What the Ethereum Shanghai Upgrade Will Mean for ETH Liquidity

One of the most important events for the Ethereum blockchain is probably the Shanghai Upgrade. Currently scheduled for the second half of 2023, the Shanghai upgrade will implement a number of improvements to Ethereum. Chief among them is the ability for ether (ETH) players to withdraw both their staked coins and earned rewards.

Users have been helping to validate transactions on the so-called Beacon Chain since December 2020, when the proof-of-stake network was launched. But so far, staking has been a one-way trip: Funds were locked up in the deposit contract while Ethereum developers built out the network in real time.

Protocols such as Lido, Rocketpool and StakeWise have started offering “liquid staking” minted tokens to fill the gap. These tokens represent staked ETH, but fluctuate in price, and can be used across the decentralized finance (DeFi) ecosystem. It remains to be seen how the upcoming Shanghai upgrade – which could pre-empt a flood of ETH tokens into the market by enabling new and existing stakers to withdraw – will affect these protocols that dominate liquid stakes today.

Overall, this upcoming upgrade has the ability to increase the popularity of ETH staking. It will drive competition between staking protocols to the benefit of users, while improving the security of Ethereum’s new PoS chain.

It’s easy to think that launching Shanghai in the middle of a bear market could hurt the staking ecosystem. Stakeholders who are bullish on the macro outlook for crypto in 2023 may choose to withdraw ETH, keeping their holdings liquid in the event of more market turmoil. Wary of regulatory moves against betting providers, new stakers may not rush to cash in the same way as during the frenzy of a bull market.

In the long run, however, Shanghai (specifically the ability to unstake and withdraw rewards) is positive for Ethereum. Specifically, Shanghai will increase incentives for ETH liquidity providers in three main ways.

First, Shanghai will stimulate more innovation in direct staking and floating staking solutions. The ability to stake, withdraw and reclaim ETH rewards with more frequency will create more nuanced financial applications as people explore opportunities to maximize returns while minimizing risk. We will see heavy innovation in derivatives staking, and likely see more complex lending solutions to give people access to ETH stakes.

Shanghai will also be a boon for individual liquidity providers on liquid betting platforms. The ability for people to redeem their wrapped ETH for underlying staked ETH will force floating stake platforms to become even more user-friendly. We will see more features and incentives emerge as these floating stake protocols vie for liquidity providers in a world where staked ETH is suddenly liquid.

Second, Shanghai will strengthen ETH’s position as the blueprint for staking protocols. The yield that Ethereum pays after Shanghai – which is a matter of network liquidity and transaction volumes – will appear as a kind of “base yield” for crypto. Newer and existing staking protocols will have to compete with Ethereum’s return mechanism, likely making the asset class more secure, reliable and predictable – and less risky.

Third, Shanghai will provide ETH liquidity providers with simple but powerful emotional security. In crypto, the guiding principle is sovereignty over your assets. Contracts that require locking up funds are a tough pill to swallow, even for those who believe deeply in Ethereum. With Shanghai, the emotional barrier to participation is lifted and liquidity providers will more confidently commit their stake.

Taken together, the Shanghai upgrade will initiate a new cycle of innovation focused on ETH staking. Liquidity providers will be the concrete benefactors of this innovation, gaining access to a growing ecosystem of features, tools and service providers. The end result is a more decentralized ecosystem of contributors and a more secure network.

There is one main consideration we should keep in mind after Shanghai goes live – to invest in centralization. On the surface, an increase in ETH staking means an increase in the network’s “decentralization”. However, if the majority of new entrants post-Shanghai choose to invest through a provider such as the crypto exchange Coinbase, we risk seeing a few centralized and chain providers dominate the ecosystem.

With this consideration in mind, we hope to see enough innovation in the striking industry that decentralization increases in the long term. More competition means more choice, which can drive protocols to differentiate themselves with better products and consumer offerings. Also, organizations like the Ethereum Foundation should focus on UX [user experience] of individual stake holders to stimulate a more robust stake network.

There are many more upgrades planned for Ethereum in the future. But the Shanghai upgrade brings with it a sense of “we’ve done it.” The transition to proof-of-stake finally feels complete. The network survived and is now ready to thrive.