Shanghai Upgrade And Its Impacts on Ethereum Ecosystem


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    Table Of Content


    Written: March 2023


    In mid-September, Ethereum successfully implemented the Merge, which resulted in its long-awaited transition from Proof of Work to Proof of Stake. This change has led to a reduction in energy consumption by 99.95% and ETH issuance by 88%. The network is now secured by stakers who put up 32 ETH as collateral for the ability to store network data, process transactions, and add blocks to the chain. Stakers are rewarded with ETH for securing the network. The latest hard fork of Ethereum, called "Shapella," includes two major upgrades: Shanghai Upgrade and Capella Upgrade. 

    Shanghai upgrade enables stakers to withdraw previously deposited ETH, which they have been adding to for around 2.5 years. As of writing this, 19M ETH have been staked, which is approximately 15% of the tokens eligible for staking. Other PoS chains have higher staking percentages than Ethereum, such as AVAX with 55%, Solana with 70%, Cosmos with 62%, and Cardano with 72%.


    This report reviews the Shanghai Upgrade from an economic perspective. The objectives are 

    1. To describe how the update would unlock ETH under various scenarios

    2.  To identify relevant variables that can be potentially impacted by the upgrade

    3. To assess the impact of the upgrade on the identified variables


    It is necessary and important to make certain assumptions around the behaviour of actors in the system and the exogenous forces that relate to the upgrade. We assume that 

    • The majority of actors are economically rational; that is, the actors are motivated by personal economic gains
    • Upgrade will run smoothly, and there will be no technical problems
    • The redemption of ETH from the beacon chain would increase investor’s confidence in the ETH network given that they will now be able to redeem their locked assets
    • Price of ETH and stETH are volatile
    • This upgrade not only has implications for the ETH network but for the larger DeFi environment (lending protocols, etc.)


    As the upcoming ETH update unlocks assets from the beacon chain, we think defining a framework for evaluating potential economic and security risks that this event may trigger is helpful.

    Shanghai Upgrade And Its Impacts on Ethereum Ecosystem

    In the framework above, we have identified 3 agents: Ethereum Network, Validators (stakers), and Traders. These agents have the capability to take any action, be it deterministic or probabilistic, in relation to the Shanghai upgrade. Ethereum Network has deterministic actions, which are the withdrawal process and control parameters put in place to manage the withdrawals in a stable manner with the goal to keep the network’s security and economic model steady.

    Validators are the second type of agents and include direct validators and indirect ones that choose to stake their assets via protocols such as Lido. Based on various factors or drivers, they can perform probabilistic actions of choosing to stake or unstake from the network. The action drivers considered for this report w.r.t staking or unstaking include; yields on ETH network, capital gains, and yields on alternative DeFi protocols.

    The staking or unstaking actions of validators can result in them either buying, selling or holding ETH, which could then have an impact on both Ethereum and larger DeFi ecosystem. 

    Traders are the third agent type who can influence the market as the upgrade approaches. Generally, any technical or other upgrade is already priced into the value of an asset, and we expect the same with ETH. Therefore, we do not expect much volatility from traders suddenly after the upgrade. However, post-upgrade if the stakers show heavy withdrawals or there is an increase in staking, then the traders will be influenced by this action and can contribute to the price volatility of the asset.

    Since the actions of Validators (stakers) are the primary source of impact on market and network in this case, the scope of this report is restricted to studying the impact on ETH and Larger DeFi from the perspective of Validators’ actions.

    In the text below, we will first look into the withdrawal mechanics that apply to validators and then the impact of the upgrade on relevant variables. 

    Withdrawals Mechanics

    Withdrawal Types

    There are two kinds of withdrawals available; partial and full withdrawals. In case of ‘partial withdrawal’, validators can withdraw and use any amount of staked ETH that exceeds 32 ETH (including earned rewards) immediately. During this process, the validator continues to validate blocks on the beacon chain. 

    The full staked balance, which is 32 ETH, and all the earned rewards of the validators, is unlocked in the case of ‘full withdrawal’. Once the entire withdrawal process is finished, all the ETH obtained can be spent. If a validator selects a full withdrawal, they will no longer secure the network and will no longer be a part of the beacon chain.

