In September 2022, Ethereum successfully completed The Merge, combining the original execution layer of the Ethereum mainnet with its new Proof-of-Stake consensus layer, called the Beacon Chain. The Merge eliminated the energy-intensive Proof-of-Work mechanism used by Ethereum, ringing in the era of staking on Ethereum. Cut to 2023, and the protocol is getting ready for its first major upgrade, “Shanghai,” since its shift to Proof-of-Stake. Shanghai will see the implementation of Ethereum Improvement Protocol (EIP) 4895, after which around 16 million staked ETH will become available for withdrawal by validators.
Stakers on Ethereum have long awaited the Shanghai upgrade, which, apart from impacting staking, will also considerably impact the market demand for ETH. Apart from EIP 4895, the Shanghai upgrade also comes with other EIPs. This article will take a closer look at the upgrade and understand its implications for the Ethereum ecosystem.
Key Points
- The Ethereum Shanghai upgrade is an upcoming hard fork scheduled for March 2023.
- The upgrade will see the implementation of EIP-4895, which will allow validators to withdraw ETH staked on the platform since December.
- Currently, around 14% of all ETH tokens, valued at around $26 billion, are staked.
- One notable omission from the update is EIP-4844, which would have facilitated the sharding of the Ethereum blockchain.
What Is A Hard Fork?
Before moving on, let’s understand the term “hard fork.” A hard fork is a new software upgrade implemented by a blockchain or cryptocurrency network incompatible with the existing blockchain protocol. This causes a permanent split in the blockchain, leading to the creation of two networks running parallel. Hard forks, unlike their soft fork compatriots, are not backward compatible, leading to a permanent change in the protocol’s rules. As a result, any node that implements the hard fork will be unable to use the previous version due to compatibility issues, forcing miners to either choose the updated version or stick with using the obsolete version.
What Is The Ethereum Shanghai Upgrade?
Ethereum finally completed its switch from Proof-of-Work (PoW) to Proof-of-Stake (PoS) in September 2022, prior to which the protocol used an energy-intensive mining process to validate transactions. With the switch to Proof-of-Stake, users wishing to take part in the validating process could stake ETH to be eligible to validate transactions. However, since the completion of the Merge, users on Ethereum have been unable to access their staked funds. The Shanghai update is designed to address this issue by adding a withdrawal functionality.
Developers on Ethereum agreed upon a March launch date for implementing the Shanghai update as a hard fork, with users being able to test the update on a public test network towards the end of February.
EIP-4895
EIP-4895 is the show’s star when it comes to the Shanghai update and will allow validators to finally withdraw the staked ETH tokens from the network. After the Ethereum network switched to Proof-of-Stake, validators have staked around 16 million ETH to help secure the network, outlining their crucial role since the protocol’s transition. Following the switch, validators were required to stake 32 ETH to be able to participate in validating blocks. The more ETH a validator staked, the higher their chances of being selected to “propose” the next block of transactions.
However, before agreeing to participate as validators, they were made aware that the ETH they staked, and any rewards accrued would remain locked up until a major upgrade was implemented. As a result, validators on Ethereum have been staking and accruing rewards since 2020, when the protocol released its Beacon Chain, the first step in The Merge. With EIP-4895, the validators can cash out their stake or any rewards they have accrued over the past couple of years or gain more control over their funds.
What Does Ethereum Shanghai Mean for Validators?
As mentioned earlier, the Shanghai hard fork will allow validators to unlock their staked ETH. This means validators could theoretically pull their entire stake from the system. However, this scenario is quite unlikely, given Ethereum’s high staking yield and dominance in the DeFi ecosystem. Furthermore, with the Shanghai upgrade freeing up their stake, validators could withdraw their assets at will, so they would not be worried about locking their assets for an indefinite period.
Validators that wish to withdraw their staked ETH can do so in one of two ways. The first option is to set up a “withdrawal credential,” This will automatically unstake all accrued rewards that validators have earned over the past couple of years. The second option allows validators to exit the Beacon Chain entirely by unstaking all 32 ETH.
What Else Is Bundled In The Shanghai Hard Fork?
EIP-4895 is not the only Ethereum Improvement Protocol shipped with the Shanghai hard fork. The update also includes four smaller EIPs that impact gas fees on Ethereum. Gas fees are paid by the user to complete transactions on the Ethereum blockchain and are known to spike considerably during periods of high activity. Let’s look at the other EIPs that have been shipped with Shanghai.
- EIP-3651 – Ethereum Improvement Protocol 3651 proposes allowing block builders and validators to access the COINBASE address at lower gas costs. (This is entirely unrelated to the crypto exchange Coinbase.) This change could significantly improve Maximal Extractable Value (MEV) payments, along with other user experiences. According to developers, EIP-3651 corrects a previous oversight on the cost required to access the COINBASE address and gives users, and developers added benefits.
- EIP-3885 – EIP-3885 will lower the gas costs for developers on the platform by creating a new code called “Push0.”
- EIP-3860 – EIP-3860 will introduce a cap on the gas cost for developers when they interact with the “initcode,” a code used by developers to interact with smart contracts.
- EIP-6049 – This EIP will notify developers of the depreciation of the “SELFDESTRUCT” code, also related to lowering gas fees.
What’s Next After Shanghai?
The Shanghai update, while significant, has a relatively small score that is primarily limited to making the withdrawal of staked ETH possible at the earliest. Because of the update’s focus on staked ETH, other major changes to the Ethereum protocol have been pushed back by a few months and are likely to be released in the second half of 2023. These upgrades include modifications to the EVM Object Format (EOF), consisting of several upgrades and improvements to the Ethereum Virtual Machine, and another called “proto-danksharding,” which would have split the Ethereum blockchain into shards and made it more scalable.
This Ethereum Improvement Protocol, known as EIP-4844, had been considered to be included in the Shanghai upgrade before developers decided to push back its implementation.
What Will Be The Impact Of The Shanghai Update?
The impact of the Shanghai update would vary between different users. If you, as a validator, have staked ETH, you will now be able to access and withdraw your rewards and funds. However, it is important to remember that only some have staked 32 ETH, with many users having staked smaller amounts. If you are a trader, you are probably wondering what impact this would have on the price of ETH. With withdrawals enabled, a significant amount of liquidity would be unlocked, leading to more market liquidity.
The Shanghai update could make staking an attractive option thanks to increased market liquidity. Users who did not want to use liquid staking protocols will be able to stake ETH directly with Ethereum, leading to an increased demand for ETH. In the grander scheme of things, enabling withdrawals will promote a more accessible market, where ETH holders will be able to react according to staking demand and supply and achieve better market equilibrium.
In Closing
The Shanghai update addresses a crucial issue for stakers on Ethereum, allowing them to finally access their staked funds. It has been one of the most highly anticipated updates to the protocol, giving users a fully functional Proof-of-Stake mechanism. However, its potential impact on the markets remains to be seen. If you are interested in purchasing or learning more about Ethereum, head to CoinSmart, Canada’s most trusted crypto trading platform.
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