In this article, we provide an explanation of the Shapella upgrade, its significance as well as the implications for ETH and the wider crypto market.
Ethereum embarked on a journey towards a full Proof of Stake (PoS) in December 2020 with the launch of the Beacon chain, progressed a step further with a successful Merge in September 2022 and will be completed at or around April 12th, 22:27 UTC at slot 6209536 with the activation of Shapella. There’ll be no change to the user experience, the protocol changes are only relevant to solo stakers and validators.
Shapella Overview
What’s all the fuss about? Shapella is an important upgrade for 3 reasons:
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It’s the last piece of the puzzle that marks the completion of Ethereum’s transition to PoS. Staking is no longer a one-way street and stakers will finally be able to partially or fully withdraw their funds from the Beacon chain.
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It reduces uncertainty and risks around staking, thereby improving confidence in the Ethereum ecosystem. The staking ratio is likely to increase from the current level of around 15% and ascend to levels seen in other PoS blockchains (above 35%).
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The upgrade is likely to encourage more institutional investors to get involved, given the activation of withdrawals from the Beacon chain. By completing its journey to a full PoS system, ETH becomes a yield-bearing asset similar to a bond.
Since the launch of the Beacon chain in 2020 up until now, it’s not been possible to directly convert staked ETH back to ETH. As of April 12th, there are just over 18 million ETH being staked across more than 560,000 validators. In return for securing the network, validators earn freshly issued ETH, as well as priority tips and MEV rewards.
Source: Beaconcha.in
With the Merge, Proof of Work was deprecated for Ethereum and the last piece of the puzzle was to unlock the staked ETH on the Beacon chain, including rewards earned by validators. This is exactly what Shapella is going to achieve, which refers to the combination of two upgrades: Shanghai for Ethereum’s Execution Layer and Capella for Ethereum Consensus Layer.
To make it possible to unlock their staked ETH, Shapella introduces something that’s known as a BLSToExecutionChange (BTEC) message to the Consensus Layer, which allows validators to set the execution address for withdrawals. Once validators have set their execution address, they can go through with a full withdrawal (which means exiting a validator) or a partial withdrawal (where they can withdraw some of their excess balance).
The former requires validators to go through two queues (the withdrawal queue and exit queue), while the latter can bypass queues and become liquid relatively quickly. However, the Beacon chain can only process a maximum of 16 withdrawals per block, with the limit in place to maintain network security. Withdrawals require no gas or fees, unlike other Ethereum transactions, since they are treated as a balance increase.
On the Execution Layer, EIP-4895 introduces Beacon chain push withdrawals as operations, so that validators can withdraw their issuance rewards from the Beacon Chain, as well as their staking balance.
To gauge different scenarios following Shapella, 21Shares recently released some results from their Ethereum Withdrawal Simulator. As shown below, under the best-case scenario, the queue for full withdrawals may take up to 20 days, while under the worst-case scenario, it is estimated to be as long as 123 days.
To monitor the exit queue, there are several tools traders can use, such as Beaconcha.in, Metrika’s ETH - withdrawals overview dashboard and wenmerge.com.
Have more questions about withdrawals? Check out this resource: https://notes.ethereum.org/@launchpad/withdrawals-faq
Shapella Deployment
One of the beneficial outcomes of the Merge and kickstarting the move to PoS was that Ethereum transactions now have more certainty. A slot is every 12 seconds and 12 slots make up an epoch (6.4 minutes), while block times under Proof of Work were highly variable.
That means the Shapella upgrade can be conducted at a highly predictable time, given that the activation will occur at slot number 6209536 (April 12th, approximately 22:27 UTC).
If you want to witness this historic moment for Ethereum, tune in to the EthStakers and Ethereum Cat Herders launch party on YouTube later tonight!👇
How Will Shapella Affect the Price of ETH?
One of the biggest questions on everyone’s mind is: how will Shapella affect the price of ETH?
Taking the Merge as a case study, it turned out to be a buy the rumor, sell the news type of event and the same could very well happen for Shapella. Although withdrawals will go live after the upgrade, it is yet to be seen how much ETH will be unstaked and potentially put pressure on the price.
But it’s important to note that not all withdrawals will lead to selling pressure for ETH. It’s likely that the majority of ETH stakers believe in the long-term success of the protocol and are staking not just purely for profit-seeking motives, since over 18 million ETH were staked without any timeline on when withdrawals would be opened up.
Also, about 71% of stakers are at a loss in USD terms as compared to the price of ETH when staking was initiated, so it wouldn’t make sense for validators to exit and sell their ETH as soon as Shapella goes live. Traders can follow the change in the circulating supply of ETH following Shapella using this dashboard created by Metrika.
