Ethereum To Usher In The Shanghai-Capella Double Upgrade, What’s So Attractive?

Since December 2020, Ethereum network validators have voluntarily locked their ETH on the Beacon chain, and there is no clear timetable for the withdrawal function.

The upcoming Shanghai-Capella “Double Upgrade” will mark the end of this era, granting validators access to staked ETH while also providing rewards for validating. In this article, we will discuss the impact of the upcoming “double upgrade” of the Ethereum network on withdrawals and ETH supply.

Ethereum “Double Upgrade”

The upcoming upgrade of the Ethereum network protocol is actually a “double upgrade” (Shanghai and Capella). They are the upgrade of the part of the Ethereum network that performs calculations and transactions (execution chain) and the part that controls the production and verification of new blocks (Beacon chain).

The execution chain refers to the part of the network that handles consensus (via mining) and execution (updating balances, changing the internal state of smart contracts) prior to Merge.

The Shanghai upgrade is a hard fork of the network execution layer (i.e., the execution chain), with the purpose of implementing a series of changes to some operations of the Ethereum network.

Its most significant upgrade will allow validators to withdraw their ETH holdings for the first time since the Beacon Chain was launched in December 2020. When the network switches from Proof-of-Work (PoW) mining to using the Beacon chain to control block production in September 2022, the Ethereum Foundation has set a tentative deadline for activation of PoW in the next network upgrade. currency function.

Recently, the “double upgrade” time was brought forward to March 2023, and it is currently awaiting the completion of several successful tests. The Ethereum Foundation has recently been working hard to meet this goal within the originally promised time frame, even delaying other upgrades scheduled to be deployed in Shanghai to prioritize the withdrawal function’s launch.

Note that validators can currently suspend their validating duties and “unstake” their ETH without withdrawing. The Shanghai upgrade allows withdrawable users to withdraw their ETH from the Beacon chain.

How will the upgrade be implemented?

Just like previous network upgrades, such as Merge or London upgrades, the Shanghai upgrade will be done using a hard fork. This requires every node listening or validating on the network to install a new version of the Ethereum network client.

Clients are programs that each node runs locally in order to interact with the rest of the network. There are multiple versions of the Ethereum client, released by different third-party providers, but each version promises to implement the provisions of the open-source Ethereum protocol as determined by the Ethereum Foundation.

Once the Ethereum Foundation clarifies the final version of the upgraded protocol, each client provider will release an upgraded version of its client, which contains the old and new versions of the protocol. For all blocks after the agreed block height (the length of the blockchain from one block to the first block on the chain), every node on the network will start using the upgraded version of the protocol.

This ensures that the original history of the network will remain intact. Since the upgraded protocol will only apply to blocks with a block height higher than the agreed number, if the chain is reverted to a block before the switch, nodes will use the previous version of the rules. This ensures that the network agrees when new rules apply.

Test

In preparation for the upgrade to the network, the Ethereum Foundation has created a copy of the Ethereum network in which to test its changes. This is achieved by configuring a small set of nodes (validators and non-validators). This sidechain and mainchain allow developers to simulate network upgrades and fix bugs encountered on a separate chain. This process is called a shadow fork.

Through a shadow fork of the ethereum main chain, developers have launched a series of public testnets for developers to test their smart contracts on a proposed version of the network. The first public testnet, Shandong, was launched on October 14, 2022, and 5 planned upgrades were initiated, excluding the token withdrawal function of the Beacon chain.

The Zhejiang testnet, launched on February 1, allows developers to test all proposals (EIPs) included in the Shanghai-Capella “double upgrade.” This includes a simulation of a hard fork that would switch nodes from the current version of the ethereum protocol to an upgraded version.

After the hard fork on the test network, users will be able to use the ETH on the test chain to test the withdrawal process but will not be able to communicate with the Ethereum network in real-time.

Staking process

Users can stake ETH on the Beacon chain to verify new blocks and contribute to the security of the blockchain. In return, stakers are rewarded when the work is done “correctly” and punished if they are dishonest or fail to do the work as required.

This feature is available now, long before the Ethereum network started listening to the Beacon chain for consensus on new blocks. However, until the Shanghai upgrade, users will not be able to withdraw their staked ETH (both reward and penalty).

To participate in this process, users must have the software required to validate and propose new blocks (execution and consensus clients) running on their system. They must also generate a public and private key pair, which the Beacon chain can use to track new validators. Once complete, the user must deposit 32 ETH into the Beacon Chain deposit smart contract and enter their public key (and some other credentials) as data for the transaction.

Successful deposits issue a “receipt” on the chain of execution, formally known as a “log.” This receipt contains data on the user’s deposit amount and registers their deposit on the Beacon chain.

The Beacon chain reads these “logs” from the execution chain and includes new stakers in the activation queue. This operation is processed as a transaction on the Beacon chain, similar to how the functions of smart contracts are executed on the execution chain.

ETH in smart contract deposit

The ETH sent by the validator to the Beacon chain smart contract will remain there forever because the smart contract is not written to have a withdrawal function and cannot be upgraded. Instead, a validator’s balance record (including reward and penalty parts) for its staking cycle will be handled separately by the Beacon chain before the final withdrawable balance is approved.

This means that the balance of the execution layer of the Beacon chain smart contract will be the accumulation of the amount of ETH staked by the verifier. This balance should be deducted from the circulating supply of ETH on the network, as described in the “un-staking” process described below.

