How the Shanghai upgrade will affect Ethereum’s price

Around March 2023, Ethereum awaits an important upgrade — Shanghai. It, in significance, ranks only behind The Merge, which moved the second-largest cryptocurrency to the Proof-of-Stake (PoS) consensus algorithm.

The forthcoming upgrade will enable users to withdraw ETH from the Beacon Chain deposit contract and is expected to bring a number of system improvements.

Many members of the community are concerned about potential downward pressure on Ethereum’s price due to the option opening. Some believe that the upgrade will negatively affect tokens of liquid staking services such as Lido and the market more broadly.

Are there grounds for concern? How will the upgrade affect Ethereum’s price and prospects? ForkLog has looked into these questions.

Shanghai on the Horizon

The Shanghai upgrade envisions implementing a suite of Ethereum Improvement Proposals (EIPs). The key one, EIP-4895, will allow withdrawals from staking. This option has been unavailable since the launch of Phase 0 of the system’s second version in 2020.

With the upcoming hard fork, developers also expect to implement EIP-3540, EIP-3670, EIP-4200, EIP-4750 and EIP-5450, aimed at implementing the EOF format. The latter would enable validating smart contracts and making changes during deployment.

If implementing EOF proves too complex, the rollout will be pushed to autumn 2023. In the meantime, another upgrade is planned that will enable EIP-4844. It is expected to bring in much of the logic and formats from the concept of danksharding.

Recently, developers have implemented a shadow Shanghai fork to test the planned upgrade’s impact on the mainnet.

During testing, several issues arose due to an incorrect configuration of the Geth client. After fixes, all nodes operated in consensus.

On February 1, the Zhejiang testnet launch took place to verify ETH withdrawals from the Beacon Chain deposit contract.

The hard fork in the testnet is expected in February.

Rally of Liquid-Staking Tokens

Against the backdrop of the upcoming major upgrade, the governance token of the leading liquid-staking platform Lido Finance is showing solid growth. In January, LDO rose by more than 130%\. Its market cap surpassed $2 billion.

Lido Finance rose to the top in DeFi Llama’s ranking, overtaking veteran TVL leader — the MakerDAO platform MakerDAO.

Lido Finance enables users to earn by staking crypto assets such as Ethereum, Polygon and Polkadot.

The most popular token on the service is Ethereum. In exchange for assets locked in the Beacon Chain, users receive stETH tokens, which can be employed in other DeFi protocols. Lido Finance is popular with retail investors who do not hold the required 32 ETH or the knowledge to operate as a validator.

Rising sharply is also the RPL token — up more than 100% in January. Rocket Pool positions itself as a decentralised protocol that pairs stakers with node operators within a single system. To participate, operators must hold 16 ETH (half the amount required for a Beacon Chain validator) and a small amount of RPL.

Given the growing prices of such cryptoassets, the market is broadly welcoming the upgrade. Shanghai could boost liquidity for staking coins and reduce the uncertainty factor—users will know the withdrawal timelines.

Impact on ETH Price

According to Binance Academy analysts, the upcoming upgrade will affect the share of coins that are staked relative to ETH in circulation.

“In turn, this could alter the supply-and-demand balance for Ethereum,” the researchers noted.

Among skeptics, there is a view that the market will be flooded with ETH after the upgrade, potentially triggering a price drop.

“While some expect increased selling pressure, others are optimistic that the upgrade will spur demand for Ethereum staking, as new options and services become available,” noted the Swiss crypto bank Sygnum’s analysts.

Activating Shanghai will allow investors to unlock blocked ETH for the first time since 2020. However, experts believe mass withdrawals are unlikely to occur all at once; the process is dynamic and depends on multiple factors.

1/ Unlike other PoS networks like Cosmos that have a fixed withdrawal period for stakers, set at 21 days, Ethereum’s is dynamic based on how many validators are exiting at a given time.

— Westie 🟪 (@WestieCapital) January 12, 2023

There are two withdrawal options:

• Partial, applicable to funds on the balance above 32 ETH. In this case the validator remains in the Beacon Chain, participating in the consensus mechanism;
• Full — the validator exits the network, no longer participating. The remainder (32 ETH and rewards) are unlocked in full.

As Ethereum.org explains, under the second option the validator takes a place in a withdrawal queue. The queue length depends on the total number of participants. The higher the total, the more users can withdraw their assets in a single epoch.

“Such a limit helps maintain system stability by controlling how many validators can exit at once. After all, validators secure Ethereum,” the Sygnum team emphasised.

After clearing the queue, participants move to the next stage — the “withdrawal period.”

“The duration of this period varies with the number of validators attempting to withdraw simultaneously. It could take from a few hours to weeks, possibly months,” the crypto-bank experts explained.

Thus, the mechanism described above makes a substantial price drop unlikely. Nonetheless, forecasting the price of Ethereum post-Shanghai remains uncertain.

“ETH may experience short-term volatility — that is normal around a significant event,” the analysts forecast.

