The damage reduction is nowhere near what it should be and seems to vary wildly depending on what damage multipliers are involved.

Vestige: Adventurer: Here the off-balance empowered fully charged heavy attack is a meager ~26% damage reduction, a far cry from 80%, while the Fiery Weapon crit is a 62% Reduction.

When I loaded into the game, I was pre-set at Master level.

I thought this was an 'opt-in' feature, so by default should be at adventurer difficulty.

On the first load in to the PTS the loading screen said Master difficulty, but when looking at the character page the difficulty was set to Adventurer.

Not sure if it's a bug or intended but companions don't take increased damage based on your difficulty.
Since overland enemies don't damage that much at base, companion tanks can actually tank them pretty well. This kinda defeats the challenge part on most bosses.

Some damage reduction buffs don't really work with the increased difficulty. This was tested on Vestige.
At first I presumed that damage taken debuff which comes from difficulty will make all damage reduction buffs worthless. However it appears some of them still work like intended while others don't.

I didn't use any skills during this test, I didn't use potions and my companion didn't have any buffing skills. The boss enemy used the same attack. The enemy is Keelsplitter from Summerset, although I bet this boss isn't to blame because I noticed the same behavior with other bosses as well. Also I tested it a couple of times and always got the same numbers.
I was testing this with Pearlescent Ward and Major Protection from Revealing Flare

This is how much damage I receive when Pearlescent isn't procced (companion is alive) with Major Protection slotted. 43647.

This is how much damage I receive when Pearlescent isn't procced (companion is alive) without Major Protection (Reveaing Flare is unslotted). 48497. Major Protection gives 10% damage reduction so this seems okay...

This is how much damage I receive when Pearlescent is procced (companion is dead) with Major Protection slotted. 41807. Now this seems off because Pearlescent should give me another 33% damage reduction. The difference between 43647 and 41807 is just too small for me to believe that this is 33%.

And finally this is how much damage I receive when Pearlescent is procced (companion is dead) without Major Protection (Reveaing Flare is unslotted). 46453. If we compare this against 48497 it's clear something's off.

Pearlescent should work fine with companions. Its tooltip gets updated when they die, and damage reduction works as intended in dungeons and arenas.

EDIT:
Upon further testing I noticed that damage reduction from Esoteric Environment Greaves calculates the same way as Pearlescent's. So this issue isn't specific to Pearlescent.

On Adventurer, these sets work as intended. So I guess their damage reduction buff applies before the debuff from your difficulty takes place.

companions do to much damage and have too much health. They seem much stronger than then play

if anyone is curious why this is happening:

Damage reduction unintentional behavior:
When you take damage (note this calculation is kinda simplified and ignores optional stuff that isnt always present)

(Damage * 7) - (Damage * Multiplicative category reduction additive) * (1 - (armor / 66000)) = damage taken.

Damage is the original hit before being multiplied by vestige difficulty in this case (so 7, cause 600% additive)

The second portion is a weird portion of the damage mitigation calculation and our point of interest. These bonuses are:
Gladiators Tenacity Ulfsild's Contingency
Gladiators Tenacity Torchbearer
Lucent Echoes (under 50%)
Pearlescent
Torc of the Alyeid King
Esoteric Greaves
Runic Sunder
Major Evasion
Minor Evasion
Psijic Deliberation
Necrotic Potency
Necro Dot Mit Disdain Harm
Major Aegis
Minor Aegis
and some others since this is a list from ~u40 ish, but whatever.

These will take the original damage, add together multiplicatively with rounding, then reduce the original damage by the given value, then subtract that value off the damage. This is not super relevant.

Problem is: it only subtracts it off the original damage value, not the value that is multiplied by Challenge Difficulty. So basically they're 7x less effective. For example:

With Esoteric Environment Greaves, and a 1000 hit it'd be:

(((1000 * 7) - (1000 * 0.5)) * (1 - (2425 / 66000)) = 6261 damage taken, while if it worked correctly, it'd be 3371.
Hit * 7. Esoteric reduction. Armor reduction
(Esoteric is a heavy gold leg, 2425 armor)

Please invest time in finally fixing these weird parts of the mitigation calculation. Don't do a band-aid fix, you'll encounter more of these issues as the game continues.

Damage increase unintentional behavior:

This one is much simpler, the -80% damage done works exactly the same as say, Major Berserk or Major Slayer: it's additive.

This means that if you have an unmodified character, it is indeed 20% of damage dealt, but if you have even just a 6% damage CP slottable, your damage increases to 26% of damage done which is a 30% increase in overall damage output.

The reason this "Light attack bug??" is seen, is because it is also additive, the 20% from Weapons Master is effectively doubling your damage since we're going from 20% damage done to 40% damage done. (or 0.2x to 0.4x) The player did probably have some other % damage bonuses but since most of them worked on the rest of their damage, they saw the LA/HA's as an outlier. The lightning staff also had to do with it, as it gives 12% direct damage bonus which is also additive with the % dmg reduction from Vestige/Challenge Difficulty.

It also makes sets like Deadly, or passives like the Class Mastery from Arcanist ridiculously overpowered in Vestige. I can hit over 40k dps in vestige mode on pale order with pure arcanist on a 6mil dummy. It should be closer to ~10-15k at most.