What the Ethereum Shanghai Upgrade Will Mean for ETH Liquidity

One of the most significant events for the Ethereum blockchain is likely to be the Shanghai upgrade. Currently planned 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) stakers to withdraw both their staked coins and accrued rewards.

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

This article is part of CoinDesk’s “BUIDL Week.” Kevin de Patoul is the co-founder and CEO of Keyrock.

Protocols such as Lido, Rocketpool and StakeWise have begun 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 may precede a flood of ETH tokens into the market, by enabling new and existing stakers to withdraw – will affect these protocols that dominate liquid staking today.

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

Bullish signals

It’s easy to think that launching Shanghai in the middle of a bear market could hurt the staking ecosystem. Stakers, skittish about the macro outlook of crypto in 2023, may choose to withdraw their ETH, keeping their assets liquid in case of more market turmoil. Cautious of regulatory movements against staking providers, new stakers may not rush to deposit funds the same as during the frenzy of a bull market.

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

Spurring innovation

First, Shanghai will spur more innovation in direct staking and liquid staking solutions. The ability to stake, withdraw and restake ETH rewards with more frequency will engender more nuanced financial applications as people explore opportunities to maximize yield while minimizing risk. We will see heavy innovation in staking derivatives, and likely see more complex lending solutions to provide people access to ETH staking.

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

Strengthening ETH

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

Sovereign assets

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

See also: Unlike Merge, Ethereum's Shanghai Upgrade Could Bring Ether Price Volatility

Altogether, the Shanghai upgrade will kick-start another cycle of innovation focused on ETH staking. Liquidity providers will be the tangible benefactors of this innovation, accessing a growing ecosystem of features, tools and service providers. The end result is a more decentralized ecosystem of contributors and a more secure network.

Points of centralization

There is one main consideration we should keep in mind after Shanghai goes live – staking centralization. On the surface, an increase in ETH staking means an increase in network “decentralization.” However, if the majority of new stakers after Shanghai elect to stake through a provider like crypto exchange Coinbase, then we run the risk of seeing a few centralized and on-chain providers dominate the ecosystem.

With this consideration in mind, what we hope to see is enough innovation in the staking industry that decentralization increases in the long run. More competition means more choice, which could drive protocols to differentiate themselves with better products and consumer offerings. Moreover, organizations such as the Ethereum Foundation should focus on the UX [user experience] of single stakers to incentivize a more resilient staking network.

Transition transmission

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

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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