What is the Ethereum Shanghai upgrade?

The upcoming Ethereum Shanghai upgrade, also known as the Ethereum Shanghai fork, aims to provide a solution for ETH stakers to retrieve their staked funds as validators. Prior to the upgrade, Ethereum used a Proof of Work (PoW) mining mechanism to validate transactions. However, with the switch to a Proof of Stake (PoS) consensus mechanism in September 2022, users can now stake 32 ETH to take part in validating on the network without the need for specialized mining equipment. However, staked funds have been locked since the Merge, preventing users from removing them. The Shanghai upgrade will address this issue by adding withdrawal functionality and several smaller Ethereum Improvement Proposals (EIPs) that aim to benefit developers by reducing gas fees during periods of high network activity.

While the switch to PoS during the Merge made the Ethereum blockchain more environmentally friendly, staking requires at least 32 ETH, making it difficult for smaller investors to participate. Platforms like Lido and Coinbase offer staking services for lower Ether holdings, charging fees on staking returns.

The Ethereum Shanghai upgrade will implement five Ethereum Improvement Proposals (EIPs). One of the most exciting aspects of the upgrade is the implementation of EIP-4895, which allows users to withdraw their staked Ethereum. This feature could encourage more people to become stakers, further securing the Ethereum network.

Historically, Ethereum has faced slow transactions and high transaction fees, leading some projects to migrate to other chains, such as Solana or Ethereum layer-2 scaling solutions like Polygon. Aside from EIP-4895, which primarily targets Ethereum stakers, the upgrade will include EIP-3855 and EIP-3860. EIP-3855 aims to improve transaction speeds, while EIP-3860 aims to reduce transaction costs. These improvements will enhance network usage across DeFi and NFTs.

How will the Ethereum Shanghai upgrade impact ETH traders?

Like most blockchain upgrades, the Ethereum Shanghai upgrade is expected to affect the price of Ether. Investors have already begun moving their assets to self-custody, resulting in a decline in Ether supplies on exchanges.

According to Nansen’s data, the Ethereum blockchain currently holds 16.8 million ETH, with Lido Finance holding the largest share of 29.5%, while Coinbase, Kraken, and Binance combined account for only 26%. On-chain data reveals that the average deposit prices for ETH were around $600, with an initial deposit surge, followed by consistent deposits up to the $3,400 price level.

Nansen also highlights that illiquid stakers on the Ethereum network, who represent 24.5% of all staked ETH, are expected to sell their holdings during withdrawals after the Shanghai upgrade. This category of stakers is responsible for roughly 4.1 million ETH or $6.9 billion worth of ETH.

Around 13% of the total ETH supply has been locked up through staking, and it will remain inaccessible until the Shanghai Fork upgrade is implemented in March 2023. Concerns have arisen that the release of these staked ETH tokens may flood the market and create selling pressure. However, two factors suggest that ETH may not experience significant selling pressure after the upgrade.

Firstly, 60% of staked ETH is currently at a loss, indicating that stakers may choose to hold onto their ETH rather than sell it. Secondly, the depositors in the largest staking pool, who hold almost 30% of all staked ETH, are also at a loss, making it unlikely that they will sell their ETH once withdrawals become possible.

Although the Shanghai upgrade is small compared to the Merge, it still has significant potential to impact users who have staked ETH on the chain. Additionally, further upgrades to the Ethereum protocol are expected later in 2023, aiming to improve the Ethereum Virtual Machine and split the Ethereum blockchain into several “shards” to enhance scalability.