Introduction
Last September saw the most anticipated event of the year for the crypto sector play out, when Ethereum finally made the move from its Proof-of-Work (PoW) mining consensus mechanism to an energy-efficient Proof of Stake (PoS) one.
Many years in the making and often delayed, the so-called Ethereum Merge represented a single bright light in a dark sea of misery for crypto in a year blighted by brutal interest rate hikes and the carnage that FTX and Terra Luna’s collapse wreaked on all investors.
It greatly reduced Ethereum’s energy consumption by 99.95%, making it appealing for eco-friendly retail investors and specifically institutions who need to comply with ESG environmental measures. It also laid the core foundation for the smart contract network’s plans to scale its transaction speeds and lower gas fees.
All systems go now for Ethereum, and its developers announced on 5 January 2023 that its next big milestone, the Shanghai upgrade, also known as Shapella, will happen at an undetermined time around the end of March, once all testnet results have been successful.
First set in motion with December 2020’s launch of the Beacon Chain, Ethereum’s PoS chain, the gradual switch offered savvy investors the opportunity to stake 32 ETH (rather than use computer-based mining) in order to get validator rewards. The only catch: You had to wait until post-Merge to unstake your ETH.
The Shanghai upgrade, and specifically its EIP-4895 update is what ETH stakers were waiting for, as it finally allows the ability to withdraw staked ETH. It also provides the runway for the so-called “Surge” upgrade, which will boost Ethereum’s maximum transactions per second (TPS) to help it scale, later to be executed. Developers believe that “Shanghai” will ensure minimal delays and problems in preparation of the Surge.
With both Mt. Gox Bitcoin and 16m unstaked ETH potentially hitting markets this month, some analysts predict a volatile month for cryptocurrency prices. Long term though, what is the impact on Ethereum’s prospects and what else should we know about Shanghai? Let’s dive in.
(Please note this information is not financial advice of any kind, but for educational purposes only.)
What Is the Ethereum Shanghai Upgrade?
The Ethereum Shanghai upgrade is the next hard fork of the Ethereum network scheduled to happen at the end of March 2023. This hard fork will implement five Ethereum Improvement Proposals (EIPs) that aim to improve the overall performance, security, and usability of the Ethereum network, with the biggest benefit being the ability to withdraw staked ETH.
The latest ETH hard fork will be paired with another upgrade called Capella, which will enable the update on the consensus layer where nodes run the Proof of Stake Beacon chain. The Sepolia Shapella is the Shanghai upgrade testnet before it executes on the Ethereum mainnet.
Why is the Shanghai upgrade important for Ethereum?
EIP-4895 enables staked ETH withdrawal
Undoubtedly the biggest upgrade is the implementation of Ethereum Improvement Proposal (EIP) 4895, which will allow Ethereum stakers to withdraw their staked funds. This change will enable validators to unlock the 32 ETH tokens that have been locked up since the launch of the proof-of-stake (PoS) consensus mechanism in December 2020.
The introduction of EIP-4895 will enable stakers to withdraw their ETH from the Beacon Chain, a feature that was not possible before. This will provide stakers with more flexibility in managing their assets and will likely encourage more people to participate in the network as stakers.
Other EIPs to improve EVM, gas fee and smart contract areas
In addition to EIP-4895, there are four other EIPs that will be implemented in the Shanghai upgrade, including EIP-3651, EIP-3855, EIP-3860, and EIP-6049. These proposals are aimed at reducing gas costs for network developers, making it more affordable to build on the Ethereum blockchain as follows:
- EIP-3651: proposes to access the “COINBASE” address, a software with low gas costs used by validators and block builders (note: not related to US exchange)
- EIP-3855: Creates a code dubbed “Push0” to reduce gas cost for developers.
- EIP-3850: Introduces an upper cap on the gas cost for developers
- EIP-6049: Reduces developer gas fees
Another important benefit of the Shanghai upgrade is its ability to improve the Ethereum Virtual Machine (EVM) and smart contract capabilities. The upgrade is expected to reduce the gas fees for developers, thus making the network more cost-effective for creating and executing decentralized applications. Additionally, the upgrade is a step towards achieving sharding, a scaling solution that would divide the Ethereum network into smaller parts or shards to increase the number of transactions processed per second.
How will Shanghai’s ETH withdrawals impact Ethereum
However, the implementation of EIP-4895 and the ability to withdraw staked Ethereum could have a ripple effect on the supply and demand of the cryptocurrency, as roughly 14% of all ether tokens are currently staked, accounting for approximately $29 billion in market value.
With this feature, stakers who have locked up their funds for almost two years would be able to withdraw and trade their tokens, which may affect the liquidity and price of ETH. Shanghai will ensure that a staggering 16.5 million staked ETH is suddenly eligible for withdrawals.
This presents both a bullish and bearish scenario for Ethereum, as in the short term we might see a deluge of unstaked ETH hit markets, being sold off en masse. This is unlikely as Ethereum dominates sectors like DeFi and NFTs and also now offers better staking returns since mining rewards have been replaced by staking.
Also, most ETH stakers bought at a higher price and will most likely wait for at least break-even point before selling. Many external factors such as the price of Bitcoin and macro-economic policy and events can negatively impact the price of Ethereum.
Conclusion
In summary, the Shanghai upgrade brings several benefits to the Ethereum network, including the ability for stakers to withdraw their funds, improved gas fees for developers, and advancements towards sharding.
The implementation of EIP-4895 in particular is highly anticipated as it allows Ethereum stakers to unlock their staked funds, potentially affecting the supply and demand of ETH. Importantly, “Shanghai” also is an important prerequisite for a successful Surge upgrade that will scale Ethereum in the future.
While some short-term volatility can be expected as millions of ETH becomes unstaked, the long term prognosis for Ethereum remains bullish thanks to its overwhelming lead in the DeFi, Web3 and NFT space and the value and adoption that a plethora of powerful new layer-2 scaling chains brings to it.
Coupled with the freedom with which ETH can be staked and unstaked on short notice and its shiny new ESG credentials as an energy-efficient PoS chain on which leading layer-2s like Polygon, Arbitrum and Optimism live and alleviate its workload, these elements all combine to make Ethereum a leading light of the crypto sector for years to come.