Ethereum’s Shanghai Upgrade Will Permanently Change ETH Economics

An Ethereum transformation is on the horizon, and no one is sure how the market will react. In time, the “Shanghai” upgrade may be remembered as a uniquely bullish event for ether (ETH), the world’s second largest cryptocurrency by market capitalization.

However, in the short term, a number of the world’s leading Ethereum quant traders who have historically outperformed ETH return on investment believe that price action will be neutral to potentially bearish due to the expected large increase in circulating supply of ETH after investors are finally able to withdraw their efforts.

James Hodges is the managing partner of Amphibian Capital, an ETH-based fund of funds.

Over a longer time horizon, Ethereum’s total switch to proof-of-stake will likely only benefit the network and ETH’s price – enough to possibly dethrone bitcoin (BTC) as the world’s largest cryptocurrency by market capitalization.

Amphibian Capital, my firm, takes this logic further and predicts that ETH could reign as one of the world’s three most valuable assets in the next decade. The Shanghai upgrade is a crucial step in that direction, which is likely to increase the liquidity and trading of Ether and possibly attract more institutional capital into the crypto-economy.

First, the Shanghai upgrade will enable users to participate in Ethereum’s validation process through the implementation of the Beacon Chain mechanism, making staking more accessible and efficient. The Beacon Chain mechanism will democratize the staking process and allow for greater participation in the network, leading to increased security and decentralization of the network – a bullish sign.

Second, the “Merge” upgrade transferred the Ethereum blockchain to a proof-of-stake consensus system, and the implementation of EIP-1559 made ETH a deflationary asset. EIP-1559 introduced a more predictable and stable transaction fee mechanism and enabled the burning of a portion of the transaction fees. These features will continue to make ether even more deflationary, thus increasing its value over time.

All this lays the foundation for increased institutional use of cryptocurrencies. We are already seeing increasing interest in ether from institutional investors who increasingly want to diversify their portfolios and hedge against inflationary pressures. The Merge upgrade addressed Ethereum’s ESG concerns that kept many investors out.

When withdrawals are unlocked, institutions will be able to bet and earn a return that will be similar to fixed financial instruments such as bonds in traditional capital markets. After the Shanghai fork, betting returns from ether could be synonymous with the risk-free rate that traditional capital markets use to price their assets.

Investors may be spooked by the idea that the Shanghai upgrade could lead to a major selloff of ETH, some of which has been staked since 2020. However, data suggests that this analysis is overstated.

CryptoQuant has noted that 60% of the staked ETH supply, or approximately 10.3 million ETH, is currently running at a loss. Meanwhile, Lido DAO, the largest Ethereum staking provider, has 30% of all staked ETH with an average loss of $1000. Usually, selling pressure occurs when the participants have a large profit, which is not the case for the stake ETH at the moment. This suggests that there may be limited selling pressure in the Ethereum market in the near term.

Furthermore, as reported by Sentiment, almost 90% of all supply of ETH is in its own custody. Crypto holders have increasingly moved towards self-storage since September 2022. When the FTX exchange collapsed in November the trend accelerated, leading to a massive drop in ETH supplies on exchanges. This reduces immediate selling pressure as capital is moved to the sidelines, and future sales are expected to be limited.

As cryptocurrency continues to evolve, investors are constantly seeking new ways to accumulate more ether. Currently the yield on floating betting provider Lido is 5.4% APR. There is also the option to become a solo validator on the Ethereum network, which requires users to invest 32 ETH. Others opt for boutique systems such as investing in ETH-denominated quantitative hedge funds, which offer higher rewards in exchange for more risk and fees.

All of these strategies have their pros and cons, and it ultimately comes down to personal preference and risk tolerance. It is important to do your due diligence and understand the potential risks and rewards before making any investment decisions.

In either case, we at Amphibian Capital are extremely positive about ETH’s long-term prospects, both from an ecosystem perspective as well as a price and market capitalization perspective.