Ethereum’s Shanghai Update

Eight years after genesis, on the 15th of September, Ethereum successfully completed ‘the merge’ integrating the Ethereum mainnet with the Beacon chain. This marks the migration of Ethereum network from Proof of Work (PoW) to Proof of Stake (PoS) consensus mechanism.

(Source: Glassnode)

This migration will improve the Ethereum network in the following ways:

The merge is the first step in Ethereum’s development plans. The 5 step development plan for ETH includes:

i. Merge: This is the hereby discussed transition from Proof of Work to Proof of Stake following the merge of Ethereum’s current mainnet with the Beacon Chain.

ii. Surge: This is the phase that will bring sharding to the protocol. It’s a scaling solution that would break the network into separate partitions called “shards,” designed to spread the computational load on the mainnet.

iii. Verge: This phase refers to the introduction of the so-called “verkle trees.” It involves an upgrade to Merkle proofs and is intended to optimise data storage for Ethereum nodes.

iv. Purge: Similarly, this upgrade also concerns data storage for validators and it will reduce hard drive space that’s required for the validators, streamlining network congestion.

v. Splurge: This is the last upgrade in the pipeline and is intended to deliver a string of miscellaneous updates that are made to ensure the overall smoothness of how the network runs.

The Shanghai Upgrade

The Shanghai upgrade is the next major upgrade in the Ethereum blockchain set to critical updates and elemental changes to Ethereum in its blockchain’s EVM functionalities. The Ethereum Foundation (EF) DevOps announced the launch of a Pre-Shanghai testnet — Shandong — on October 14, 2022.

Following the launch of the testnet, EF DevOps introduced the following Ethereum Improvement Proposals.

· EIP-3540: EVM Object Format (EOF) v1

· EIP-3651: Warm Coinbase

· EIP-3670: EOF — Code Validation

· EIP-3855: PUSH0 Instruction

· EIP-3860: Limit and Meter Initcode

· EIP-4895: Beacon chain push withdrawals as operations

Notable Ethereum Improvement Proposals from the Shanghai upgrade

1. Beacon Chain Withdrawals

After several proposals, the Ethereum network settled with the EIP-4895: Beacon chain push withdrawals as operations. EIP-4895 will allow Beacon Chain holders to withdraw their staked ETH as well as accumulated rewards. In addition, it will add a system-level ‘operation’ to ‘push’ validator withdrawals from the beacon chain to the EVM. These operations generate unconditional balance increases for the recipients specified.

2. Layer 2 Fee Reductions

A preliminary version of the process that would allow rollups to verify enormous amounts of data is another hotly debated update that some developers hope to include in Shanghai.

To help lower transaction fees on Layer 2 rollups, EIP-4844 will propose a proto-danksharding technique. This would enable more data to be processed on the network, lowering gas prices.

3. EVM Object Format

The most anticipated change — the EVM object format or EOF — looks at separating the code from the data. Currently, The separation of code and data, which is advantageous for on-chain code validation, is highlighted in EIP-3540. It will be a step towards interoperability. Code validation for EOF contracts will be made possible upon deployment via EIP-3670, a companion to EIP-3540. This allows contracts with incomplete PUSH data or unclear instructions to be rejected.

Micah Zoltu, developer, said that the biggest problem with the upgrade is that the community has not reached a consensus yet. Everyone has a different list and feels that their proposals are the most urgent.

Expectations after the Shanghai upgrade

Since the Beacon chain went live 16,945,768 ETH (~14% of the total supply) has been staked. But currently Ethereum does not allow the functionality to unstake ETH. This means that stakers are locking up their liquidity for an uncertain amount of time. This dis-incentivizes staking of ETH.

According to data from Messari, the current % of ETH supply staked is one of the lowest for major Proof of stake chains. The staking ratio for other major PoS chains on average is 46%, going as high as 90% for BNB. After the Shanghai upgrade, enabling unstaking of ETH it is expected that there would be a significant increase in the staking ratio for ETH, effectively reducing staking APY (Staking APY is inversely proportional to total number staked ETH).

This could mean that investors may choose to invest in ETH or rotate their assets into ETH being the leading smart contract blockchain fulfilling ESG mandates. However, there are also speculations that enabling withdrawals may trigger a mass exodus from ETH adding selling pressure to the already low liquidity markets.

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