A look at Ethereum’s Shanghai upgrade

Ethereum’s Shanghai upgrade will allow investors who staked their Ether to support last year’s “Merge” to withdraw their ETH, and implement Ethereum Improvement Proposal (EIP) 4895. Ethereum switched from a Proof of Work (PoW) consensus mechanism to Proof of Stake (PoS) model following The Merge.

Will unlocking ETH put pressure on the price?

Ethereum users who staked ETH since 2020 to support The Merge, can now breathe a sigh of relief as Ethereum’s Shanghai upgrade is scheduled to go into effect next month, March 2023. Shanghai is a hard fork which allows those who’ve staked ETH to finally have the option to withdraw their coins. 

Ever since the Ethereum Merge last September, when Ethereum switched from PoW to PoS, the users who decided to stake Ether have been unable to withdraw the ETH they staked. This is all set to change next month as Ethereum’s Shanghai hard fork is scheduled to take place, which will give stakers the ability to remove their ETH from validator nodes. 

It’s unclear if the newly added ability to withdraw coins will cause a large amount of selling pressure or not, as many stakers have made gains in ETH from staking, which until now they’ve been unable to withdraw. The current staking reward is around a 4.29 percent annual percentage rate (APR), at time of writing.

Shanghai sets the stage for Ethereum’s Sharding upgrade, which will improve Ethereum’s ability to scale, although EIP-4844, the proposal for sharding, wasn’t included in the Shanghai upgrade. Sharding is a database partitioning technique which will split Ethereum’s blockchain into multiple chains which each contain a subset of on-chain activity, making Ethereum more scalable.

Some analysts have predicted that there could be a lot of people selling ETH all at once, trying to lock in fiat gains. Others have predicted that staking will increase, as now it’s less risky since a staker’s coins will be able to be removed from nodes. Ethereum validator nodes require 32 ETH to stake, but thanks to staking pools, many users who don’t possess that many coins can still participate in staking.

Important information for those staking Ether

In order to unstake ETH, stakers have two options. They can create a “withdrawal credential” which will unlock accrued ETH which has been paid as a reward for staking, and leave the original 32 ETH to continue staking. This is known as a “partial withdrawal”. 

The second option is to leave the Beacon chain and remove your validator from the network by sending a voluntary message from the validator node. This will unlock all accrued ETH as well as the 32 ETH originally staked on the validator. This is a “full withdrawal”.

There may be a bottleneck which could possibly cause a delay in unlocking funds, as only 16 withdrawal requests can fit into a slot, and slots are available only every 12 seconds. If too many partial and full withdrawal requests happen at the same time, some requests may be delayed, until they can be fit into a slot as both partial and full withdrawals will be using the same slots.

These delays may be unlikely, as not everyone will choose to withdraw their coins, and those that do most likely won’t be doing it at the exact same time. Currently, about 14 percent of Ethereum’s total supply of ETH is locked in staking, or around 16 million coins.

What impact will the Shanghai upgrade have on Ethereum Users?

The Shanghai hard fork is set to take place next month. On February 1st the Shanghai hard fork went into effect on Ethereum’s test network. So far there have been no major issues on test net. The main effect of Shanghai will be that users who have staked will be able to withdraw their Ether if they desire to. 

Ethereum traders may notice a lot of additional selling pressure if many stakers decide to cash out their accrued ETH which they received as staking rewards. We may see a decline in Ethereum’s spot price if many users decide to sell their rewards for fiat or other tokens.

Ethereum stakers that did not have 32 ETH to stake on their own validator, have done their staking through staking pools, which are validator nodes that combine the ETH of many users with a smaller amount of Ether, and stake their coins jointly, and payout rewards proportionally minus a small fee for the service.

Ethereum Staking pools have offered staking as a service to smaller ETH holders, however these pools typically employ a liquid staking model, which means that pool participants trade their ETH for a token which represents a percentage amount of a validator node’s Ether.

These Liquid Staking Tokens act as a derivative which grant exposure to staking rewards. Since these services have sprang up, users have been able to stake and withdraw, so Shanghai should not impact them in any significant way.

The biggest impact may be the liquidity for stakers, as many entities and organisations holding large amounts of Ether were hesitant to lock it up without the ability to withdraw. Now that they will be able to, we may see them incentivised to spin up validator nodes of their own and begin staking to enjoy the passive rewards. Many investment funds, DAOs, exchanges, and other players with large ETH holdings may begin to stake for the first time, causing an increase in network security.

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