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What is the Ethereum Shanghai Upgrade?

12 mins
Updated by Artyom Gladkov
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Ethereum’s moment of truth is almost here. Even though the much-awaited Ethereum Shanghai Upgrade (the mainnet version) got pushed to April, the expectations (and concerns) continue to soar. For starters, the upgrade is expected to unlock the indefinitely staked ETH from the Beacon Chain (the layer which helped Ethereum transition from PoW to PoS).

This guide will cover every element of the proposed changes associated with the Ethereum Shanghai Upgrade. Additionally, we cover the possible impact of this highly anticipated event on the broader crypto market, ETH prices, and the involved stakeholders.

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Making sense of the first big update post-Merge: the Ethereum Shanghai Upgrade

ETH PoS Is Not a Security, Here Is Why

The Ethereum Shanghai upgrade is supposed to be a hard fork geared at introducing several developments and network-specific improvements to Ethereum. ETH unstaking happens to be the most anticipated one. 

Ethereum’s proof-of-work (PoW) to proof-of-stake (PoS) transition didn’t happen overnight. Instead, the foundation was laid in 2020 with the release of the Beacon Chain — the engine that would eventually power the new and presumably faster version of Ethereum.

But Beacon Chain needed ETH to feed on. And that is when willing participants started to stake their ETH with validator access in mind. The only rule was that to stake directly into the Beacon Chain, a minimum of 32 ETH was needed. And yes, staking rewards were promised. Yet, the staked ETH and the rewards weren’t eligible for withdrawal. 

Ethereum upgrades: Yahoo Finance
Ethereum upgrades: Yahoo Finance

Over time, several liquid staking providers like Lido Finance, Coinbase, and Rocketpool even came into existence, allowing users to start staking with as little as 0.01 ETH. This paved the way for “Liquid Staking Derivatives” — a receipt-like token that can also be used elsewhere to generate compounding yields.

Yet, the actual ETH, anyway, would still be staked (even though it was less restrictive with Liquid Staking). When Ethereum finally merged in September 2022 (merging the mainnet with the Beacon Chain), users and network participants assumed the staked (locked) ETH would be released. However, the Ethereum Foundation made it clear that withdrawals (staked ETH release) would only be possible after the Shanghai Upgrade. 

And just so you know, as of March 2023, more than 16 million ETH (comprising almost 14% of the current supply) is locked. This makes Shanghai a highly anticipated event. 

What are the proposed changes?

While much focus is on ETH withdrawals post the Ethereum Shanghai upgrade, other developments could be incoming.

But to understand all of that, we need to look at the concept of EIP first. EIPs are proposed improvements or, rather, changes made to the Ethereum blockchain (protocol). And each hard fork or a similar chain-defining event might comprise more EIPs. The Ethereum Shanghai upgrade is made of five such EIPs. We also have the primary area of focus against each EIP.

  1. EIP-3651: Possible reduction in Ethereum network fees
  1. EIP-3855: Possible reduction is the transaction size
  1. EIP-3860: Possible fix of a Denial-of-Service attack vector and capping gas fees
  1. EIP-4895: Allowing validators to withdraw staked ETH
  1. EIP-6049: Possible capping and positive impact of transaction fees for Ethereum developers

As you can see, most EIPs, other than the EIP-4895, focus on reducing gas fees for the Ethereum network users (EIP-3651) and even the Ethereum developers (EIP-3855, EIP-3860, and EIP-6049). With the Ethereum network growing rapidly, such enhancements would greatly benefit the network and its users.

But in particular, the focus remains on EIP-4895, a term with which the Ethereum Shanghai upgrade is already associated. 

What’s with EIP-4895 and ETH withdrawals?

In simple terms, the EIP-4895 will release the staked ETH from the Beacon Chain (now a part of the mainnet). This EIP will not just release the staked ETH but also the staking rewards that were promised. Even the liquid staking protocols will benefit as they, staking ETH on behalf of the clients, will also have the option to experience the withdrawals. 

