Upgrading to the Future: A Closer Look at Ethereum's Shanghai & Capella Upgrades

Ethereum’s Shanghai/Capella (‘Shapella’) upgrade, scheduled for April 12th, 2023, marks a significant milestone for Ethereum, as it enables staking withdrawals and allows validators to unlock their staked ETH rewards.

Fun fact: ‘Shapella’ is a portmanteau of ‘Shanghai’ (Ethereum’s execution layer) and ‘Capella’ (Ethereum’s consensus layer). Shanghai will introduce a novel transaction type at the execution layer, enabling stakers to withdraw validator balances. Meanwhile, at the consensus layer, Capella will enable the Beacon Chain to process withdrawal requests.

Staking involves depositing 32 ETH to activate the validator software, which is responsible for storing data, processing transactions, and adding new blocks to the Ethereum blockchain.

Around 18 million ETH ($34.5 billion – or about 15% of the total supply), is currently staked and locked in the network. This locked ETH will soon be accessible to validators- all thanks to the Shanghai upgrade!

Ehereum staking began in 2020 when Ethereum started transitioning from a Proof of Work (PoW) to a Proof of Stake (PoS) consensus mechanism. The launch of the Beacon Chain was the first step in this transition, introducing the PoS protocol and validators who stake (or ‘lock up’) 32 ETH to participate in the consensus process.

Until the Shapella upgrade, staking has notoriously been a one way street- validators could stake ETH for purposes such as earning rewards or participating in governance, but could not withdraw any funds.

The upcoming Ethereum network upgrade will introduce five Ethereum Improvement Proposals (EIPs) in which EIP-4895 is one of the key upgrades as it will unlock staked ETH and allow withdrawals.

1. Warm Coinbase addresses: EIP-3651 aims to reduce the high gas cost of accessing the Coinbase. This will save gas fees and make Coinbase payments more affordable.

2. PUSH0 Instruction: EIP-3855 introduces the PUSH0 instruction to the EVM, aiming to reduce gas and storage costs for contracts pushing constant 0 onto the stack. This proposal simplifies the process, minimizes redundancy, and lowers the risk of contract misuse.

3. Beacon chain push withdrawals as operations: EIP-4895 is the main focus of the Shanghai Upgrade, facilitating the withdrawal of staked ETH for validators.Upon implementation, EIP-4895 will enable validators to seamlessly transfer withdrawals from the Beacon Chain. Learn more about withdrawals below.

4. Limit and meter initcode: EIP-3860 proposes to limit the size of code that creates new contracts on Ethereum and add a small cost to it to make it fair. Currently, there is no limit, which can lead to delays and risks. By adding these limits and costs, EIP-3860 aims to simplify the process and reduce the potential for harmful code.

With the withdrawal feature, validators will be able to exit the network and retrieve their staked ETH and rewards.

For solo stakers, there are two types of withdrawals:

1. Partial withdrawals: When a validator's balance exceeds 32 ETH, the extra amount can be withdrawn and used immediately, while they continue participating in the Beacon Chain.
2. Full withdrawals: If a validator exits the Beacon Chain, their total balance, including the initial 32 ETH and rewards, is unlocked and spendable after the exit process finishes.

Withdrawals

A popular concern is that the unlocking of 18 million ETH could potentially trigger a massive sell-off in the market. An increased supply of ETH may drive the price downward.

Partial withdrawal will happen automatically.While users can still access their partial rewards immediately, the actual processing of withdrawal requests could take hours due to the limit of 16 requests per slot and the 12-second interval between slots. The processing time will depend on the number of requests submitted once the Shanghai update is live.

This concern is somewhat alleviated by the fact that full withdrawals aren't automatic. Validators must send a message to the blockchain to join the exit queue. To maintain network security and stability, the withdrawal rate establishes a churn limit, dictating the maximum number of validators allowed to exit during each epoch (32 blocks, or 6.4 minutes approximately) .With a total of 563061 active validators, only 7 can complete full withdrawals per epoch.

Lower Participation in ETH Staking

Currently, only 15.66% of the circulating ETH supply is staked, significantly lower than other Proof of Stake (PoS) tokens. This is primarily due to the risks and limitations associated with staking ETH, such as the uncertain timeline for the Shanghai Upgrade and the inability to unstake until the upgrade is complete.

Liquid Staking Derivative Demand

After the Upgrade, liquid staking for ETH is expected to gain popularity as Liquid staking derivatives allow users to earn rewards without locking their funds and provide easy exit options. When users deposit ETH, they receive a token representing their staked amount, which increases in value based on earned rewards.

Currently, liquid staking accounts for 33.29% of the total ETH staked. Lido Finance, the first liquid staking provider, holds 31.2% of all staked ETH and 72.9% of the liquid staked ETH market share.

Rocket Pool Atlas Upgrade (April 18): The Atlas Upgrade for Rocket Pool aims to significantly scale the protocol to meet growing demand. Key features include: ETH unstaking, gas optimization for reduced transaction costs, higher rewards for node operators, and the introduction of 8 ETH minipools to increase accessibility.

Fold Finance mevETH: Fold Finance is introducing mevETH, a liquid staking solution with omnichain and LayerZero capabilities. This innovative solution offers high yields via MEV (Miner Extractable Value) and enables seamless cross-chain transactions for enhanced user experience and greater flexibility.

Eigenlayer Testnet Launch: Eigenlayer has launched its testnet, which features liquid and native restaking options for users. The platform aims to provide more efficient staking solutions and improved user experience through its innovative approach to liquid staking.

Ethereum's upcoming major upgrade following the Shanghai fork is the Cancun fork, which is anticipated to launch later this year. One of the key features of Cancun is the implementation of EIP-4844, also known as Proto-Danksharding or ‘The Surge.’

This enhancement aims to boost the scalability of Layer 2 rollups, paving the way for Ethereum sharding.

Cancun may also introduce a new contract format to the Ethereum Virtual Machine, Ethereum’s core smart contract engine, called the EVM Object Format (EOF).

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