Lookonchain analyst is confident that investors need not fear selling pressure after Shanghai. By his calculations, the average price at which ETH is deposited into the Beacon Deposit Contract is $2,260.

With the coming of #Ethereum Shanghai upgrade, some investors worry that opening staking withdrawals will put selling pressure on $ETH.

We analyze investors who deposit less than 5000 $ETH, and the average price they deposit $ETH to Beacon Deposit Contract is $2,260. pic.twitter.com/l3eK1eJQM5

— Lookonchain (@lookonchain) January 9, 2023

That suggests rational market participants are unlikely to dump the withdrawals at a loss.

Independent researcher Tripoli noted that withdrawals will require credentials with a prefix of 0x01, “not installed by early validators.” Their transition from 0x00 is “limited to 16 operations per block.”

“So far, about 20% of new validators do not set 0x01. This is likely those following outdated guides, as well as centralised organisations that have not updated their procedures,” Tripoli emphasised.

According to his observations, Lido is most active in deploying the corresponding data type.

“The liquid-staking provider holds 88% of the eligible credentials. It controls more than 60% of all validators prepared for automatic withdrawals,” the researcher noted.

He believes this situation is a positive factor for the network and only “naive observers” would bring up centralisation debates.

“Heavy adoption of [0x01] will cause a bottleneck in the partial withdrawal queue. That will dampen the scale of the initial withdrawal spike,” Tripoli shared.

Estimates by the expert suggest that on the first day after activation Shanghai could see around 110,000 ETH withdrawn through partial withdrawals (excluding Lido validators with 0x01 credentials).

That figure stands in sharp contrast to the naïve models that predicted 400,000 ETH per day.

“Given that the set of non-Lido validators includes most centralised platforms and alternative liquid-staking derivatives, it is reasonable to expect these validators will sell only a portion of their rewards. It is unlikely this scenario will spell catastrophe for the market,” the researcher said.

Untapped Potential

As of 06.02.2023, only 14.25% of Ethereum’s circulating supply is staked (the Staking Ratio). This is a fairly low figure compared with other popular PoS blockchains such as Cardano or Solana.

Following the March upgrade, the situation should begin to shift. The gap illustrated above is likely to gradually narrow as Ethereum staking is perceived as less risky.

It is also plausible that a substantial portion of ETH unlocked by EIP-4895 will flow into DeFi protocols. This could revive the DeFi sector, lift its total TVL, and likely bolster the broader market recovery.

In liquid-staking protocols, roughly ~6.87 million ETH valued at $11.3 billion (DeFi Llama data as of 06.02.2023) is deployed.

By comparison, 16.64 million ETH worth about $26 billion are locked in the Beacon Chain deposit contract (as of 15.02.2023). This figure has risen by about 25% over the past six months and by 77% over the past year.

The sizable discrepancy points to substantial upside for derivatives like stETH and the TVL of corresponding platforms.

The upcoming upgrade could also positively affect utility tokens of liquid-staking protocols — LDO, RPL, ANKR and SWISE.

Analysts at Sygnum also foresee stronger demand for decentralised services like Rocket Pool. Rocket Pool’s TVL has risen roughly twofold over the past two months and has already passed the $1 billion mark.

The share of Rocket Pool in liquid staking sits at 5.64%. The perennial leader, Lido, accounts for 73.51%.

The chart below shows that liquid-staking services hold the largest share of assets (45.8%) in the Beacon Chain’s deposit contracts.

Whales hold 20.2% of the stake, while centralised exchanges hold 15.4%.

Analysts at Sygnum expect many platforms to expand their functionality, such as with MetaMask wallets. They also anticipate continued growth in ETH staked and the number of validators in the network. The latest 2022 figure rose by 79%, reaching 495,252 by December.

Binance Academy analysts believe opening withdrawals will generally have a positive effect and “make the ETH market more fluid.” In their view, holders will be better positioned to respond to supply and demand to achieve market equilibrium.

JPMorgan is convinced that the Shanghai factor is positive for Coinbase. The bank’s researchers estimated that 95% of clients would express interest in Ethereum staking after the upgrade.

According to their forecast, the “new era” could add an additional $225–545 million to Coinbase’s current annual ETH staking revenue (estimated at $50 million at the time of writing).

Conclusions

The Shanghai upgrade marks a significant step in the development of the second-largest cryptocurrency. Yet ahead lie several milestones aimed at solving the perpetual scaling challenge and making Ethereum quantum-resistant.

After withdrawals from staking are enabled, ETH staking should become more attractive due to higher liquidity. For instance, activity in the ecosystem could increase among those who did not use services like Lido and Rocket Pool for various reasons.

According to crypto investor and blogger Lark Davis, the number of holders of the second-largest cryptocurrency grew by 263% in 2022. This bodes well for Ethereum and positive sentiment around upcoming upgrades.

Few can predict the price of Ethereum and related tokens after Shanghai with precision. Yet any meaningful upgrade is likely to bring heightened volatility.

One thing is certain: Ethereum and many other crypto assets should rise in value as the market recovers, and much will depend on the successful implementation of the upcoming upgrade.