One of the biggest impending events for the Ethereum blockchain is the Shapella upgrade, renamed from the previous Shanghai Upgrade, which is scheduled for April 2023. This upgrade will implement several improvements to the Ethereum network, including Ether (ETH) stakers and validators’ ability to withdraw their staked coins and accrued rewards.
Users first started staking their ETH in order to help validate transactions and secure the network when the Beacon Chain was launched in December 2020, marking Ethereum’s initial shift from Proof-of-Work (Pow) to the more environmentally-friendly Proof-of-Stake (PoS).
However, all this time, this staking has only been a one-way journey — users locked their funds in the deposit contract while developers continued working on ETH 2.0.
The lack of ability to move funds for an undetermined amount of time led to the rise of protocols like Lido, Rocketpool, and StakeWise which began offering “liquid staking.”
These solutions allow users to get involved in staking with any amount as well as gain liquidity by collateralizing the locked funds with a staking token (for instance: stETH issued by Lido) that can be used in decentralized finance (DeFi). These tokens represent staked ETH, and while they are pegged to the native tokens, they fluctuate in price due to the supply and demand within the secondary market.
But with the upgrade imminent, this will bring some changes in the market.
What Does the Upgrade Involve?
The upgrade comes months after the Ethereum blockchain underwent the technological overhaul, called the Merge, on Sept. 15, which officially switched the network’s consensus mechanism from PoW to PoS.
This one involves several improvements to the network, including Ethereum Improvement Proposal (EIP) – 4895, which is responsible for allowing validators to withdraw staked tokens.
Validators are crucial to the Ethereum blockchain as they are the ones who stake 32 ETH (worth $52,400 as of writing and $156k at its peak) in the chain in order to participate in validating blocks.
Those who wish to unstake ETH after the upgrade can do so in different ways. One way is to make partial withdrawals which involve unstaking only the rewards accrued over these past two years and a few months. These rewards are withdrawn to an Ethereum address and spent, but the validator continues to be a part of the beacon chain and validates as usual.
The second and more consequential option is completely withdrawing and exiting the Beacon Chain. In this, the validator unstake all 32 ETH plus any rewards. Full withdrawals are made via an exit, which places the validator into the exit queue depending on the size of the validator set in the network.
As of late January 2023, developers have begun stress testing the Shapella upgrading using a shadow fork that supports the withdrawal of staked ETH.
The ability to withdraw staked ETH is the key development for the Shanghai fork, but several other smaller EIPs in the upgrade propose improvements to the network.
EIP-3651 aims to lower gas costs related to Maximal Extractable Value (MEV) payments when accessing the COINBASE address (not related to the crypto exchange but refers to the software which allows developers to receive new tokens).
EIP-3855 proposes lowering gas costs generally for developers, while EIP-3860 caps developer gas costs in certain cases and simplifies EVM engines to minimize failure risks. EIP-6049 will deprecate the SELFDESTRUCT opcode by giving developers a warning.
This relatively smaller upgrade was initially considered for including EIP-4844, which is to split the Ethereum blockchain into several different “shards” to enhance scalability, but it has been pushed back.
How Does it Impact Ethereum?
Shapella upgrade is a major upgrade that will strengthen ETH’s position as the blueprint for staking protocols in the crypto market. With this, the yield that Ethereum pays following the event will likely emerge as the benchmark yield for crypto.
This event will also spur innovation in direct and liquid staking solutions. More competition, better products, and innovation in staking derivatives and lending solutions with access to ETH staking will help users get the best solutions.
However, while increased staking after the upgrade due to the freedom to remove funds will mean a more decentralized network, it is feared that it won’t be so. If new stakers chose a centralized crypto exchange like Coinbase, it would run the risk of having a few centralized providers dominating the ecosystem.
Although it has many benefits, most importantly, Ethereum’s transition to PoS will finally be complete with the Shapella upgrade. And while there are many upgrades planned for Ethereum in the future, especially around scalability, e.g., sharding, this will mark the end of a major improvement to the network, with stakers now allowed to withdraw their funds from the network.
When it comes to price, ahead of the Shapella upgrade, ETH has been enjoying gains. The 2nd largest cryptocurrency, with a market cap of nearly $200 billion, is trading at $1,638 at the time of writing.
According to CoinGecko, ETH price is up over 8% in the past week and more than 30% YTD but still down 66.4% from its all-time high (ATH) from Nov. 2021.
What Does the Market Think?
With Shapella’s hard fork allowing validators to pull their staked Ether as well as any rewards earned from the system, some believe this can trigger the selling of ETH in the market.
Others believe this is unlikely to happen due to the strong staking yield and Ethereum’s dominance in the DeFi space. Also, given that after the upgrade, validators will be able to withdraw staked assets freely, they don’t really have to worry about locking up a significant sum of money anymore.
According to OrBit Markets, an institutional liquidity provider in digital assets options, the Shapella upgrade can have “a significant impact” on ETH’s price due to changes to the supply and demand of ETH both in the short term and long term.
“With the staking yields expected to decrease following the upgrade, investors who previously staked may unstake and move to other assets offering better yields. This would create large selling pressures on the ETH price,” Yang Zhiming, co-founder of OrBit Market and former head of currency derivatives for Asia Pacific at Deutsche Bank, told the media publication.
Staked Ether accounts for 14.3% of the token’s total supply or over 17 million coins. This has massive implications. The current value of all staked Ether is more than $28 billion.
Similar opinions are shared by Saxo bank, as while the entire staking balance cannot be withdrawn on the Shapella upgrade day, the total staking rewards equating to around 1 million ETH can be instantly taken out. These ETH could be liquidated into the market, bringing price volatility, wrote Saxo Bank’s Mads Eberhardt last month.
As such, in the days leading up to the event, Ether may become volatile as a signal that the market is supporting concerns about potential price turbulence after the upgrade.
Not to mention, this being a bear market, skittish stakers who don’t want to keep their funds in crypto amidst the rising inflation and interest rates and uncertain macro environment may choose to withdraw their ETH.
Additionally, the regulatory movement against staking providers — crypto exchange Kraken recently stopped its staking programs in the US after the SEC fined $30 million for offering unregistered staking services — might make many US investors cautious.
Meanwhile, Bernstein noted in its recent research report that ahead of the upgrade, Ethereum has been witnessing much healthier on-chain activity and “gradual conviction-based spot positioning” in ETH and BTC.
While there may be some caution heading into this event because of concerns around supply from the unstaked ether, with 70% of the ETH staked via liquid staking pools such as LIDO or exchanges, the remaining ether has been directly staked into the Beacon Chain, which is unlikely to turn out to be short-term holdings, wrote analysts Gautam Chhugani and Manas Agrawal. As such, there may be “improved conviction in holding in spot markets, as the fears recede,” the report added.
Meanwhile, banking giant JPMorgan estimates that the upgrade will bring more investors to stake their funds in the protocol, bringing this number to 60% of the Ether issued.
But it’s yet to be seen just how the upcoming Shapella upgrade affects ETH price. While in the short term, it may affect the price negatively, overall, this upgrade is positive for Ethereum staking as it can increase the popularity of ETH staking, enhancing the security of Ethereum’s new PoS chain.
