STAKING RISKS DISCLOSURE

Chiliz Interactive Services Limited (“Company”, “CIS”, “We”, “Us”, “Our”) provides Distributed Ledger Technology (DLT) services, including assistance with the development of DLT networks and ensuring the security of transactions within DLT networks. This Staking Risks Disclosure Document is provided by the Company for general informational purposes only and does not constitute financial, investment, legal, tax, or other professional advice. Prior to accessing the Chiliz Staking dApp interface, you are encouraged to consult with your financial, legal, or tax advisor and to carefully consider whether engaging in staking activities and DLT transactions is suitable for you. You understand that your participation in staking, through your use of the Chiliz Staking dApp, can involve significant risk.

Preamble

Staking is an integral part of the Chiliz Chain’s consensus mechanism. Within Chiliz Chain’s Proof-of-Staked Authority (PoSA) consensus mechanism, ‘staking’ refers to the process by which participants, referred to as ‘validators’ or ‘delegators’, lock up a certain amount of Chiliz tokens ($CHZ, the Chiliz Chain’s native crypto-asset) to support the security and operations of the Chiliz Chain and to maintain its integrity. Staking is not an investment product; rather, when staking $CHZ, participants earn rewards in the form of $CHZ for contributing to the network’s stability. 

Validators play a critical role in the Chiliz Chain’s consensus mechanism by creating and validating blocks. While there is a maximum number of block-creating validators that can only be changed through Governance Proposals, the number of ‘active’ validators, which are not creating blocks, is unlimited. These active validators are in the queue in case a block-creating validator goes down or gets ‘jailed’, a concept that is explained in the second section of this document.

Besides validators, $CHZ token holders can also stake – or delegate – their $CHZ as part of a validator’s stake in order to participate in the governance of the Chiliz Chain and earn rewards. By delegating $CHZ to a validator, token holders become ‘delegators’. Delegators can delegate part or the full amount of $CHZ they hold, to one or more validators. In turn, the chosen validator/s can stake more $CHZ and therefore earn more rewards.

This dedicated Staking Risks Disclosure document aims to further explain the mechanisms through which token holders can delegate $CHZ to validators in order to participate in staking, and identify the risks associated with such mechanisms. 

Staking mechanisms

1.1. Delegating $CHZ to Chiliz Chain validators

To become a delegator, $CHZ token holders must stake/delegate a minimum amount of 0.01 $CHZ to a validator of their choice. Delegators may opt to delegate their $CHZ tokens to different validators. For example, a user holding 1 $CHZ may delegate 0.5 $CHZ to Validator A and 0.5 $CHZ to Validator B. It is advisable that delegators maintain a balance of approximately 5-10 $CHZ to cover the gas fees incurred when delegating $CHZ to validators.

Users can delegate their $CHZ  by connecting their wallet on the Chiliz Staking dApp. From this interface, $CHZ token holders wanting to delegate their $CHZ can choose a validator whose pool they want to stake with. We strongly encourage users to conduct their own research prior to selecting a validator to whom they will delegate their $CHZ. Such research should allow token holders to choose a validator based on different factors, such as the validator’s reputation, commission rate and voting power. Once their $CHZ are delegated, delegators can view the details of their recent ‘Delegate transactions’ on the Chiliz Staking dashboard. 

Besides staking $CHZ on Chiliz Mainnet via the above-mentioned interface, it is important to note that $CHZ token holders can also delegate $CHZ to validators on the Spicy Testnet. The Spicy Testnet is the test network for the Chiliz Chain 2.0, allowing developers and projects to test new features, protocols, or updates in a risk-free environment before deploying them to Chiliz Mainnet. As a risk-free environment, the Spicy Testnet is not covered under this document, however, participants can find further information applicable to the Spicy Testnet within Chiliz Chain Documentation.

1.2. Staking rewards

Staking rewards are the rewards received by wallets which are locking their $CHZ in the staking pool contract. Staking $CHZ is an essential component of the governance of the Chiliz Chain. Staking rewards come from the $CHZ inflationary mechanism, as well as from priority fees paid by users of the network in each block to get their transactions prioritized. As an example, if a block includes 50 $CHZ worth of inflation and 50 $CHZ worth of priority fees, those $CHZ are used to reward stakers (both validators and delegators) for participating in staking.

