Ethereum Improvement Proposal EIP-7251 is set to be implemented during the Pectra upgrade, currently scheduled for Q1 2025. This proposal introduces changes aimed at enabling stakers to aggregate or consolidate greater amounts of ETH on their existing validators.

Below, we'll break down what EIP-7251 entails and provide general guidance regarding what wholesale digital asset managers could consider regarding their ETH validator arrangements.

Abridged summary of EIP-7251 and its key changes

• Validators can now stake up to 2048 ETH on a single validator, a significant increase from the previous limit of 32 ETH. Putting lower pressure on the network if broadly accepted as less validators will be needed to maintain the same level of service across the Beacon Chain.
• Rewards can now accrue beyond the 32 ETH threshold, with additional ETH boosting the validator’s voting weight. A validator with 32.1 ETH has more voting power than a validator with exactly 32 ETH.
• Higher staking limits may lower the cost per validator for large stakers by reducing the need to operate multiple validator nodes.
• Under EIP-7251, validators can choose to remain on the 0x01 withdrawal credential and bypass the upgrade, or they can upgrade to 0x02 and implement the changes. Upgrading allows validators to consolidate multiple validators into one or keep their existing setup unchanged while activating the higher Maximum Effective Balance (MaxEB) of up to 2048 ETH.
• Solo stakers who manage multiple validators currently, benefit by needing fewer validators when they implement the change, reducing operational complexity and associated costs like hardware or maintenance.

How ETH staking works and what EIP-7251 means for stakers

Before diving deeper into EIP-7251, here’s a broadly characterised overview of how Ethereum staking works:

• Validators are selected to propose new blocks based on the amount of ETH they stake (effective balance), with a current requirement of exactly 32 ETH per validator. Validators earn rewards by creating new blocks and confirming (attesting to) the validity of blocks proposed by others, following the rules inherent in the Beacon Chain smart contract.
• By staking, validators enhance the network’s security by processing transactions and placing their staked ETH at risk of slashing as a penalty for malicious actions or negligence. They are rewarded for positive contributions to the network and penalised for improper behaviour.

Changes introduced by EIP-7251

EIP-7251 proposes to increase the Maximum Effective Balance (MaxEB) of validators from the current 32 ETH to 2048 ETH. This significant change allows validators to consolidate their stakes into fewer validators, potentially simplifying the management of staked capital.

The proposed specific changes are:

• The effective balance cap for any validator that has set '0x02' in their withdrawal credentials will have its maximum effective balance increase from 32 ETH to 2048 ETH. This means that only validators that have '0x02' set in their withdrawal credentials will be eligible for this feature. The Beacon Chain will allow existing validators to update their withdrawal credentials from '0x01' to '0x02' only once per block or allow new validators to join directly with '0x02'.
• The automatic sweep of staking rewards to the withdrawal address will now occur when accumulated rewards reach 2048 ETH instead of just above 32 ETH; and
• Considered against the current Maximum Effective Balance and the Partial Withdrawal Threshold, the composition will look as follows with the addition of new withdrawal credentials.

Note: Validators opting to use '0x01' as their withdrawal credentials will remain unaffected by the MaxEB proposal.

It is worth noting that with ‘0x02’ credentials, 32 ETH is required to initially commence duties, but following this a validator is allowed to go down as low as 16 ETH before the network stops it from performing duties or earning rewards.

Key components of EIP-7251

The following table details the current model, the proposed changes, and the implications of the proposed changes.

 

Once the validator has has chosen to update to ‘0x02’ from ‘0x01’, it will not be possible to change it back to ‘0x01’, unless that validator exits and then is redeployed by depositing ETH for a new validator which uses ‘0x01’ as its withdrawal credentials.

For all validators using ‘0x00’ and ‘0x01’ as their withdrawal credentials, their MaxEB will remain at 32 ETH and they will continue to receive their Beacon Chain partial rewards via the same round-robin process that is being used currently.

The Pectra upgrade introduces the capability for validators to initiate partial withdrawals of arbitrary amounts without the need to fully exit the validator set.

Actions to be considered by validators

While validators are not required to take immediate action, once EIP-7251 is released, the following aspects are worth considering:

• updating withdrawal credentials to the new ‘0x02’ withdrawal credentials, to opt into the higher MaxEB and begin compounding rewards on deployed 32 ETH validators;
• revisiting internal processes to account for being able to manually trigger partial withdrawals from the execution layer to manage their funds more proactively; and
• evaluating whether to consolidate multiple validators into a single validator with a higher stake up to MaxEB.

Detailed considerations for consolidating validators

Consolidation involves combining stakes from multiple validators into one validator with a higher effective balance. This decision has several implications.

Potential benefits

Updating validators from ‘0x01’ to ‘0x02’ can lead to compounding rewards and simplified reporting. Validators with this change have the opportunity to compound their earnings, potentially increasing their total rewards over time. Additionally, if an institution decides to also consolidate multiple 32 ETH validators into a single validator, this potentially simplifies tracking and reporting obligations, offering operational efficiency. Further, staking additional ETH can become much easier, without having to setup a new validator and enter the queue for onboarding onto the chain.

