attack the network via censorship or some other means.
In emergency scenarios, new slashing conditions can also be deployed to remove specific validators from the consensus process. For example, the rest of the network could come together to slash the stake of a hacker, government, or other unwanted entity that was able to gain too much control over the staking process.
How Does Staking Slashing Work On Bitcoin?
It should be noted that slashing on bitcoin works differently than every other cryptocurrency network due to bitcoin’s use of PoW and a relatively limited scripting language at the base blockchain layer. While other networks can implement rather straightforward smart contracts directly on the blockchain to handle the staking process, staking on bitcoin necessitates the use of a separate protocol, such as Babylon. Additionally, there is no staking in bitcoin directly, and Babylon is used to enable cross-chain staking for alternative PoS chains that wish to secure their networks with bitcoin-based liquidity.
While PoS chains that have expressive smart contracting capabilities can implement their slashing mechanisms directly on their chains, Babylon uses a system of simpler bitcoin scripts and off-chain cryptographic proofs to handle slashing for bitcoin that is being used to secure other PoS chains.
Specifically, Babylon uses extractable one-time signatures (EOTS) to ensure that a staker’s bitcoin private key can be made public in a situation where it is used to sign conflicting messages related to validation on a secondary PoS chain. This private key that has been made publicly available can then be used to slash the Babylon staker’s staked bitcoin by sending the funds to an unspendable bitcoin address.
While the result is the same (the staker loses their money), the way slashing is implemented in Babylon’s protocol for cross-chain bitcoin staking differs quite substantially from traditional PoS models.
How to Avoid Bitcoin Staking Slashing
As covered previously, the main reason slashing exists is to punish validators who wish to engage in malicious behavior; however, even well-meaning validators can get slashed if they aren’t properly managing their nodes.
Here are some key pointers to keep in mind when it comes to not getting slashed when staking bitcoin or any other cryptocurrency:
- A validating node should remain online and available to the staked cryptocurrency networks at all times. Missing a block signing opportunity or attestation can lead to slashing for inactive nodes.
- Practice proper private key management. While the validating node itself should remain online, the private key associated with the bitcoin staked on the node should be held in a separate hardware device to prevent hackers from taking advantage of the stake for their own, potentially nefarious purposes.
- Keep node software up to date. PoS chains tend to move faster and receive updates more often than bitcoin, and sometimes the updates pushed out to these networks involve fixes for emergency-level bugs.
- Understand the PoS chains that are being validated and stay up to date on the latest news relevant to these systems. While slashing conditions tend to be rather similar between chains, unique rulesets are implemented every now and then. It’s difficult to follow the rules associated with slashing if the rules are unknown.
- Research the reliability and reputation of PoS chains before staking any bitcoin on them. Chains that are relatively new without diverse userbases may offer attractive yields; however, those higher rates of return come with additional implied risk. After all, it does not take many resources for a bad actor to control a chain that has not had much stake added to it.
- Opt into a validator service provider, such as Lorenzo, that can simplify the entire validation process and implement additional guardrails to avoid potential slashing scenarios.
Avoid Bitcoin Staking Slashing with Lorenzo Protocol
One of the key benefits of Lorenzo is that it simplifies the entire staking process in a way that minimizes the likelihood of slashing to occur. There are a set of security mechanisms in place on the Lorenzo protocol that are intended to avoid slashing scenarios at all costs. These features include:
- Lorenzo offers staking insurance for a small fee, which allows stakers to potentially get reimbursed in a situation where a slashing condition takes place. The slashing insurance pool is managed by Lorenzo DAO.
- Before PoS chains are added to Lorenzo’s liquid staking system, they are reviewed and approved by the Lorenzo DAO. This means less credible projects will not be able to offer their PoS chains to Lorenzo users.
- The operators of the Babylon nodes handling the staking of bitcoin at the base layer of the system receive credit scores, which ensures that the operators with the highest uptimes and most responsible activity will take care of the vast majority of the staking for Lorenzo users.
Of course, the easiest way to gain the benefits of bitcoin staking without having to worry about slashing at all is to acquire stBTC, which is the liquid staking token derivative issued by Lorenzo to stakers. Holders of stBTC are able to access the value of the BTC that has been staked in addition to staking rewards. While slashing risks still exist for holders of these tokens, they are minimized by putting the responsibility of avoiding slashing into the hands of specialists in the form of Lorenzo operators. While stBTC is initially issued on the Lorenzo appchain, it can be transported across blockchains and the entire decentralized finance (DeFi) landscape.
Lorenzo is also built on top of Babylon, which has its own set of features for slashing avoidance. Anyone getting involved with bitcoin staking for the first time may want to look into stBTC and Lorenzo first, as the platform makes it much easier to avoid costly mistakes that could lead to loss of funds via slashing.
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