    Within the beacon chain validators, there exists a withdrawal credentials field that includes a withdrawal prefix composed of the first two bytes. Presently, this value can only be one of two options: 0x00 or 0x01. Validators whose credential is 0x00 are not eligible for an immediate withdrawal. To enter the withdrawal queue, these validators must switch to the 0x01 credential. About 58% of active Ethereum validators still have 0x00-type withdrawal credentials.

    The speed at which credentials can be updated to 0x01 or automatic sweep will take place will be 16 partial operations per slot, i.e., every 12 seconds, starting with index 0. Since the queue for partial and full withdrawals is the same, balances over 32 ETH will be a part of the automatic sweep, and full withdrawals will be processed much slower.

    Anticipated Timeline for Partial withdrawals 

    If a validator holds 0x01 credentials, they should anticipate a partial withdrawal from their balance in two to five days after the upgrade. The timeframe for the automatic sweep is based on the total number of active validators, and the estimated time for the sweep to complete. The range of two to five days is provided, as the timeframe for completion varies depending on the number of validators who apply for migration to 0x01 credentials. It takes approximately two days if no validators migrate, and up to five days if all validators apply for withdrawals with migration. The following formula can be used to calculate the maximum duration of the automatic sweep:

     [(active validator count/16) * 12]/60/60/24 days

    Shanghai upgrade - calculate duration of automatic sweep

    Over 1M ETH could become liquid by way of partial withdrawals, post-Shanghai/Capella. As per data of 30 Mar 2023, total amount of ETH staked is almost 19 Million (18,982,223 ETH) and total number of active validators is 558,062 validators, which means per validator staked ETH balance is 34 ETH which is 2 ETH greater than initial deposit  (32 max cap) of each validator. This earned ETH will be eligible for  withdrawal, and it has no utility sitting idle in the validator staked balance. If stakers withdraw 2 ETH/ validator, this will add over 1 million (1,116,124 ETH)  in supply.

    Anticipated Timeline for Full Withdrawals 

    The process of executing a full withdrawal involves two separate phases, each with its own duration. Firstly, the validator must exit from the consensus layer, after which they can initiate withdrawals, but with an additional waiting period. It takes a minimum of 28 hours for the staked ETH to become fully withdrawable. Total time taken for the staked ETH to become fully withdrawable can be calculated from below:

    Total Time Taken =  Exit Epoch (5 Epochs or 32 mins) + Withdrawable Epoch (256 Epochs or 27.3 hours).

    Following this, additional time is needed for the next validator sweep to execute full withdrawals. The duration of this additional time depends on several factors, including the validator index, sweep position, and the total number of validators.

    It's essential to note that validators play a critical role in securing the network, and as such, a churn limit must be set to ensure that the number of validators does not fluctuate too rapidly. The churn limit is calculated as the maximum number of validators exited per epoch, with the formula being:

    Churn Limit =  max[4, total active validators/(2^16)]

    The table below outlines the maximum number of validator exits and the rate at which the maximum amount of ETH can be withdrawn per day.

    Shanghai upgrade - max existing validators

    Impact on Relevant Variables 

    As identified in the framework, we now assess the impact of the upgrade on the following variables


    We take into consideration the potential increase in market supply, stakers’ cost basis, withdrawal processing and taxation to ascertain the impact on ETH price.

    Potential increase in market supply

    As of now, around 19 million of the total ETH supply are staked. These coins are deposited by more than 560,000 validators, and their average balance exceeds 32 ETH. This indicates that the average Ethereum validator has earned roughly 2 ETH in rewards from the consensus layer so far.

    In the table below, 3 scenarios are shown. Scenario 1 is the case in which there are no full withdrawals and 100% of the eligible validators (0x01 credentials) opt for partial withdrawals. Scenario 2 shows a case of 25% full withdrawals and 75% partial withdrawals. Scenario 3 highlights a case of 50% partial and 50% full withdrawals.

