What Ethereum’s Shapella Upgrade Means for Validators

It’s been what feels like a week (but was actually still just a few months) since one of Ethereum’s most pivotal transformations since its inception, ‘The Merge’. 

ETH’s much-anticipated (and largely priced in) transition from Proof of Work to Proof of Stake protocols was kickstarted by the earlier London Hard Fork, and while it doesn’t yet seem to be the investor mecca many had clamoured for – it has already revolutionised the use case and outlook of crypto’s second most circulated currency. 

Progress stops for no one, however, and definitely not for crypto users: the next chapter of Ethereum’s journey will be written very shortly with the upcoming Ethereum Shapella Upgrade. This upgrade is the merging of the much-anticipated Shanghai upgrade and the Capella upgrade. Since the Capella upgrade is happening simultaneously on the consensus side of Ethereum, the two have been merged to what is now being referred to as the Shapella upgrade.

Validator Funds Unlocked 

A gold Ether coin sits on top of a pile of nondescript gold coins.

But what does this mean, in practice? Well, the Shanghai (or now, Shapella) Upgrade is arguably an essential step to complete Ethereum’s paradigm shift started by ‘The Merge’. 

For now, validator funds (the assets that, by being staked, provide security and safety for the Ethereum network) have been travelling on a one-way road: from a variety of independent validator’s wallets to large staking pools. This is because staked funds were designed not to be withdrawable in the early stages of the transition.

While this was anticipated and by design, it has been the single greatest barrier towards greater staking adoption. While staked funds are decentralised by definition, the crypto community is very wary of signing off control of one’s own funds to any degree, and staking is no exception. 

This was particularly true in a year where the conversations around yield generation and custodianship were dominated by the narratives of behemoth collapses such as those of the FTX, Voyager and Celsius Network funds. 

Aside from trust and governance issues, needing to lock away funds remained a barrier even for those with full understanding of and blind trust in blockchain technology. With inflation running rampant, uneasy markets and the constant looming threat of a recession, the pool of people with an appetite for uncontrollable, unmodifiable investment commitments grew quite small, quite quickly. 

Some exchanges and staking pool providers decided to mitigate these PR and practical challenges with the introduction of liquid staking, a system where validators would be issued a representative staking token – a cryptocurrency designed to represent the assets locked away, which validators would then be able to use and spend in many similar ways to the coin it represented (often Ethereum). 

This system was a valid solution, but presented its own problems, adding layers of trust and technological complication which could easily become additional failure points at the wrong time or with the wrong market sentiment. 

The Shanghai Upgrade will be the end of all the above: with its introduction, validators will finally be able to withdraw the very same coins they staked, without needing to be issued a token or having to wait any longer. 

A Price Dilemma, A Tech Solution

While the technological and long-term usability benefit of this shift is fully clear, what the experts very much are at odds on is whether this Upgrade will have a positive impact on the short-term price of Ethereum. 

Some are arguing that the months of pent-up selling pressure will explode into a mass sell-off event which will provisionally tank Ethereum’s price. If this were to happen, it would be a massive blow to the whole sector’s snail-pace recovery from the crashes of 2022 – right when things had stopped looking so gloomy for the first time in months. Ethereum’s value has climbed 25% in the last 6 months, and 77% last year.

These fears are rapidly dispelled by those with a deeper understanding of how this transition was designed – that is, in a way that took into account the potential human sentimental response to the ‘opening of the floodgates’. 

Exit Through The Queue 

The withdrawal mechanism for validators is, indeed, built with its very own failsafe. 

Any funds that move away from a staking pool won’t exit it immediately: allowing for this to happen would pose the entire network at risk of collapsing in the case of a mass sell-off such as the one imagined by the more gloomy investors. It would result in a scenario similar to a hypothetical disappearance of all miners in Proof of Work blockchains – in essence, a dead network. 

Instead, withdrawal requests will be placed in an ‘exit queue’. This queue is designed to ward off the impatient and the sheepish: its output is regulated and set to a ‘churn limit’, a maximum amount of withdrawals authorisable at any given point. This ‘churn limit’ will be further lowered based on the amount of coins attempting to leave pools: the more requests for outgoing funds, the slower these will be released.

Partial (as opposed to full value) withdrawals will be slightly quicker, but even those will be limited to around 58k per day. This will ensure that, no matter how freeing the upgrade is in the long term, the transition to a free in-and-out flow will be as gradual and painless for price action as possible.

Most importantly, it will keep the single most damaging factor out of investment decisions: reactionary emotional responses. 

A Sturdier, More Accessible Ethereum 

A man in a long sleeved business shirt is sitting at a desk with one hand on his laptop and another hand holding an Ether coin that he is showing to the camera.

Freedom isn’t the only thing that will be achieved. In fact, the unlocking of pre-staked funds and the transformation of ETH staking into something that doesn’t require 2 or 3 year investment plans will further render Ethereum validation more accessible to the wider public. This is much needed for a network that is lagging behind competitors Solana and Cardano in terms of staking rate, with a mere 13% when compared to the rival chains (who sit around 72% this year). 

To stave off the growing fears of an increasingly centralised Ethereum, this change will also lead to an increase and appreciation of all types of liquid and illiquid staking offerings. The result is only likely to be a more fragmented, and thus more centralised, staking market – with the user share of behemoths such as Coinbase likely to lose quite a few percentage points to  Rocket Pool and Meta Mask offerings.

How To Prepare

A hand has a gold Ethereum coin balanced on the thumb as though it's about to flip it.

As per the picture painted above, realistically it won’t be possible (or sensible) to act on this upgrade right off the bat. Between the unspecified date (though this is likely to go ahead by April) and the exit queue issues, this is not the type of news you needed to act on yesterday. 

Now, however, is the perfect time to assess whether one is comfortable with the level of Ethereum staked, and whether one feels optimistic or pessimistic about the impact of the news on market sentiment. 

The considerations should not be limited to the amounts involved only, but should cover a thought or two as to whether the current vehicle for staking is one worth committing to in light of the many new offerings likely to be launched soon by other providers. 

Given the lengthy wait times ahead for any withdrawal requests, a change of provider could take weeks or even months – and is not something to be done lightly. 

Furthermore, the switch is likely to further increase interest in liquid staking products: if holding any, now would be a great moment to consider an exit price strategy or, if feeling very positive, a further accumulation strategy. 

One thing is certain: if you’re in it for the long term, there’s never been a better (or greener) time to be Ethereum holders.

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