Secondly, many of the withdrawals from the Beacon chain may be restaked with a different protocol/venue. There are also forced withdrawals, such as Kraken, which had to shut down its staking operations in the US due to regulatory pressure and Celsius because of bankruptcy.
Finally, because of how PoS works on Ethereum, it’s not possible for validators to compound their earnings. Any balance above 32 ETH is still equivalent to one validator and, to set up another validator to earn more rewards, a user must first withdraw their staking rewards then accumulate some more ETH to deploy another validator.
If you already run a validator, check out this guide for the latest client releases and walkthroughs of how to exit a validator.
However, some increase in the circulating supply of ETH is expected, as some earnings are withdrawn and there are some validators that exit. Blockchain analytics firm Glassnode estimates that the selling pressure following the activation of withdrawals would be around $300 million worth of ETH. The report notes that this amount is fairly consistent with the average weekly inflow of ETH to exchanges, so the price impact is expected to be mild even in the extreme case where a large amount of ETH is unstaked.
The consensus is that Shapella is expected to have little to no immediate effect on the price. But in the medium to long term, the upgrade is viewed as bullish, as it’s more likely that a greater amount of ETH will be staked due to the convertibility between staked ETH and ETH, which removes any liquidity risks for staked derivatives.
State of Liquid Staking Derivatives
Shapella will be a catalyst for liquid staking derivatives and staking-related tokens. The table below shows the state of the liquid staking market, with Lido holding the crown as the most dominant protocol. However, Frax Finance has seen tremendous growth since launching frxETH and is now in fourth place, just behind RocketPool with a 1.7% market share.
Source: Dune
LSD Market Snapshot
The table below provides a market snapshot of 6 of the key crypto-assets related to staking or liquid staking from the top ERC-20s by market capitalization (with ETH provided for comparison). All these liquid staking derivatives (LSD) related tokens have outperformed ETH year-to-date. As mentioned in our 2023 outlook, LSDs will be one of the dominant themes for the crypto markets this year.
Over the past week and month leading up to the Shapella upgrade, ETH has outperformed these tokens, with only RPL, ANKR and YFI closely tracking ETH’s performance. When considering growth in trading volumes, RPL stands out as the only gainer which could suggest greater upside potential following the Shapella upgrade (especially if volume continues to increase).
All other tokens listed above have seen large declines in volume in the month leading up to Shapella, which suggests traders are losing interest in these assets (although there could be a renewed volume burst following the upgrade).
Data correct as of April 12th, 10:00 UTC. Sources: Sanbase & TradingView.
As for daily active addresses, only ETH and YFI have seen increases in the past month out of the assets listed above, which may suggest most crypto traders are positioning themselves for bullish continuation following Shapella. All the other staking related tokens mentioned have experienced a decline in the number of active addresses.
Want to explore other potential plays following Shapella? A complete list of LSDs can be found here.
Following on the heels of the Shapella upgrade is RocketPool’s very own upgrade on April 18th (00:00 UTC), known as Atlas, which allows anyone can run a minipool with just 8 ETH (instead of the 16 ETH that’s currently required to run a RocketPool minipool). The RPL token benefits from any influx of new validators, as to run a minipool you’ll also need at least 10% of your staked ETH amount in RPL tokens. This means as more ETH is staked with RocketPool and the circulation of rETH rises, so will the market capitalization of RPL.
If you want to get set up with running a minipool, do a practice run on testnet first and make good use of the guides provided by the RocketPool community!
With the risk of not being able to redeem for ETH eliminated, there’s a high likelihood of large inflows into liquid staking tokens following Shapella. LSDs provide a convenient way to earn yield from staking, especially if the queues to enter and exit as a validator become really long, so it's possible that the tokens mentioned above continue their stellar performance throughout 2023.
Summary
In summary, the Shapella upgrade completes the transition to a full PoS system, enabling withdrawals from the Beacon chain and is expected to be a positive catalyst for the entire Ethereum ecosystem.
While the selling pressure from unstaked ETH and validator rewards is not expected to affect the market significantly, the elimination of risks surrounding staking should entice more investors. In turn, this should boost Ethereum’s staking ratio, effectively removing more ETH from the circulating supply and bringing more institutional players into the fold.
Shapella is a significant milestone and drives us closer towards completion of the Merge portion of Ethereum roadmap (shown above by the top row). The next steps will help to realize the vision of making staking more accessible, decentralized and as robust as possible with upcoming upgrades such as secret leader elections and single slot finality.