Do note that this EIP-4895 and the overall Ethereum Shanghai Upgrade itself focus on allowing validators (entities with stakes equal to or higher than 32 ETH) to withdraw the Ether. 

But before we understand the withdrawals, it is necessary to track the current state of staking. This will also help us understand the possible impact of the token release. 

The ETH staking timeline

Before Dec. 1, 2022, it all started when willing network participants started staking their ETH to power the PoS Beacon chain. The floodgates are still closed, but things are expected to change soon. 

From late 2020 to February 2023, the number of validators has grown steadily — 520K+ at the time of analysis.

Ethereum Shanghai Upgrade- Validators: Binance Research
Ethereum Shanghai Upgrade: Validators: Binance Research

Also, one node operator can host multiple validators, depending on the stake added to the network. Hence, all the 520+ validators might not be unique. 

The chart below shows that 24.9% of the total stakers are solo flyers. They could be the individuals who started staking in 2020, even before the Beacon Chain went live. Lido Finance is the market leader in staking, with almost 30% of the market share. 

Ethereum Shanghai Upgrade and Stakers: Binance Research
Ethereum Shanghai Upgrade and stakers: Binance Research

Even the top “centralized” exchanges comprise almost 26% of the attacking market. The likes of Lido and exchanges offer liquid staking — a feature that continues stakers to access liquidity. Hence, even though we expect some selling pressure in the market, the liquid staking services and protocols might offer some sort of offset effect against the selling pressure.

Ethereum Shanghai Upgrade- Liquid vs Illiquid: Binance Research
Ethereum Shanghai Upgrade Liquid vs. illiquid: Binance Research

Illiquid stakers who are simply looking to get back their ETH and staking rewards might consider selling. However, it would be interesting to see if the current price, close to $1,600, tickles their fancy.

Stakers in profit or not?

Only 31% of the entire staking populace is in profit. The largest concentration is among ETH holders who bought in the $400-$700 range. And the price history of Ether tells that this chunk of stakers belongs to the December 2020 timeline.

State of staked ETH: Binance Research
State of staked ETH: Binance Research

And the 31% of the profit-making staking concentration even takes liquid stakers into consideration — entities that might not want to sell the assets immediately. Hence, selling pressure doesn’t look all that ominous for now.

Phased withdrawal or not?

It is interesting to consider how the overall process of withdrawal might work. 

When partial

Anything above the standard validator limit of 32 ETH can be withdrawn. And that way, the user still manages to be a validator. 

If you are planning to withdraw partially, the first step is to set a “Withdrawal Credential.” That would activate partial withdrawals on your account. And even then, the withdrawals won’t be immediate but phased — 1 sweep per week.

As of March 2023, total rewards earned by stakers currently amount to $1.6 billion (at a price of $1560). Also, Ethereum’s current daily transaction value is close to $10 billion. With the reward withdrawals being phased, the $1.6 billion release across days or even weeks shouldn’t put any significant sell pressure on the price of ETH. 

When full

This phenomenon strips off all the validator rights. This way, you can withdraw every bit of your staking balance, including the rewards. However, the exits cannot be made at once. Keeping the current rate limit in mind, only seven validators can leave the network per epoch (timespan of block formation — 30.000 blocks keeping the current network traffic in mind). 

As each epoch for Ethereum is currently 6.4 minutes, a total of 7 x (1440 minutes / 6.4 minutes) = 1,575 validators, max.

And each validator holds 32 ETH or multiples (required condition). Hence, there can be a selling pressure of 32 x 1575 = 50,400 ETH each day (approximate), considering each validator only has 32 ETH worth of “skin-in-the-game.”

Even though this is some insane selling pressure, the out-of-money portion of over 55% might not encourage sell-offs. 

ETH in-money and out-of-money: Coinmarketcap
ETH in-money and out-of-money: CoinMarketCap

Note: The out-of-money stat is generic and not only related to the stakers.

And that sums up how the EIP-4895 will work in its entirety. But with Ethereum, a direct implementation on the mainnet is never an option.

Understanding the Ethereum Shanghai upgrade testnets

Before we start, here is a fun fact: the Ethereum Shanghai upgrade might also be known as Shapella.