    Scenario 1Scenario 2Scenario 3
    Full Withdrawal (%)02550
    Max exit per 12 sec slot (validators)161616
    Total slots per day720072007200
    Total validators eligible to withdraw per day115,200115,200115,200
    Validators with 0x01 credentials (%)424242
    Partial ETH withdrawals96,76896,39096,012
    USD value of ETH@ 1800174,182,400173,502,000172,821,600
    Full ETH withdrawals (Max 1800 validators)015,30030,600
    USD value of ETH@ 1800027,540,00055,080,000
    Total Withdrawals in USD174,182,400201,042,000227,901,600
    ETHDaily Trading Volume8,000,000,0008,000,000,0008,000,000,000
    % of Withdrawals w.r.t Trading Volume2.22.52.8

    The above indicates that anticipated selling pressure is likely to increase, during the initial days after Shanghai upgrade. Nevertheless, even if we consider the most advanced estimates, the projected daily selling pressure constitutes less than 3% of the daily spot volume, which is approximately around $8 billion. Given the limited impact on daily trading volumes, it is expected that a smooth transition will occur without any substantial effect on price and with minimal selling pressure.

    Stakers’ cost basis

    The potential selling pressure projection also depends on the validator’s cost basis at the time of deposit on the Beacon chain. Currently, only 20.5% of validators have a lower cost basis, which means that the majority of the stake (79.5%) has little financial incentive to sell at the moment. Although some validators who joined the validator set early and have low cost basis and potential unrealized profits may be considered, they are also the ones who had the strongest belief in Ethereum, and thus, are unlikely to sell. This further confirms the expectation of only modest to insignificant sell pressure from partial and full withdrawals.

    The fact that ~50% of staking is liquid in the form of LSDs, so most is not actually net new supply of tradable ETH, which should act as another mitigant to selling pressure. Further, very low supply of ETH (15%) is locked on the network and the upgrade  is expected to strengthen investor confidence, and could lead to increase in demand and hence increase in price.

    Potential withdrawals by key staking groups

    Once Shanghai upgrade is activated, only a maximum of approx. 60,000 ETH can be withdrawn each day at the current churn limit. This prevents the sudden dumping of a large amount of ETH into the market and would prevent large price volatility.

    We look at a specific scenario of the amount of ETH that can be potentially withdrawn by taking into consideration the probable actions of the two large staking groups ‘Lido’ and ‘Kraken’. As stated above, withdrawals depend on how many 0x00 type validators convert to 0x01. At present, 0x00 type validators have highest avg accumulated rewards as shown below. 

    SerTypeProportion of Active validatorsAvg Rewards
    10x00 credentialed58%2.47 ETH
    2Lido 0x01 credentialed 25%1.23 ETH
    3Non lido 0x01 credentialed17%1.06 ETH

    Considering no 0x00 type validator updates to 0x01 type, the first block will include 16 partial withdrawals which will include 9-10 lido 0x01 type validators and remaining 5-6 non lido 0x01 type validators. As Lido withdrawals will possibly be reinvested, so only ETH being added to supply is likely to be withdrawn by non-lido 0x01 type (5-6 validators per block) with avg cl accumulated reward of 1.06 ETH per validator. This brings the total eligible partial withdrawals to 45729 ETH or 82M USD (6 * 1.06 ETH* x 7200 Avg blocks per day). This shows that partial withdrawals may be even lesser than the projection shown above, if Lido validators do not withdraw their rewards.

    Kraken validators, which constitute 7.3% of total validators, may have to process full withdrawals due to SEC crackdown on Kraken which can result in the exit of over 38,000 (1.2M ETH) validators. Given the present churn limit of 8, it would take approx 20 days for these withdrawals if the queues only entertain Kraken validators. In this extreme unlikely scenario, the supply injected in the market is not significant enough to create major price volatility.


    Taxation is another factor, which can motivate or demotivate validators to withdraw and impact the market. If we look at the present network stats, most validators (58%) have not yet converted to 0x01-type withdrawal credentials. One potential reason could be  that they may be intentionally delaying the switch for tax or accounting purposes. Since rewards earned on 0x01 credentials are withdrawable, the ETH rewards for these credentials are considered income. Specifically speaking, given that the US tax filing deadline is Apr 18 for this year, validators with 0x00 credentials may deter from switching credentials and withdrawing, as their rewards are not considered taxable as they can not be withdrawn, sold or realised. 

    Network Security

    Despite the fact that deposit activity is showing steady growth, Ethereum's staking ratio remains strikingly low. Even after two years since the launch of the Beacon chain, only 15% of the total ETH supply has been staked, while other smart contract platforms have ratios of approximately 50% or more as shown below. 