Among the fees collected in each block, 65% of the inflation rewards are kept by the block’s validator, and are subsequently distributed to the delegators staking on that particular validator node (the other 35% of the inflation rewards get invested to help maintain and grow the Chiliz Chain network). Thus, if a block has 100 $CHZ rewards (50 $CHZ from inflation and 50 $CHZ from priority fees in this example), the distribution of those would look like this:  82,5 $CHZ will be distributed as rewards to the validator (50*65% from inflation + 50 $CHZ from priority fees paid). Let’s say the validator has 10,000,000 $CHZ self-staked and 10,000,000 $CHZ delegated from many delegators, and the validator has also set the commission rate to 10%. In this scenario, since both the validator and its delegators are staking the same amount, the rewards (i.e. $CHZ 82,5) will be split equally (i.e. 41,25 $CHZ each) between the validator and the delegators.

Then, the validator will retain a 10% commission fee over the delegators cut. The validator commission fee is a fee that the validator keeps since they provide the service (i.e. running the validator node) so the delegators don’t have to. In the above scenario, this fee would be equal to 4.125 $CHZ, and delegators will therefore share the total amount of 37.125 $CHZ as rewards, based on how much they originally staked. For instance, if a delegator staked tokens accounted for 10% of the total amount of $CHZ delegated to the validator, it will receive 10% of the total reward distributed to delegators of this specific validator.

It is important to note that the commission fee is deducted before the rewards are distributed, and it is therefore unrelated to the Annual Percentage Rate (APR) displayed for each validator. Rewards compound every day – or every time an epoch passes, an epoch on Chiliz Mainnet being roughly 24 hours. Technically, they pay out as every block passes, and it’s updated on the Chiliz Staking dApp once every epoch. On this interface, your staked $CHZ includes both the total amount you have staked and any staking rewards earned since then. Your staked balance is updated daily, until you undelegate/unstake. The rewards cannot be claimed separately; delegators must undelegate/unstake their $CHZ then claim them all, including the compounded rewards.

1.3. About governance and voting power

The Chiliz Chain relies on a structure of validators that help in reducing gas fees and shorten the block time. In a PoSA consensus-governed blockchain, validators are able to vote on proposed changes to the network (called ‘Governance Proposals’). Governance Proposals are open for 7 days, and only active validators can vote. A ⅔ consensus is required for the Governance Proposal to pass. If a consensus is not reached by that time, the Governance Proposal does not pass.

The more $CHZ are staked by a specific validator, the more voting power the validator has, making their vote more influential. Therefore, although  delegators may not have the ability to vote on Governance Proposals, they may directly influence the result of such Governance Proposal’s vote through the $CHZ they delegate to a specific validator. Indeed, $CHZ  delegated to validators are accounted for in the total amount of $CHZ staked by the said validator, increasing its influence on Governance Proposals.

On the Chiliz Staking dApp, voting power indicates a validator’s influence within the Chiliz Chain, contributing to overall security and efficiency of the network. Please note that more voting power does not necessarily mean more staking rewards for delegators. Users can see the history of proposals including any open proposals that validators are still voting on or are waiting to be executed.

1.4. Unstaking $CHZ

Delegators can unstake/undelegate part or the entire total amount of $CHZ they have delegated to one or more validators at any time by selecting the ‘Undelegate’ button on the Chiliz Staking dApp. However, please note that there is a wait-time (or cooling period) between your request to undelegate/unstakeg your $CHZ and the time when such $CHZ are effectively unstaked and therefore unlocked for you to use/move as you wish.

On the Chiliz Mainnet, the cooling period technically takes 2 full epochs to complete (72,000 blocks, or roughly 2-3 days). Therefore, delegators must wait 2 epochs before they can claim the undelegated amount of $CHZ tokens. During the cooling period, the amount of undelegated $CHZ will appear in the ‘Pending’ section of the governance page. After the 2 full epochs have passed, the amount of undelegated $CHZ will appear in the ‘Claimable’ section. In addition, please note that no rewards are being generated during the cooling period.

Risks associated with staking

Participating in staking activities exposes delegators to diverse risks. To help you navigate through the complexity of staking mechanisms, we strongly encourage you to assess your exposure to the risks described below. We are not required to provide the information set forth below but are doing so to encourage you to educate yourself about the risks of staking.