The “Un-Staking” process

After the upgrade, validators will be able to make two types of withdrawals/withdrawals: partial withdrawals and full withdrawals. For both cases, the validator must also be active for 2048 epochs (approximately 9 days, one “slot” every 12 seconds, 32 slots per epoch) before issuing an “exit” signal.

Withdraw coins

When withdrawing money/coins in full, the validator must first stop participating in the validation. They can do this by sending a Voluntary Exit Transaction to the Beacon chain.

Once a validator is considered exited and withdrawable, they can send a final transaction to initiate the exit. When validators submit full or partial withdrawal requests, they are added to a single withdrawal queue. The network will only process 16 withdrawal requests per block, by including the first 16 withdrawal requests in the queue, following the first-in-first-out rule. This results in approximately 115,000 validators (exited and withdrawable) being able to withdraw on any given day.

When a withdrawal is processed, new ETH that was not previously in circulation will be minted to the withdrawal address specified by the validator. As mentioned earlier, this new ETH will not be removed from the Beacon chain deposit contract where the validator originally deposited its staking. Note that any transactions required to complete the “unstaking” process will not incur a gas cost to the validator.

Possible impact

Neither the staked ETH nor the increase in ETH supply due to staking rewards to validators has yet entered the spot market since the inception of the Beacon chain. This ETH remains locked on the Beacon chain until withdrawals are enabled. This means that the unlocking of the Shanghai upgrade has the potential to significantly increase the token supply, as (at the time of writing) 1116 validators were able to withdraw coins after the unlock.

The limit placed on the final withdrawal queue for exiting the Beacon chain means that a maximum of 16 validators in a single slot can withdraw. Assume that each validator withdraws in full (the validator will need to “exit and withdraw coins”), and each validator’s staking balance is 32 ETH (assuming that the 32 ETH validator nodes are discrete, which is a reasonable assumption, but other analyzes vary), which means a maximum of 3,686,400 ETH per day. However, this unlock rate is only possible if there is a backlog of more than 6 validators in the final withdrawal queue.

In the long term

However, we should not underestimate the backlog of users waiting for an immediate withdrawal, which is less than 1% of the 500,000 validators. This group chose to collectively lock up over 16 million ETH without a guaranteed withdrawal date. We believe that unlocking could eventually lead to an increase in staked ETH, as stakers feel more comfortable locking their ETH in the knowledge that it is recoverable.

We also believe that an increase in successful withdrawals could strengthen confidence in the network, leading to a net inflow of new stakers in the medium to long term. The operational cost of participating as a validator is much lower than mining on a proof-of-work chain. As such, validators will not be under pressure to withdraw their staked positions to cover computational costs. This gives us confidence that a mass exodus of validators after allowing withdrawals is unlikely.

In the short term

However, in the short term, we think a large number of validators will want to perform partial withdrawals of their Beacon chain balances, which could result in a net outflow of Beacon chain ETH.

Validators are motivated to perform partial withdrawals of their Beacon chain balances because their balances exceed the ratio of 32 ETH, and there is no benefit on the Beacon chain. By not performing a partial withdrawal, the validator basically loses access to their ETH, losing their wife and soldiers.

In addition, we believe that users who wish to stake ETH will not withdraw immediately but will wait to see if the withdrawal process goes smoothly. In the short term, these two phenomena may hinder the flow of ETH to the Beacon chain.

Liquidity staking token

Liquid staking tokens have become one of the most popular ways for users to stake ETH on the Beacon chain, allowing users to use the tokenized version of their staking ETH to trade their staking positions.

This remains a popular staking method as it facilitates centralized staking, similar to the mining pools that dominate Bitcoin’s hash rate. Liquidity staking providers have lowered the threshold for staking and allowed users with less than 32 ETH (approximately $52,000 as of February 9) to earn staking rewards.

In addition, they will continue to allow faster unwinding of staking positions. Users can directly sell their tokenized staking positions for ETH directly on the on-chain spot trading platform instead of completing the full withdrawal process outlined above. May require longer transaction times at the cost of paying gas fees for their execution layer transactions.

Other upgrades

As mentioned earlier, the Shanghai-Capella “double upgrade” includes a series of upgrades beyond the activation of the Beacon chain coin withdrawal. There are two other upgrades worth noting.

WarmCoinbase upgrade (not related to the Coinbase trading platform)

Involves EIP-3651

This upgrade is mainly to enable users to optimize. It allows users to set an initial gas fee paid to miners, and then increase or decrease the gas fee if certain conditions are met. This upgrade especially helps MEV seekers who wish to optimize costs by dynamically adjusting fees, which previously had to be a fixed value.

PUSH0 instruction upgrade

Involves EIP-3855

This upgrade aims to reduce the average smart contract size by adding a basic instruction PUSH0, which allows zeros to be added to bytes. Before this upgrade, use other non-specialized instructions to fill 0 as bytes, but relatively speaking, using dedicated instructions will consume more Gas. This upgrade plans to introduce this dedicated instruction, which will help Ethereum developers reduce Gas costs when deploying smart contracts on the network.

Conclusion

The upcoming Shanghai-Capella “double upgrade” will mark another important milestone in the Ethereum Foundation’s future network roadmap. For more than two years, validators have been willing to stake their ETH on the network without access, which is what this upgrade focuses on.

We believe that in the medium and long term, the success of this upgrade will lead to more ETH being locked in the Beacon chain because investors in the bear market are actively looking for sources of token income. We believe “Token Refundable” will solve the pain point of low participation for many unstaked ETH holders.

DISCLAIMER: The Information on this website is provided as general market commentary and does not constitute investment advice. We encourage you to do your research before investing.

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Harold

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