    SerChainStaking RatioStaking Market Cap (USD)

    Despite its low staking ratio, Ethereum continues to dominate the staking market by a significant margin in terms of absolute dollar value, with a staking market cap of $32 billion. Until now, staking ETH was considered high-risk due to the indefinite lock-up period required for staking a risk-on asset. However, with the upcoming Shanghai upgrade, staking will become less risky, and ETH will be transformed into a liquid commodity that offers staking rewards. As a result, significant inflows are expected from investors and institutions that were previously hesitant to participate in undefined lock-up periods. This change will allow previously sidelined entities to enter staking, reducing the free-floating supply and potentially creating demand. Furthermore, new staking solutions are expected to offer enterprise-grade staking for institutions. This anticipated increase in the staking ratio is expected to enhance the base layer's security.

    Network Yields

    Network yields are dependent on the staking behaviour of validators. If the upgrade creates a demand for staking, then the yields would go down making alternative yield options more attractive to validators (investors). If staking demand substantially increases, Ethereum’s yield would decrease making Ethereum staking less attractive compared to other alternatives as shown in the table below. This would mean that investors’ belief in the fundamentals of ETH as an asset would be more of a driving factor for staking rather than the yields.

    1Stablecoin LiquidityCurve (DAI,USDC,USDT)0.17%
    2Lending BorrowingAAVE (ETHPool)
    3Lending Borrowing Compound (ETHPool)2.21%
    4YFI Savings AccountYearn Finance (ETH)0.68%
    5PoS RewardsEthereum Staking5.42%

    However since the overall user confidence in the ETH ecosystem would increase after the upgrade, other DeFi protocols that offer alternative yield opportunities for cryptocurrency investors and traders are likely to benefit from complementary effects if they offer better yields.

    Larger DeFi Ecosystem

    LSDs (stETHPrice)

    Those who hold LSDs for the long term would be less likely to sell. This is because they have previously had liquidity on their stake and have already received rewards that are reflected in the market value of liquid staking tokens. As a result, they have previously experienced the benefits of having liquidity on their stake.

    In fact,  we anticipate that the demand for stETH can increase as investors' confidence is likely to increase given that the upgrade offers a path to redemption of staked ETH.

    Lending Markets 

    Users may want to employ recursive yield strategy to increase their yields by staking on the network, however if the utilisation rates of lending protocols are set in a manner that counters this, it should not pose a risk to them.

    If borrowing rates are lower, borrowers can take ETH loans and stake those funds for capturing the difference between validator yields and borrowing rates. Recursive borrowing of stETH/ ETH and cbETH/ ETH pools can result in yields of up to 20% from PoS earnings. However, if the borrowing rate is greater than staking rewards then the cost of borrowing ETH overflows the staking rewards and net value will be negative or close to zero which will make recursive borrowing unprofitable and unlikely. This can be seen from the utilisation rate graph below of the stETH/ETH pool on Aave. We can see that after 45% utilisation, the rate grows exponentially which would likely make the recursive borrowing strategy unprofitable. This would protect the protocol from excessive borrowing and the related risk of liquidations.

    Shanghai upgrade - Utilization rate


    Withdrawing funds from staking has the potential to decrease risk for stakers and increase capital efficiency for Ethereum (ETH), transforming it into a liquid commodity that can offer a risk-free rate in a decentralised and permissionless financial ecosystem. After the Merge and now the Shanghai upgrade, staked funds will be unlocked, increasing confidence and attracting new hesitant stakers. This is indicated by the low staking ratio, which is expected to grow significantly after Shanghai upgrade. Despite some short-term sell-pressure and volatility due to partial withdrawals, we expect withdrawals to act as a bullish event for ETH network, resulting in a higher staking ratio and improved security. Overall, moderate sell pressure induced by withdrawals is expected due to the non-liquid stake, solo validators, attractive inflation-adjusted staking rewards, and the cost basis of some deposits.

    We would, however, like to highlight that the rationale for setting up withdrawal churn limits, withdrawal queues, exit queues and other control parameters was to better handle network congestion and outflows on account of withdrawals. This mechanism can be further bolstered by attaching dynamic incentive/disincentive mechanisms with full withdrawals. This could be in the form of fees which would mean that the more withdrawals happen on the network, the higher would be the cost to withdraw. Aligning fee mechanisms with validators’ behaviour can result in a system  in which withdrawals are processed quicker and network security is maintained.



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