You must determine for yourself whether it makes sense for you to participate in staking in light of the risks described below. You must understand that you, and you alone, accept responsibility for any losses that may occur, regardless of how they occur. The risks set out below are not exhaustive nor fully comprehensive. Use this information as the starting point for further inquiry.  Your use is also subject to the Terms of Use of the Staking and Delegation Dashboard, which you agree to when using the Chiliz Staking dApp. 

2.1. Slashing Risks 

Slashing is a security mechanism traditionally built into Proof-of-Stake (PoS) blockchains which consists of a penalty imposed on validators who do not respect the network rules. Slashing is a method aimed to make validators act responsibly and in Chiliz Chain’s best interest. It therefore discourages malicious activities like double signing, prolonged downtime, and validating invalid transactions.

• Dependency on Validators’ behaviors: When slashing occurs, the validator’s staked $CHZ, as well as the $CHZ delegated by users, can be partially or entirely “slashed” (i.e., destroyed or lost as a penalty). Therefore, these slashing penalties affect both validators and delegators who have staked $CHZ with the validator being slashed, and may result in losing a portion of the delegated $CHZ in proportion to the amount staked by that validator.

On the Chiliz Chain, two slashing penalties occur depending on the amount of blocks per epoch missed by the validator, which is based on the total amount of blocks in the said epoch and the amount of validators. The exact formula can be found on Chiliz Chain Developers Docs, but let’s pick an example.

• Validator downtime: If an epoch contains 28,800 blocks and there are 12 block-creating validators on the chain, then each validator shall be responsible for creating 2,400 blocks during this epoch. This amount must be divided by two, and therefore, if a validator misses 1,200 blocks, the first slashing penalty will occur. In this scenario, the full epoch rewards would be lost as a penalty for the validator. However, unlike slashing within other PoS ecosystems, slashing on the Chiliz Chain does not apply to the $CHZ  initially staked by validators and delegators. In other terms, while you might lose epoch rewards, the original amount of $CHZ you staked will not be affected by this penalty.   

• Jailed validator: A second penalty takes place when a validator misses a higher amount of blocks per epoch. The formula is also detailed in our Chiliz Chain Developers Docs, but following our previous example, the amount of blocks per epoch for which a validator is responsible (i.e. 2,400 blocks) must be multiplicated by 0,75. Therefore, in our scenario, if the said validator missed 1,800 blocks during this epoch, it will be “jailed” for 4 epochs, which means that the validator cannot participate in block validation during this period. Therefore, if the validator to whom you have delegated $CHZ gets jailed and you will not earn any rewards for this period of 4 epochs.

2.2. No Guarantee of Rewards

Participating in staking by delegating $CHZ to Chiliz Chain validators does not guarantee delegators to earn $CHZ rewards.

• Network condition and performance: Rewards distributed to validators and their delegators are generated from the $CHZ inflationary mechanism and from priority fees paid by Chiliz Chain users to get their transactions prioritized. Because network conditions can change, delegators must understand that past rewards do not necessarily predict future rewards as the amount of rewards in each block may vary.
  
  
• Validator downtime: Delegators’ rewards depend on the validator performance during each epoch. If a validator encounters downtime, it might not be able to validate blocks for a certain period of time, and therefore would not earn the rewards generated in these missed blocks. Additionally, extended downtime may lead to losing all rewards generated during a specific epoch, or lead the validator to be ‘jailed’ for a period of 7 epochs, during which the validator will therefore generate no rewards.
  
  
• Unbonding: Validators may simply decide to stop participating in Chiliz Chain and unstake (unbound) their $CHZ, which would result in the validator no longer generating rewards. In this scenario, the validator would no longer have the minimum amount of $CHZ staked to operate, and would downgrade from ‘active’ to ‘candidate’. In any case, delegators can always request to undelegate their staked $CHZ and redelegate them to another validator of their choice.

2.3. Market Risks

Market Risks refer to the potential impact of market conditions, including in times of high market volatility, on the price of your digital assets. 

• Redemption and market value: When undelegating your $CHZ on the Chiliz Chain, there is a cooling period of 2 full epochs (up to 86,400 blocks) or approximately 2 days, before you can claim the undelegated $CHZ. During this period, delegators are not able to transfer, sell or redelegate their $CHZ to validators. This risk must be taken into account when undelegating $CHZ, as crypto-assets can be highly volatile and the market value of $CHZ could be significantly higher or lower by the time the cooling period is complete and users claim back their $CHZ.

2.4. Governance Risks

Governance Risks refer to the risks associated with changes implemented within the Chiliz Chain via Governance Proposals.