Post the merge, Ethereum ended up with a user-side execution layer and a backend-like consensus layer. The Shanghai upgrade is relevant to the execution or the client side, whereas the synonymous consensus version is called Capella. To be precise, the Capella hard fork is what happens inside the chain, right at the Beacon Chain.

Shanghai and Capella make Shapella (no points for guessing that!)

Back to the testnets

However, this Shapella upgrade would first be tested and deployed onto the testnets to locate and mitigate bugs and roadblocks, if any. 

The process started when ETH withdrawals were tested on the “Zhejiang” public testnet close to Feb. 7, 2023. No issues were encountered, and the public testnet is still around to help stakers and validators test out the withdrawals as simulations. 

On Feb. 28, 2023, Sepolia testnet (made famous during the Merge) successfully transitioned to Shapella. The next step for the Shapella to be tested is on the Goerli testnet, which we are expecting to happen anytime in mid-March. After a successful Goerli testnet transition, we expect a mainnet deployment. 

However, the preparation for the upgrade started in January with a successful “Shadow Fork” deployment.

The Shandong testnet stands deprecated now as it contained EIPs focussed on EVM updates — a development that won’t be surfacing with the Shanghai upgrade anymore. And that sums up our testnet checks before the Ethereum Shanghai upgrade or the Shapella goes live on the mainnet.

The sentiments surrounding the withdrawal

Nothing about the Ethereum Shanghai upgrade is random. Kiln, a leader when it comes to “enterprise-grade staking,” recently conducted a survey to understand user sentiments and proclivities surrounding the upcoming hard fork.

Despite a small sample size, the survey results paint a picture. Here is what we could infer:

Ethereum Shanghai Upgrade and staker intent: Kiln Survey
Ethereum Shanghai Upgrade and staker intent: Kiln Survey

68% of the survey participants seem interested in re-staking or even compounding their stakes once the withdrawals are enabled. Also, 42% of those with re-staking and stake-compounding intentions would want to begin immediately. This proclivity might offset the selling pressure, if any.

Ethereum Shanghai Upgrade and staking timeframe (probable): Kiln Survey
Ethereum Shanghai Upgrade and staking timeframe (probable): Kiln Survey

As for the folks interested in unstaking the ETH, 44.5% plan to do so immediately. However, a massive 66.7% of the unstaking evangelists (not just the immediate ones) are planning to withdraw less than 320 ETH. And this would again point away from a mass validator exodus.

Ethereum Shanghai Upgrade and the path to unstaking: Kiln Survey
Ethereum Shanghai Upgrade and the path to unstaking: Kiln Survey

Do note that these figures also take liquid staking into consideration and might not be all aligned with the solo staking sentiments.

The possible impact of the Ethereum Shanghai Upgrade 

The theory driving the Ethereum Shanghai Upgrade, or rather the Shapella, has been discussed in detail. But none of that matters if we do not measure the impact of the hard fork on the stakeholders. Here are other areas that could see a significant impact.

Impact on validators

Validators still need to stake 32 ETH to be able to receive network validation rights. But once the Ethereum Shanghai upgrade rolls out, they might be more incentivized to do so.

Ethereum’s monetary model states that staking rewards are correlated inversely to the validator volume. In simple words, fewer validators mean more staking rewards. Also, staking rewards are currently categorized as consensus and execution rewards. While execution rewards are related directly to the need for block space and transaction volume, consensus rewards are inversely related to the number of ETH staked.

Staking rewards APR: Binance Research
Staking rewards APR: Binance Research

Note: Consensus rewards make up a larger chunk of the staking APR rate.

So if we see a lot of withdrawals, new validators might benefit more until the number rises again. 

Impact on other crypto assets

Ethereum currently has a market dominance of almost 19%, per data from CoinMarketCap. Therefore, if some selling pressure is experienced, it might lead to market-wide consolidation. However, the out-of-money stance and the staker sentiments around the Shanghai hard fork might not impact the market so badly in the mid-to-long term.

