What Does the Shappella Upgrade Means for Ethereum and LSD Tokens?
On 12 April 2023, the Ethereum chain has been upgraded in accordance with EIP-4895 standard, which will enable staking withdrawals on Ethereum. The upgrade is highly-anticipated for many members of the Ethereum community and will be one of the largest upgrades by far. As a result, many are looking at how the upgrade will affect the price of Ethereum and LSD projects and tokens.
Background
In order to better understand the upgrade, we begin by closely examining the problem it aims to solve. In December 2020, Ethereum went through an upgrade from the Proof-of-Work (PoW) system to Proof-of-Stake (PoS) consensus mechanism, in an event better known as The Merge. The Merge resulted in crucial changes to the Ethereum ecosystem due to the fundamental shift from a PoW to PoS consensus mechanism. This in turn will continue to lead Ethereum and cryptocurrency toward mass adoption.
Ethereum has always aimed to increase scalability, decentralization, and environmentally-friendliness with each upgrade. In comparison with other blockchains, Ethereum has achieved relative scalability with its consensus mechanism, as it no longer employs time-consuming problem-solving consensus mechanisms such as Bitcoin’s Proof-of-Work. Since the consensus mechanism does not require costly powerful machines to solve the hash, barriers of entry for new validator nodes become relatively low, allowing for many people to participate in securing the chain and thus leading to a more decentralized ecosystem. Furthermore, the consensus requires less computing power and therefore less energy consumption, making it increasingly environmentally-friendly.
Despite its advantages, the chain still has a downside; stakers cannot withdraw their staked Ethereum tokens until a designated period of deposit is over. As a solution to this issue, some projects have created protocols to allow users to stake Ethereum and benefit from liquidity. These protocols utilize a token that is pegged with Ethereum, so token holders can trade the derivative assets freely on the market. Staked digital assets that are pegged to the Ethereum are called Liquid Staking Derivatives.
What are Liquid Staking Derivatives (LSDs)
Liquid Staking Derivatives or LSD Protocols are synthetic assets that represent another asset. Their value is based on the underlying value of the asset that they represent. In the case of LSDs for Ethereum, it is mainly designed for users who want to stake and earn yield with their ETH tokens without the minimum requirement of 32 ETH to be cold-staked or lack the technical knowledge to operate as an effective validator. However, the downsides to LSD Protocols include issues such as centralization and pegged volatility. Some examples of LSDs are stETH by Lido, rETH by RocketPool, and SETH2 by Stakewise.
At present, Lido holds 30% of the market share while Rocket holds 1.44%.This situation decreases competition and creates an oligopoly amongst the available LSD options, in which a few protocols dominate the market. Another problem with LSDs is their pegged token, which is vulnerable to experience depegging when price of the liquidity token becomes significantly less than the token it is pegged to.
Shanghai Upgrade
The Shanghai Upgrade is an upcoming upgrade for the Ethereum network on April 12th 2023. It is expected to implement a series of proposals to upgrade Ethereum based on EIP 3651, EIP 3855, EIP 3860, EIP 6049, EIP 4895. Each of these upgrades will be contributing to a better Ethereum chain in the future.
EIP 3651, also known as Warm Coinbase, decreases the gas fees for transactions that go through the Coinbase address. Implementing EIP 3855 helps developers in lowering gas fees by using PUSH0 for developers to duplicate zeroes resulting in less gas and storage fee.
EIP 6049 proposes an improvement of security and reliability to the smart contract by changing SELFDESTRUCT opcode to a secured function called “halt”; the improvement makes smart contracts more secure by not allowing anyone to destroy the contract but in a more controlled way for contracts to self destruct by only allowing the owner of the contract to call the self destruct and having a fixed gas cost.
Lastly, the much-anticipated EIP 4895 allows Ethereum stakers to fully or partially withdraw their Ethereum stake. Stakers can either partially or fully withdraw their Ethereum; validators need to update their withdrawal credentials from 0x00 to 0x01, or else partial withdrawal will not happen. Updating the credentials will take place on a first-come first-served basis, as only 16 requests can be done every 12 seconds or every block. For stakers who are looking for a complete withdrawal of 32 ETH, withdrawal of the staked amount and its rewards will not be immediate as there will be two processes that validators need to go through in order to exit, validators’ exit process and the full withdrawal process. In conclusion, it will take a validator a minimum of 28 hours in order to make a full withdrawal, although the majority of full withdrawals will take much longer than this. The implementation of this step-by-step process is to prevent prevent a massive amount of staked ETH being withdrawn at the same time, risking the security of the network and destabilizing the price of Ethereum.
Impact on Ethereum price
The impact of the Shanghai Upgrade on the price of Ethereum remains uncertain, and there are two possible scenarios that may occur during the event.
For those who are bearish on Ethereum, there are concerns about the pressure from the United States government towards US-based protocols and cryptocurrency exchanges that offer Ethereum Staking-as-a-Service (SaaS). Most recently, Kraken announced that they will be unstaking all their Ethereum after being sued by the SEC. This has set a negative precedent for future cryptocurrency exchanges and protocols providing SaaS in the United States. Additionally, there are investors who are looking to withdraw their Ethereum and exchange it with fiat currencies to offset the costs and losses from 2022.
Inversely, for those who are bullish on Ethereum, the Shanghai upgrade is expected to potentially bring significant improvements to the Ethereum network, including faster transaction processing times and reduced fees. These improvements may attract more users to the network, which could potentially increase the demand for Ethereum and drive up its price. Furthermore, a total of 10% of the entire staking pool can be withdrawn every month, and the time-consuming two-step process in unstaking Ethereum may discourage investors from withdrawing.
It is important to consider both the potential positives and negatives when evaluating the impact of the Shanghai upgrade on the price of Ethereum. While there may be some short-term selling pressure from investors looking to withdraw their staked Ethereum, the long-term improvements to the Ethereum network could ultimately drive demand and increase the price of Ethereum.
Impact on LSD token prices
Another impact of the upgrade is on LSD protocols, Currently LSD protocols have their derivative tokens pegged 1:1 with Ethereum, and they need to spend to maintain the derivative tokens. LSD protocols could maintain their peg better after the Ethereum upgrade which leads to less costs. These protocols would be able to give a higher APY after the upgrade as derivative tokens become stable; therefore, as to date the governance tokens the protocols are increasing. LDO increased by 100%+, PENDLE grew by 900%+, and RPL rose by 120%, and the trend continues to increase.
One potential outcome that is being anticipated is that investors could transfer their recently unstaked Ethereum to Liquid Staking Derivatives (LSDs) to take advantage of greater profits and the capabilities of decentralized finance.
LSD protocols hold 42% of the total staking volume of the Ethereum network. It will highly impact the price of the governance tokens, the derivative tokens, and the APY of the protocol. Each LSD protocol has designed different ways for its users to liquidate their position and will try to sufficiently redeem all their investors. investors would also need to learn the liquidating process for protocols they want to invest in as it will affect the security for these protocols. Each protocol will have their own liquidating process and will affect the security; therefore, investors need to do their own research before investing in any LSD protocols.
Conclusion
With the crypto space constantly growing, it is important for new investors to DYOR (‘do your own research’) before making any investments. As a crypto exchange, we intend to provide users with the necessary knowledge to make investment decisions. Through these articles, we hope that Bitruers will be able to learn more about the crypto space.
