The Shanghai Upgrade: What's Next for Ethereum

Introduction

The Merge is finally behind us, and while one might think that the vast chunk of innovation is behind us, that is far from the truth. The Merge is just part one of five in Ethereum’s roadmap. These five parts are often referred to as the five “-urges” of Ethereum: The Merge, The Surge, The Verge, The Purge, and The Splurge. Each of these parts could easily be their own series of articles, but we haven’t quite finished the first stage. I will be discussing what’s next for Ethereum in the Shanghai Upgrade, including validator withdrawals, EVM Object Format, and a few miscellaneous improvements before we move onto the Surge.

Beacon Chain Withdrawals

How Beacon Chain Deposits Have Worked

The first feature of the Shanghai Upgrade is the long-awaited EIP-4895, which will allow validators to withdraw their 32 ETH from the staking contract. So far, depositing ETH into the staking contract has been a one-way street: once you deposit your 32 ETH to stake as a validator, you can’t get it back. Since the Beacon Chain’s launch on December 1, 2020, over 14 million ether have been deposited into the staking contract. This amounts to about 11.6% of all ether in circulation and a value of about $18.7B.

How Withdrawals Will Work

EIP-4895 will allow validators to push withdrawals from the Beacon Chain to the EVM, or Ethereum Virtual Machine. The EVM is a software platform that executes transactions, smart contracts, and defines the network’s state each block. The network state consists of data like accounts, balances, and a machine state. This is a function of the old state and a new set of valid transactions. In order to withdraw all their ether, a validator must first exit the validator set, or queue. A validator can remain in the validator set and withdraw their staking rewards as long as their balance post-withdrawal is at least 32 ether. Withdrawing ETH involves a new transaction type called a “withdrawal operation”, which is different from a normal transaction. Regular transactions are executed by the EVM and incur a transaction fee that can, on occasion, fail if insufficient funds were paid for transaction fees. However, a withdrawal operation is unconditional and cannot fail. They are a balance update of +32 ETH to the receiving wallet instead of an EVM execution to avoid the complexities and potential failures that come with a normal transaction. Since they are just a balance update, they do not incur a gas fee, and they are processed immediately by the execution layer after being requested from the Beacon Chain.

Long-Term Effects of Unlocking Withdrawals

There has been debate surrounding whether unlocking withdrawals from the staking contract will be fundamentally bullish or bearish for ETH, since over 11% of the supply has been locked up. There are points to both sides of the argument, but this article solely highlights them. On the downside, a significant amount of capital has been locked up, and if macroeconomic trends continue to worsen, there will be significant incentives to sell this ether. It is very likely that we could see a non-trivial amount of sell pressure after the Shanghai Upgrade launches.

On the other side of this argument, only 6 validators can exit the validator set per epoch (every 6.4 minutes), meaning it would take over a year for all of the validators to exit the set due to a very long queue. This means if there is a release of ether into the market, it will be a very slow one. Additionally, those who have locked up 32 ETH most likely have a significant amount of additional capital and are long-term believers in the network. Thus, they would be unlikely to pass up ETH-denominated staking rewards over the long-term. Also, 75% of staked ETH is at a loss compared to when it was purchased, meaning not much gain is to be realized at the moment. Liquid staking tokens also exist such as stETH and rETH, meaning there is already a large opportunity for people to accrue staking rewards and sell off if they’d like. Finally, the opening of withdrawals presents a more attractive opportunity for institutional investors. As institutions begin to roll out custodial services for assets like ether, institutions will most likely take interest in staking, and a more liquid option with minimal fees and tracking error would be an attractive opportunity.

EVM Object Format

The second addition that comes with the Shanghai Upgrade is something called EVM Object Format, contained in EIP-3540. This gives all smart contracts a specific identifier based on what version of the EVM they were deployed. Right now, the EVM has no pre-defined structural organization. This EIP would allow for the separation of code and data on-chain. Smart contracts deployed to Ethereum are immutable, meaning that once they are deployed, they cannot be changed. Any change pushed to the EVM has the potential to break existing smart contracts, and they cannot be fixed due to immutability. This would force someone to deploy an entirely new version of the affected smart contract(s). This EIP would categorize contracts into two categories: EOF-formatted and legacy contracts. This would allow new changes to the EVM to be applied to EOF-formatted contracts, and legacy contracts would be completely unaffected. This allows for greater flexibility in the upgradability of the Ethereum Virtual Machine while providing protection for older contracts that are not optimized for unforeseen changes to the EVM.

Miscellaneous Improvements

Besides these two main improvements, there are a few minor EIPs to be pushed in this upgrade including EIPs 3651, 3855, and 3860. These include general gas fee improvements, specifically applying to direct Coinbase payments. They also work to reduce smart contract risk in terms of the use or misuse of various optimization methods within contracts.

Conclusion

Overall, Ethereum has a lot of exciting things lined up for the future in terms of terms of features to be added, scalability and security improvements, and cleaning up the network itself. However, there is a long way to go on the roadmap, and many fixes and features still need to be put into place before entering its next stage. The Shanghai Upgrade will occur sometime in early 2023 and will set us up nicely for the future of a post-Merge Ethereum.