Ethereum’s Shanghai upgrade activates, ushering in a new era of staking

Ethereum’s long-awaited Shanghai update has activated, enabling the first ever withdrawals of staked ether (ETH) and ushering in a new era for the blockchain.

The Shanghai upgrade was triggered at 22:27 UTC and is expected to complete in two blockchain epochs, which will take approximately 14 minutes. The changes are also referred to as “Shapella” due to the two simultaneous upgrades occurring at the blockchain’s execution layer (“Shanghai”) and consensus layer (“Capella”).

Although the contents of these data blocks will not be validated for a few more minutes, withdrawals of stakes from ETH are expected to start processing immediately and participants can request to withdraw ETH withdrawals from now.

The much-anticipated hard fork – essentially upgrading the blockchain by forking a new one – has been characterized by members of the Ethereum community as a historic milestone, completing its multi-year transition to a full proof-of-stake network, and following last. this year’s successful “Merge”.

In a proof-of-stake system, users “stake” cryptocurrency as a form of collateral to secure and verify new blocks of data. Last year, the blockchain abandoned its original proof-of-work consensus mechanism — the same one Bitcoin uses — but until now, users had been unable to withdraw their stakes or redeem accrued rewards, a defining feature of the new paradigm.

Digital asset market analysts have speculated for months whether the Shanghai hard fork would be a catalyst for either a price rally or a crash: Will its success boost market sentiment, or will players cash in the ETH en masse and rush to dump their holdings?

In the minutes before the Shanghai upgrade, the ether (ETH) price was around $1,915, up 1.07% in the last 24 hours and approaching $2,000 for the first time since August 2022.

When Ethereum went through the “Merge”, the hard fork that switched its old consensus mechanism from proof-of-work (PoW) to proof-of-stake (PoS), the project introduced a new type of “validators” to keep the blockchain running. While the PoS consensus mechanism reduced Ethereum’s energy consumption by 99%, the developers also believed that under PoS the network would be more secure and enable more decentralization.

“It’s always been our goal that Ethereum is something that’s an army of tens of hundreds of solo node operators, not, you know, three or four big chunks of data,” said Ben Edgington, product manager for Teku, a ConsenSys client for Ethereum. (A client is a piece of software that runs the blockchain.) “I think we’ve designed a protocol that enables that, which I think is a big step forward from PoW.”

Vitalik Buterin, the co-founder and mastermind behind Ethereum, wrote in a November 2020 blog post that PoS would lead to “higher wealth concentration in the long term.” This is because in PoS you only need Ether to stake and can get more Ether through staking. In PoW, you still earn ether, but need external resources to do so. So in the long term, Buterin argued, PoS “coin distributions risk becoming more and more concentrated.”

To participate in the block validation process and secure the Ethereum network, validators must “stake” at least 32 ETH by sending them to a smart contract where the funds are locked up. The more ETH a validator stakes, the more likely they will be tasked with proposing a “block” of data transactions to be verified on the blockchain. When a validator proposes a block and it is approved by the other validators, that validator receives an additional reward.

When the PoS chain first launched, 32 ETH was around $15,000. Since then, ETH has appreciated tremendously, now around $58,000. The price gains represent a reason for the speculation that some investors may choose to sell their ETH – to book profits.

Not everyone has that much ETH lying around to bet the full 32 ETH. So floating staking providers became an option, where users who wanted to participate in the staking process could contribute any amount of ETH they wanted, and third-party providers would stake the ETH and run the validator on behalf of the collective of clients.

Lido, the largest provider of floating stakes, controls approximately 23% of all ETH stakes. Coinbase, Kraken and Binance, some of the largest crypto exchanges in the world, control another 22% of the ETH being staked.

There are many ways validators can unstake, although the two main types of unstaking are partial withdrawals and full withdrawals.

A partial withdrawal is when stakers withdraw the rewards they earned from staking, but leave the original ether that was staked. Solo stakers running their own validators had to migrate their credentials to a 0x01 withdrawal credential. Without it, partial withdrawals cannot happen automatically.

Partial withdrawals became available when the upgrade was triggered (so the blocks didn’t need to be completed), allowing users to reap the long-awaited rewards immediately. However, Ethereum can only process 16 partial withdrawal requests in a single slot (which happens every 12 seconds). Depending on how many requests will come, the queue for withdrawals can take hours.

“During the first couple of epochs, there will most likely be no partial withdrawals, since the first hundred validators are all 0x00,” said Barnabas Busa, a DevOps engineer at the Ethereum Foundation. This is because they are genesis validators who joined the network when the Beacon Chain went live and thus have the old withdrawal credentials set. (Longtime Ethereum supporters may be more interested in continuing to secure the network than cashing out.)

Full withdrawals – where players also redeem their original principal – were published at the same time, allowing validators to deposit their 32 ETH and any rewards they’ve collected. By exiting the chain, the validator ceases to participate in the block validation process and ceases to contribute to the security of the network.

Full withdrawals do not happen automatically, so those validators who want to exit must send a message to the blockchain to be added to the queue.

Staking services are on their own timelines for the release of staked ETH withdrawals. Coinbase previously said it would begin processing withdrawal requests for its stakers approximately 24 hours after Shanghai is completed. Lido said that strikers will not be able to collect their withdrawals until the protocol goes through another upgrade in May.

Since Beacon Chain went live in December 2020, more than 18 million ETH have been staked (about 15% of the total ETH supply). Now that Shanghai is live, approximately 1.1 million accrued ETH from rewards are eligible to be withdrawn immediately.

Market analysts have feared that unlocking the ETH deposited in the Beacon Chain could start a rush by stakers to liquidate their tokens.

CoinDesk has also reported that there could be further selling pressure from entities facing financial pressure. Bankrupt crypto lender Celsius Network was able to sell its stake ETH balance of 158,176 ETH, to recover a portion for creditors. Kraken, a US-based crypto exchange, recently agreed to shut down its staking operations to pay SEC fees, thus likely having to liquidate all of its 1.2 million ETH.

Some market analysts believe that the selling pressure for ETH is likely to be spread over several days given the withdrawal queue, allowing buyers to see and analyze the selling pressure.

While leveraged ETH withdrawals are the main focus in Shanghai, there are also four smaller mechanisms for Ethereum (known as Ethereum Improvement Proposals or EIPs) that will improve gas fees for developers.

Note: This article will continue to be updated.