Potential drawbacks

On the other hand, consolidation comes with its risks and limitations. Consolidated validators potentially face higher penalties if slashed, as the penalties are proportional to the staked amount (at the moment). While the likelihood of being slashed does not inherently increase with consolidation, the impact of such an event would be significantly greater. Further, locking a large amount of ETH in a single validator reduces liquidity and flexibility, potentially limiting the ability to deploy additional ETH elsewhere or quickly adjust staking strategies.

It is important to note that there are discussions taking place considering whether to update the slashing penalty rules such that validators who have consolidated their ETH do not face such harsh penalties.

Optimising validator consolidation below MaxEB

To maximise rewards through compounding without hitting the Maximum Effective Balance (MaxEB) cap of 2048 ETH too soon, turning on ‘0x02’ to allow valdiator to compound at an ETH balance below the MaxEB is beneficial. This strategy allows your stake to grow through compounding until it reaches the MaxEB, after which excess rewards are paid out.

Comparison of consolidation strategies

We'll compare three staking configurations:

1. Unconsolidated Validators using 64 validators at 32 ETH each, with compounding possible up to MaxEB
2. Full Consolidation at MaxEB using 1 validator at 2048 ETH, with no compounding possible past MaxEB
3. Lower Consolidation Below MaxEB using 2 validators at 1024 ETH, leaving room for compounding up to MaxEB.

The following assumptions were used in this comparison:

• Base Reward Rate: 3.48% annual return.
• Compounding Frequency: Continuous (rewards are added every epoch, ~6.4 minutes but compounded daily for these calculations, with an average reward for Pier Two managed validators used as a base to calculate the compounding impact).
• Time Horizon: 3 years.
• MaxEB: 2048 ETH.
• Amount of ETH total: 2048 ETH.

 

Key observations

The below becomes relevant based on the above analysis:

• Lower Consolidation at half MaxEB allows compounding until MaxEB is reached and produces the most rewards on a three-year time horizon.
• Unconsolidated Validators yield the highest total ETH after 3 years due to continuous compounding without reaching MaxEB.
• Full Consolidation at the MaxEB of 2048 ETH cannot compound rewards beyond that amount and all rewards are paid out automatically by the Beacon Chain.

Depending on the goals of the validator:

• If maximising ETH holdings is the primary goal, Unconsolidated Validators or Lower Consolidation Validators are appropriate.
• If simpler management is preferred and slightly lower returns are acceptable (and assuming slashing doesn’t scale and is updated), Full Consolidation at MaxEB is suitable. Additionally, the compute and infrastructure savings of consolidating should be considered.

Slashing and penalty risks

Understanding the slashing and penalty risks is crucial when considering increasing your stake per validator. Slashing serves as a deterrent against malicious activities and unintentional misconfigurations that could harm the network. The penalties are designed to be proportional to the validator's stake, meaning higher stakes result in higher absolute penalties.

Detailed slashing and penalty risks

The table below outlines different slashing and penalty scenarios, their causes, and the potential impact on validators with varying stake amounts.

As you consider increasing your ETH stake on a single validator under EIP-7251, it's crucial to understand the slashing risks involved. Slashing is a mechanism designed to penalise validators who engage in behaviours that could harm the network's security or efficiency. The primary categories of slashing offences are:

1. Double Attestation
2. Double Proposal
3. Surrounding Attestation

While EIP-7251 does not introduce new slashing conditions, it could potentially impact the financial consequences due to higher stakes per validator. This section details these slashing risks, incorporating any changes resulting from EIP-7251.

 

As noted earlier, and to encourage consolidation under EIP-7251 and the broader Pectra upgrade, there are discussions taking place about modifying or removing the initial slashing penalty, which currently is set at 1/32 of the validator's effective balance. This initial penalty scales linearly with the effective balance, meaning that higher-stake validators directly incur higher risks in absolute terms. By adjusting the scaling properties of slashing penalties, consolidation could become more attractive to validators, as the financial risk associated with higher stakes would be mitigated. It is highly likely this system will be revised with some suggestions being for either a fixed 1 ETH initial penalty or perhaps a 1/2048 (or 1/relative size between 32 and 2048 ETH) slashing penalty.

So if a validator has an effective balance of 64 ETH (because they consolidated their 32 ETH from another validator), their slashing penalty will be 64 ÷ 4096 = 0.0156 ETH if they are the only validator that is slashed at that time.

Final comments

EIP-7251 represents a significant shift in Ethereum's staking landscape, offering both opportunities and challenges for validators as it introduces complexities around slashing risks (which may be resolved) and strategic consolidation that needs to be carefully considered.

Whether you are contemplating updating your withdrawal credentials from ‘0x01’ to ‘0x02’, consolidating your validators, or assessing the implications of increased staking amounts - please reach out at any time to discuss what EIP-7251 means for you.

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For more information or to schedule a consultation, please contact us. Stay tuned for further updates as we continue to monitor and analyse the developments surrounding EIP-7251 and the broader Pectra upgrade.