The Shanghai Upgrade - Beyond the Sea of New Opportunities for Ethereum Users

Ethereum has seen a considerable increase in revenues and drop in costs since the Merge in September 2022 which changed its consensus mechanism from proof-of-work (PoW) to proof-of-stake (PoS). Soon, the blockchain will experience another major upgrade called Shanghai.

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What is the Shanghai Upgrade?

The Shanghai Upgrade is part of Ethereum's ongoing evolution to Ethereum 2.0, a set of upgrades that aims to make the blockchain more scalable, secure, and sustainable.

Before getting to the details about the Shanghai Upgrade, we need to brush upon the basics about Ethereum a bit. The Ethereum blockchain is made up of two layers, which are the execution layer and the consensus layer. The former hosts all smart contracts and protocol rules, and the latter is where the validators are made sure to follow the protocol rules. Therefore, when Ethereum undergoes a comprehensive upgrade like the Merge or Shanghai, it entails both layers. The upgrades on execution layers are named after past host cities of Devcon, whereas the upgrades for the other layer are named after celestial objects.

This time, indeed, the upgrade on the execution layer is called Shanghai, while that on the consensus layer is named Capella (one of the biggest and brightest stars in the sky). Thus, the name of the whole Ethereum upgrade actually is Shapella, a combination of Shanghai and Capella. But most people are more familiar with the name Shanghai, which is technically not a wrong name, so we will call it the Shanghai Upgrade for the sake of simplicity and familiarity.

The Shanghai Upgrade is a hard fork that will implement five Ethereum Improvement Proposals (EIPs) as follows:

- EIP-4895: Enabling validators to fully or partially withdraw staked ETH

- EIP-3651: Reducing gas costs for validators and block builders when they receive fees for maintaining the blockchain

- EIP-3855: Lowering gas costs for developers

- EIP-3860: Putting a limit on developer gas costs in specific cases

- EIP-6049: Putting a limit on developer gas costs in some other situations

These EIPs were tested and selected during the Shandong testnet, which was launched in October 2022 to prepare for the Shanghai Upgrade on the mainnet. Among these five, EIP-4895 is considered the most important and highly anticipated.

The Shanghai Upgrade was supposed to go live in March 2023, but the release time was pushed back to 22:27:35 UTC on April 12 due to delays during one of the testnet executions.

After the official implementation of the Shanghai Upgrade, Ethereum will allegedly complete the remaining work of the Merge and transition into a fully functioning PoS blockchain.

Why the Shanghai Upgrade matters

Since Ethereum introduced the PoS model on the Beacon Chain in 2020, people have been able to stake ETH and accrue rewards for validating the network, but withdrawing the staked and accrued ETH has not been possible. That leads to the birth of liquid staking, the act of staking or delegating a small amount of ETH to validators in order to receive a different token that represents the staked ETH and can be used for other purposes.

Everything is going to change after the Shanghai Upgrade and validators will be able to withdraw their ETH.

It is estimated that there is approximately 17.9 million staked ETH on Ethereum, which represents roughly 15% of the total circulating supply and is priced at around $32 billion at the curren t price. EIP-4895 will certainly lead to the release of a portion of those staked ETH tokens to the market, increasing the circulating supply of ETH.

However, crypto investors do not need to worry much that all $32 billion will be released to the market at once. There will be two types of ETH withdrawal, partial and full. Those who want to fully withdraw (also known as unstake) must wait in an exit queue, and the number of validators who can make a full withdrawal is limited per every 32 blocks. These limits prevent a mass withdrawal that could potentially disrupt the operation of Ethereum and cause a collapse in ETH price.

That said, an increase in ETH circulating supply can spur more robust activities on Ethereum and the various layer-2 blockchains. Also, as validators are now more deliberate in using their staked ETH, it is speculated that more people will work as validators on Ethereum. Whether the new validators stake their own ETH or use ETH from liquid stakers, they contribute to enhancing the decentralization of the network and making Ethereum more secure. Actually, the network already experienced a surge in staked ETH and the number of validators prior to the Shanghai Upgrade, exceeding 500,000 in total validators. On the part of liquid stakers, they can easily withdraw the ETH rewards and use them to support more validators, thus earning even more ETH as a result.

The general sentiment around EIP-4895 is positive. Yet, as positive as we may get, allowing the withdrawal of staked ETH will undoubtedly change the basic market structure of ETH and the ramifications may not fully manifest all at once right after the Upgrade.

Additionally, the Shanghai Upgrade will significantly decrease gas fees for Ethereum and all layer-2s running on top of Ethereum. High gas fees have been one of the biggest issues with Ethereum, so it is not unreasonable to expect a boom in dapps and activities in all these chains after the Upgrade.

Conclusion

The Shanghai Upgrade has again proven that Ethereum is indeed one of the most decentralized, popular, and advanced blockchain at the moment. The sheer efforts put in this Upgrade from developers all over the world are incredible. In fact, the Shanghai Upgrade was supposed to include EIP-4844, which is a proposal about sharding. But due to the complicated nature of EIP-4895 and the workload that comes with it, it was decided that EIP-4844 would be postponed to the Cancun Upgrade that would happen later in 2023.

The Shanghai Upgrade will allow stakers and validators to be able to withdraw staked ETH, as well as to further reduce gas costs for Ethereum users. After that, the Cancun Upgrade will introduce sharding to the network, improving transaction speed and substantially scaling Ethereum. It is exciting to see how Ethereum will grow in the future.

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