The Ethereum Shanghai Upgrade: Everything you need to know

Published on 13 March 2023 by Lotte Berends in News Research

Introduction

The Ethereum Shanghai Upgrade, set to take place in April 2023, is the next highly anticipated hard fork upgrade aimed at introducing several developments and improvements to Ethereum. The unlocking of staked ETH is by far the most anticipated and most discussed aspect of the upgrade. This article will discuss the key aims of the upgrade, the possible consequences of unlocking staked ETH, lower gas fees, and the introduction of the EVM Object Format.

Aims of the Shanghai Upgrade

The objective of the Shanghai Upgrade is to address three key issues pertinent to Ethereum’s functionality. These concerns encompass enhancements to the gas fees of Layer-2 solutions, developments in the Beacon Chain, and changes to the EVM Object Format. Through the implementation of this upgrade, Ethereum seeks to optimize its performance by addressing some of the challenges they have been facing. The Ethereum Shanghai Upgrade contains five Ethereum Improvement Proposals (EIPs), which we have listed with their main focus area:

EIP-3651: Possible reduction in network fees.
EIP-3855: Possible reduction in size of transactions.
EIP-3860: Possible solution for a vulnerability that could be exploited in a Denial-of-Service attack, along with the implementation of a limit on gas fees.
EIP-4895: Unlocking staked ETH for withdrawal.
EIP-6049: Possible capping of transaction fees with a positive impact for Ethereum developers.

Unlocking of staked ETH

Shanghai Upgrade set to unlock staked ETH

Before the Ethereum Merge, in which the network switched to its current Proof of Stake consensus mechanism, people interested in acquiring a position as validator on the Beacon Chain had to stake a certain amount of ether (ETH) as a way of ensuring that they will act in the best interest of the system. After the Merge, these staked amounts of ETH remained locked up in the smart contract. EIP-4895 of the Shanghai Upgrade is set to lift the restriction on the withdrawal of locked ETH, which will allow for the retrieval of staked ETH in a phased manner.

Consequences for ETH price levels

If a large amount of staked ETH is unlocked and released onto the market, it may have a significant impact on the supply and demand dynamics of the Ethereum ecosystem. The unlocking of staked ETH may release a significant amount of the coin onto the market, resulting in a sudden increase in the supply which could lower the price of ETH. With more than 16 million ETH locked as of March 2023 (figure 1), almost 14% of the current amount in circulation, the effect on supply can be significant. The phased release of staked ETH is aimed at mitigating the potential negative impact on ETH’s price volatility. However, only 31% of people that have staked ETH are currently in profit (figure 2), which would not make selling staked ETH particularly appealing right now. There are also people that argue that the ability to withdraw staked ETH quickly will encourage more people to become validators and stake amounts of ETH while doing so. This could reduce the supply and consequently increase the price, but its expected effect is limited.

Figure 1. Source: Ethereum’s Shanghai Upgrade, by the charts. By Binance Reserach.

Figure 2. Source: Ethereum’s Shanghai Upgrade, by the charts. By Binance Reserach.

Participation in the network

Unlocking staked ETH may also impact network participation, as validators may choose to withdraw their staked ETH if they feel that the incentives or conditions for staking are no longer favorable. This may impact the overall security and efficiency of the network, as fewer validators would be available to validate transactions and create new blocks.

On the other hand, the ability to withdraw staked ETH may serve as an incentive for more individuals to actively participate in the Ethereum network as validators. The network’s security will benefit from this.

Overall, the convergent expectations about the consequences of the Shanghai Upgrade for network participation pose a challenge to making any hard predictions. It will be interesting to see what the upgrade’s actual effects will be and how Ethereum will continue to draw participants to their network.

Impact on the crypto market

In the mid-to-long term, it is expected that the unstaking of ETH will not have a significant negative impact on the crypto market. Concerning the short term, a potential mass release of ETH might result in market-wide consolidation, but overall, the effects on prices are expected to be limited.

Aside from a possible effect on prices, the unstaking of ETH might have consequences for other networks that operate on a Proof of Stake consensus mechanism. Once the Ethereum staking pool opens up, users and validators from other PoS-networks might turn to the Ethereum Network.

Lower gas fees

In addition to unlocking staked ETH, the Shaghai Upgrade also aims at lowering the gas fees concerning Layer-2 solutions built on the Ethereum network. A whole range of Layer-2 solutions has already contributed to making the use of Ethereum faster and more cost-effective. The Shanghai Upgrade intends to enhance this even further by optimizing the gas fee consumption for transactions performed on the network. This development has the potential to significantly reduce transaction costs for users and increase the overall efficiency of the Ethereum network, thereby improving its appeal and viability as a decentralized platform.

Introduction of the EVM Object Format

The upcoming update is also set to introduce the EVM Object Format, or EOF for short, which is expected to further consolidate Ethereum’s position as the largest blockchain network that supports smart contracts. The EOF contains a number of Ethereum Improvement Proposals aimed at improving the implementation process of future upgrades, and at making the system faster, safer and cheaper. The improvement proposals of this EOF will either be implemented with the Shanghai Upgrade, or with the Cancún Upgrade that will follow later in 2023.

The Shanghai Upgrade in the bigger picture

The Shanghai Upgrade will be another major upgrade to the Ethereum Network in a row of others (figure 3), accommodating the network’s switch from proof of work to proof of stake, improving usability, and consolidating Ethereum’s position on the market.

The implementation of these upgrades is expected to pave the way for the next stage of the Ethereum blockchain’s development, with a particular emphasis on the implementation of “sharding.” This technique involves dividing the blockchain into smaller, interconnected chains or “shards,” with each shard responsible for processing a subset of the overall transaction load. The introduction of sharding is seen as a crucial step towards improving the scalability and performance of the Ethereum blockchain, and is expected to facilitate the processing of a higher volume of transactions while maintaining the security and decentralization of the network. However, for now, we will first eagerly await the implementation of the 2023 Shanghai Upgrade.

Figure 3. Timeline of recent Ethereum upgrades. By Kiln.

Conclusion

In this article, we discussed the key points of the upcoming Shanghai Upgrade, with the most anticipated one being the unlocking of staked ETH, and the possible consequences for the network and the crypto market. In conclusion, the Shanghai Upgrade represents a major step forward for the Ethereum network, addressing key issues related to gas fees and staking. With the ability to unlock staked ETH, there may be an impact on the supply and demand dynamics of the Ethereum ecosystem, potentially lowering the price of ETH or encouraging more individuals to become validators. The upcoming update also aims to reduce gas fees and introduce the EVM Object Format, which is expected to further enhance the efficiency, speed, and security of the Ethereum network. While the implementation of sharding is still pending, the Shanghai Upgrade is a crucial development that paves the way for future advancements in the Ethereum ecosystem. Despite the potential challenges and uncertainties that come with these upgrades, it is clear that the Ethereum network is committed to innovation and growth, striving to remain at the forefront of the decentralized technology landscape.