As the Shanghai/Capella upgrade draws increasingly close, it is crucial to identify possible pressure points within the Ethereum ecosystem. The Shanghai upgrade is an “update” to the Ethereum Blockchain that will give back control over staked ETH to validators after roughly 28 months. This upgrade intends to enable the withdrawals of staked ETH from the Ethereum blockchain. Having established this, let’s look at some critical implications regarding withdrawals.
Implications on Stake Flow
First, enabling withdrawals will create an open, two-sided staking flow. The staking flow is one-sided; ETH can only flow into the network and never exit it. Interestingly, enabling withdrawals may incentivize even more people to stake as they will know they can always withdraw their ETH if needed for something else. Stakers who do not run their validators and stake with a centralized staking provider can change their provider to a different one. So, for example, they can withdraw their funds from a provider offering a lower staking rate to another provider offering a better rate, move from a centralized provider to a decentralized one, or even run their own validator.
Implications on Liquid Staking Derivatives
Withdrawals will also impact liquid staking derivatives such as Lido, RocketPool, and StakeWise. For example, liquid staking coins such as stETH or rETH had a history of temporarily losing their peg to the price of ETH during market turbulences. However, with the two-sided staking flow, any significant discrepancy in their peg would be quickly arbitraged away. Early adopters in liquid and centralized staking captured a vast majority of the market as they did not have much competition. However, these incumbent players’ market share could significantly change once withdrawals are enabled, especially if they don’t offer a competitive rate.
The ability to shift freely between staking providers will benefit the ETH staking market. Enabling staking withdrawals is one of the most anticipated upgrades to Ethereum. It will be imperative to make sure this change is executed smoothly. To help with testing, validators will have several devnets and testnets available to run through the process and iron out any potential issues before going live on the mainnet. Withdrawals are yet another improvement bringing Ethereum one step further toward building a sustainable, secure future.
Implications on Decentralization
There is one primary consideration to consider after Shanghai goes live – staking centralization. On the surface, an increase in ETH staking means an increase in network “decentralization.” However, suppose that most new stakers after Shanghai elect to stake through a provider like the crypto exchange, Coinbase. In that case, there is the risk of seeing a few centralized and on-chain providers dominate the ecosystem. With this in mind, what will benefit the network in the long run, is enough innovation in the staking industry to improve decentralization. More competition means more choice, which could drive protocols to differentiate themselves with better products and consumer offerings. Moreover, organizations such as the Ethereum Foundation should focus on the UX [user experience] of single stakers to incentivize a more resilient staking network.
Implications on Asset Control
The Shanghai upgrade will return to ETH liquidity providers/validators the sovereignty over their assets (ETH coins). In crypto, it is usually the case that contracts that require participants to lock up funds are a tough pill to swallow, and that is the case even for those who deeply believe in Ethereum. With Shanghai, the emotional barrier to participation is lifted, and liquidity providers will more confidently commit their stake.
Implications on Innovation
Shanghai will spur more innovation in direct staking and liquid staking solutions. The ability to stake, withdraw and re-stake ETH (rewards) more frequently will engineer more nuanced financial applications as people explore opportunities to maximize yield while minimizing risk. We will see heavy innovation in staking derivatives and more complex lending solutions to provide people access to ETH staking. Shanghai also will be a boon for individual liquidity providers on liquid staking platforms. The ability for people to redeem their wrapped staked ETH for underlying staked ETH will force liquid staking platforms to become even more user-friendly. We will see more features and incentives emerge as these liquid staking protocols fight for liquidity providers in a world where staked ETH is suddenly liquid.
What other EIPs are in the Upgrade?
Ethereum Improvement Proposals (EIPs) typically describe standards for the Ethereum platform, including core protocol specifications, client APIs, and contract standards. Among the approved proposals for the upcoming upgrade is the EIP 4844, which focuses on leveraging proto-danksharding technology, and is expected to boost network throughput and slash transaction fees, a significant improvement for scalability. It introduces a new kind of transaction type to Ethereum, which accepts “blobs” of data to be persisted in the beacon node for a short period. These blobs will help compress blockchain data, thereby improving scalability for the EVM and layer 2 scaling solutions.
Other EIPs address the Ethereum Virtual Machine (EVM) upgrade, including EIP 3540, EIP 3670, EIP 4200, EIP 4570, and EIP 5450. These are all updates targeted at improving specific features within the Ethereum network.
The Shanghai testnet version, dubbed Shandong, went live on October 18, allowing developers to work on implementations such as Ethereum Virtual Machine (EVM) object format; it is one of the community’s most-anticipated updates since it separates code from data, which could be beneficial for on-chain validators.
The Merge was the first step of a five-part scaling process, which has since been elaborated upon by several Ethereum developers, ecosystem participants, and commentators. The fundamental change of the Merge is the drastic reduction in power consumption, which reduced Ethereum’s energy usage by 99%. The five developmental phases – as named by Ethereum co-founder Vitalik Buterin – are “The Merge,” “The Surge,” “The Verge,” “The Purge,” and “The Splurge,” and they all attend to specific scalability needs of the network.
The Shanghai hard fork was a smooth process and was already tested on the Goerli public testnet. It is unlikely that things will turn out differently on the mainnet come April 12. As Ethereum slowly extends its functionalities to satisfy its short-term scalability demands, it continues to create room for innovations while setting the trend for the rest of the crypto industry.
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