Plus, as compared to other chains with the proof-of-stake (PoS) consensus mechanism, Ethereum has a smaller percentage of its native coin staked. Cardano (ADA), for that matter, has almost 72% of its supply staked. Therefore, once the entire staking pool opens up, we might see more users from other ecosystems (primarily stakers) flocking over to Ethereum. 

The PoS layer-1 war might just intensify following the Shanghai hard fork. 

Impact on the buying narrative

Per CoinShares’ investor survey, Ethereum is still the most popular crypto in regard to the growth outlook.

Shagnhai upgrade ETH and positive institutional outlook: CoinShares
ETH and positive institutional outlook: CoinShares

And the ESG narrative might have a major role to play in this. For the unversed, Ethereum’s energy consumption has dropped significantly post-merge. 

ETH and ESG outlook: Binance Research
ETH and ESG outlook: Binance Research

Following the Shanghai hard fork, the prices might drop temporarily due to some near-term selling pressure, giving institutions a good price point to enter. 

Impact on the ETH supply

Right now, ETH is deflationary, albeit marginally. With the consensus mechanism shifting to proof-of-stake (PoS) and the EIP-1559 taking center stage, the inflation rate is currently -0.03% as of Feb. 13, 2023. However, this might change once the Shanghai Upgrade takes form. But this might not be all pessimistic. For one, unstaking will increase liquidity, which might lower volatility in days to come. 

ETH turning deflationary: Binance Research
ETH turning deflationary: Binance Research

Impact on the price (speculative)

The impact on ETH prices cannot be predicted due to the volatile nature of the ecosystem. However, previous instances have shown that every major Ethereum upgrade has eventually pushed the prices higher

Some initial network metrics look optimistic. The “ETH Age Consumed” metric is on a gradual decline, showing a reluctance in long-term holders to ride the speculative price narrative. 

Impact of DeFi outlook

Staking withdrawals will surely urge people to look and reinvest their stakes for liquid staking derivatives. And this might be good news for the broader DeFi outlook. And Ethereum’s DeFi outlook might receive a sizable boost as the likes of Lido Finance and Rocket Pool — popular liquid staking services — are Ethereum based.

Ethereum DeFi TVL: DeFillama
Ethereum DeFi TVL: DeFillama

Plus, while the TVL, as of March 9, 2023, stands at $28 billion, unstaking might just push it to almost $35 billion. And a 7 billion rise is actually equal to what BSC — the second largest DeFi chain — is worth in terms of TVL. 

Ethereum DeFi TVL with staking: DeFillama
Ethereum DeFi TVL with staking: DeFillama

Where does the Ethereum Shanghai Upgrade fit on the road to ETH 2.0?

In July 2022, Vitalik Buterin said that Ethereum is only 55% complete post-merge. Yet, with the Ethereum Shanghai upgrade, the ecosystem might receive a major boost to move towards its finality rapidly. With the stakes opening up and the ecosystem receiving more liquidity, ETH 2.0 might be closer than ever. 

Ethereum Shanghai Upgrade and the future: Kiln Survey
Ethereum Shanghai Upgrade and the future: Kiln Survey

And even though withdrawals happen to be the focal point of the Ethereum Shanghai upgrade, there are several other smaller EIPs planned to target gas fee reduction. And all of that is expected to prepare the Ethereum blockchain for the next stage — the Surge — with “sharding” as its core. 

Frequently asked questions

When can I unstake Ethereum?

When is Shanghai ETH?

How long does it take to withdraw pledged ETH?

What is the Ethereum 2.0 upgrade?

What is the Ethereum Shanghai Upgrade?

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Ananda Banerjee
Ananda Banerjee is a technical copy/content writer specializing in web3, crypto, Blockchain, AI, and SaaS — in a career spanning over 12 years. After completing his M.Tech in Telecommunication engineering from RCCIIT, India, Ananda was quick to pair his technical acumen with content creation in a career that saw him contributing to Towardsdatascience, Hackernoon, Dzone, Elephant Journal, Business2Community, and more. At BIC, Ananda currently contributes long-form content discussing trading,...