Ethereum's Shanghai Upgrade: The LowDown

A Tale as Old as Time

In 2015, the Ethereum network launched with a proof of work (PoW) consensus mechanism akin to that of Bitcoin. Where it set itself apart, however, was a unique functionality of being able to execute smart contracts - a feature that attracted many new projects, builders, and developers on to the network. The increased traction on Ethereum's main chain, however, led to congestion issues whereby transactions became increasingly slow and costly, thereby seeding the genesis of blockchain's scalability issue. Solving the issue of scalability was both an intricate and complex process, eventually leading to Vitalik's famous "Blockchain Trilemma" issue, whereby it was posited that out of the trifecta of scalability, decentralization and security, blockchains could only fully achieve two of the three at any one time, but never all three. To address this issue, Ethereum opted to transition its consensus mechanism from PoW to proof-of-stake (PoS). This concept of a PoS Ethereum , which was originally known as ETH 2.0, required Ethereum to instate a separate chain that utilized this PoS consensus, named the “Beacon Chain”.

In brief, PoS blockchains require users to stake their ETH to secure the network, which would then allow them to create new blocks and validate transactions on the blockchain. In return, they would receive remuneration in the form of ETH. The Beacon Chain required users to stake 32 ETH in order to become a validator on the chain. However, these users, or validators, would be unable to unstake their staked ETH or receive any rewards until the Beacon Chain had merged with the mainnet. This eventually took place in September 2022, commemorating the combination of the Beacon Chain with the new PoS Ethereum mainnet, with an Ethereum developer declaring that“this is the economic certification that we are firmly and irreversibly in the Proof of Stake network” during the launch party. However, despite this upgrade, otherwise coined as "The Merge", validators were still unable to unstake their ETH.

Here's Where the Shanghai Upgrade Comes In.

The Ethereum Shanghai Upgrade, also known as the Shapella upgrade, is the next major upgrade following “The Merge” and is an essential step in the continued development of the Ethereum protocol, finalizing its transition from PoW to PoS. This upgrade has the potential to improve the overall scalability and security of the network, increase accessibility and flexibility for users, and open the doors to new developments within Ethereum’s future roadmap.

Most importantly, however, the Shanghai upgrade would allow validators to withdraw their staked ETH from the Beacon Chain, which is in line with the Ethereum Improvement Proposal-4895, or EIP-4895.

There are caveats to this, however.

Following the Shanghai upgrade, validators would be allowed to withdraw their staked ETH in phases, thereby allowing them to cash out their hard-earned rewards. However, given the massive amount of liquidity at stake here (pun intended), the Ethereum Foundation certainly runs the risk of crashing if all validators withdrew their staked ETH altogether at the same time. Currently, staked ETH accounts for about one-seventh of the total ETH supply, which equates to a staggering $26 billion.

To avoid this scenario of pandemonium, limits will be imposed on the number of withdrawals that validators may make on each block, thereby styming the outflow of staked ETH from the chain. Validators, however, will not be required to pay gas fees to process their withdrawal transaction.

Withdrawals: How they Work

When processing their withdrawals, validators will be able to have the option of choosing between partial or full withdrawals.

Partial Withdrawals

For partial withdrawals, validators will only withdraw the rewards that they have earned previously. Their validator account and status, however, will be retained and will still be active on the Beacon Chain, allowing them to continue validating their transactions as per normal.

Full Withdrawals

Full withdrawals, on the other hand, would allow validators to extract their entire staked balance, which includes the initial 32 ETH that was required for them to achieve their validator status, alongside all other rewards earned at the same time. However, to initiate this full withdrawal, validators are required to submit a voluntary exit message with their validator keys, starting the process of exiting from staking, and their validator account will be placed in the exit queue.

As with all transactions on any blockchain, the time taken to actually exit may depend on how many other validators are in the process of doing the same. Upon completion of the full exit process, the validator's account will lose its validator status and will no longer be eligible for rewards.

Could the Shanghai Upgrade Impact the Price of ETH?

At present, it is uncertain as to whether or not the Shanghai Upgrade will positively or negatively affect the price of ETH. However, if reactions to the Shanghai Upgrade are anything like what we saw with The Merge, we can safely assume that it is likely to generate quite a bit of excitement, together with a boost in overall demand. However, some also speculate that the "mass unlocking" of staked ETH may potentially lead to selling pressure due to the increased supply in circulation as well, thereby reducing the value of ETH.

Other Improvements

Besides the main development of EIP-4895, the Shanghai upgrade also includes several smaller EIPs that aim to reduce gas fees during times of high network activity, providing benefits to Ethereum developers. Among these proposed improvements are EIP-3860, which sets limits on developer gas costs in specific cases, and EIP-6049, which addresses a related concern.

Closing Words

While the Shanghai upgrade (or Shapella upgrade, if that suits your fancy), may not be as revolutionary as The Merge upgrade, it could nevertheless still have large impacts for users with staked ETH and the broader Ethereum community in general.

While the Shanghai upgrade may be the object of our focus at this point in time, it should also perhaps be mindful to consider the planned upgrades on Ethereum in the future that are expected to arrive in the later half of 2023, such as some intended improvements to the Ethereum Virtual Machine (EVM) and another aiming to divide the Ethereum blockchain into various "shards" to improve scalability.

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