• Governance changes: The smart contracts you interact with when participating in staking are governed through Chiliz’s decentralized governance, where proposals are voted by Chiliz Chain validators. This gives validators on the Chiliz Chain the privilege of voting on changes to the smart contract that you have interacted with or interact with. There is a risk that any changes that they might make in the future would result in a loss or other negative effect on you and your $CHZ.
  
  
• No centralized authority: As the Chiliz Chain is governed through validators votes, no central authority has control over the proposed changes or their implementation. We do not have any legal obligation to assess any changes to smart contracts or warn you about or take any other action with respect to any Governance Proposal that might lead to a smart contract change.

2.5. Legal and Regulatory Risks

Legal and Regulatory Risks revolve around the legal framework applicable to staking activities and their implications for participants in staking activities, including when such frameworks introduce new provisions directly or indirectly applicable to participants.

• Diverse Legal Implications: Blockchain technologies and related services are regulated differently according to the laws of the jurisdiction under which you have established residency. We strongly encourage Chiliz Chain users, including participants in the on-chain staking functionality to seek appropriate legal guidance in order to ensure that staking activities are in compliance with their local laws and regulations, including when participants intend to establish themselves in different jurisdictions.
  
  
• Regulatory Uncertainty: Blockchain technologies and digital assets are subject to many legal and regulatory uncertainties. The regulatory landscape for blockchain technology and related services is constantly evolving around the world and any future changes may negatively affect, restrict or impact in various forms staking activities, which could impede or limit the ability to continue the use of such assets and technologies.
  
  
• Compliance Issues Risk: Participants in staking activities must be aware that their on-chain/off-chain activities may be subject to scrutiny from tax authorities, financial regulators, or law enforcement agencies. Because these on-chain/off-chain activities may involve multiple transactions, participants are strongly encouraged to, and should take any necessary steps, including seeking guidance from professional advisors, to ensure they can demonstrate compliance with any applicable laws.

2.6. Technology and Security Risks

Technology and Security Risks relate to the risks inherent to the technical infrastructure and underlying technology used for users to participate in staking activities within the Chiliz Chain. 

• Smart Contracts Vulnerabilities: By participating in staking, you are interacting with smart contracts, which involves the risk that the smart contract code contains bugs or a security vulnerability. Bugs and vulnerabilities in smart contract code can result in a loss to you. Participants must be aware that there is no certainty that the cryptography that underpins the blockchain will never be broken, potentially resulting in a loss to you.
  
  
• Network Upgrades: Upgrades to the blockchain (often called “hard fork” or “forks”) may create instability, vulnerabilities, or may have unintended adverse effects and change the way in which the staking mechanisms described in this document work. Any malfunction, unintended function or unexpected functioning of the blockchain may consequently cause staking to malfunction or function in an unexpected or unintended manner.
  
  
• Bugs and Exploits: Hackers and other groups or organizations may also attempt to interfere with the staking mechanisms, in a number of ways, including, without limitation, denial of service attacks, sybil attacks, spoofing, malware attacks or consensus-based attacks. When staking mechanisms, other smart contracts or components are released as open-source software, hackers or other individuals may uncover and exploit intentional or unintentional bugs or weaknesses, which may negatively affect the blockchain. In these scenarios, delegators’ assets, in particular staking rewards, may be subject to expropriation and/or theft.

2.7. Third-Party Software Risks

Staking activities involve specific risks associated with third-party software.

• No Liability for Third-Party Software: Staking mechanisms rely in part upon third-party software, including custodian and non-custodian wallets connected to Chiliz Staking dApp, that CIS does not operate or maintain. We do not guarantee the security or functionality of any third-party software and we are not responsible for any losses due to the failure or exploitation of the third-party software. You should familiarize yourself with the third-party software and only participate in staking if you are comfortable with the software and the risks associated with it.

2.8. Private Keys Risks

Within crypto-assets related services, Private Keys are a main factor of Risks for users as they constitute the main means to access to digital assets. 

• Loss of the Private Keys: One of the main factors of risks resides in the controlling and safekeeping of the private keys that allow you to access and move your assets. In any case, we do not have access to your assets or to your private keys, and you are fully responsible for safeguarding any digital assets that come into your possession by ensuring the security and confidentiality of the private keys which control those assets. You should understand and protect yourself against the risk that your private keys will be lost or stolen, thus resulting in a loss of your digital assets.