The Shanghai Upgrade - Selling Pressure? Or Buying Pressure for $ETH

What Is Shanghai Upgrade and When Will It Happen?

After the Merge was successfully delivered on September 2022, the remaining missing component of Ethereum economic model is the withdrawal of staked $ETH. Shanghai upgrade will include code allowing withdrawals of $ETH staked in the Beacon Chain since December 2020, finally giving the network participants the ability to take out their locked $ETH. The upgrade is now set for March and will include a few other things in addition to the withdrawal function.

We are all aware that Ethereum core developers frequently postpone their proposed timelines, but this time they have been very clear that the withdrawal function will be the Core of Shanghai upgrade, and other EIPs will only be included if there is no delay in withdrawal.

Massive Withdrawal Is Both Unlikely and Prevented By a Mechanism

The fear of a massive withdrawal of staked $ETH and subsequent selling pressure on the price of $ETH is unfounded. There are currently 15.9 million units $ETH staked, which is worth around $20 billion value. 77% of the total staked $ETH was staked when the price was higher than the current price, investors are unlikely to immediately withdraw and sell after the upgrade in such an underwatered position. These stakers chose to stake when there was no clear timeline for withdrawal, suggesting they presumably are long-term holders.

It may be argued that the price of staked has no direct relationship with the cost of purchase as one can have a $100 cost basis of his holdings but staked when $ETH was traded at $3,000. In such a scenario, they will take profit and exit the position. The selling pressure from this group has very little impact due to the withdrawal mechanism.

Full Withdrawal and Partial Withdrawal

There are two kinds of withdrawal, full withdrawal, and partial withdrawal. A full withdrawal refers to the validator removing a full node of 32 $ETH from the staking pool.

A withdrawal queue is designed to prevent potential sell-off of staked $ETH as a result of full withdrawal. Only six validators (32 $ETH per validator) are allowed to exit per epoch (an epoch is 6.4 minutes for Ethereum). As a result, a total of 1,350 validators can exit per day, which has 43,200 $ETH per day and is worth $56M at the current price. Even if all of these $ETH are sold within the same day, they represent only 0.8% of the $ETH daily trading volume and can be easily absorbed by the market.

Besides the full exit of the validator, there is also the option of partial withdrawal, which refers to transferring the excess (more than 32) $ETH to the withdrawal address. While every validator node must have 32 $ETH, the validating rewards accrued do not compound. To compound, one need to withdraw those $ETH that is more than 32 unit and re-deposit them. However, this is not possible before the withdrawal is enabled.

The current average node balance is estimated to be 33.95 $ETH, so there is a 1.95 unit of $ETH that exceeds the 32 unit. This excess portion will be withdrawn and re-staked or sold in the market. The current total number of validators is 497,773; thus, 970,657 units of $ETH will be withdrawn. These $ETH are accumulated staking rewards since the start of the staking function in 2020; a large number of partial withdrawals is a one-time event, and the number of partial withdrawals will be small in the future.

The majority of these partially withdrawn $ETH is likely to be re-staked, but given the significant size, there may be some selling pressure in the initial days after withdrawal is made available. This pressure, however, will likely pass soon due to their one-time nature.

More people will stake $ETH after the Shanghai upgrade

Ethereum has the lowest staking ratio (amount staked / total supply) among all layer 1 blockchains. People are reluctant to stake because they cannot withdraw their $ETH. The staking ratio is expected to rise following the Shanghai upgrade. Since the staking ratio would still be significantly lower than those of other PoS blockchains, even if it doubled from its current level, there is lots of room for growth.

Re-staking provides additional rewards for $ETH stakers

Re-staking initially meant to take the staking rewards and re-stake them in order to reap the benefits of a larger base’s compounding effect. A new middle-ware project called EigenLayer created an innovative approach to re-use staked $ETH, and completely redefines what “re-staking” means.

Eigenlayer is a protocol that allows validators to use their staked $ETH to validate other protocols in addition to the Ethereum simultaneously parallel. This means that you can re-use your staked $ETH that is being used to secure Ethereum to help secure other protocols such as oracles and cross-chain bridges.

Protocols running on Ethereum are already secured by Ethereum’s validators. Eigenlayer can assist in securing those protocols that are not directly built on Ethereum. Oracles are one example. Chainlink is secured by its native token $LINK, and can use the re-stake function to gain security from Ethereum’s validators, this can provide 10x more security and reduce the likelihood of a profitable oracle attack.

By helping secure additional protocols, $ETH stakers can gain extra yield provided by those protocols in addition to the current staking yield. The current $ETH staking yield consists of two components: $ETH issuance (approximately 1,700 units of $ETH per day) and transaction fees which vary depending on the network usage. In the future, the total yield of stakers will include a third component, a services fee paid by protocols that use Ethereum validating power. More people will stake their $ETH if the total staking yield is higher.

Closing Thoughts

We are now in the 2nd year of this bear cycle, and there may not be a rebound this year. Crypto OGs always say that good technological advancement only happens during a bear market, and this appears to be true.

Shanghai upgrade is on the way, and Eigenlayer is probably the most innovative way to leverage Ethereum’s vast security power. As a responsible holder of $ETH, I will stake my holdings after the Shanghai upgrade to secure Ethereum and the ecosystem, and I recommend you do the same.