APR 07, 2023 • 7 Min Read
Since Ethereum’s Beacon chain went live at the end of 2020, over 18M ETH or 15% of the total supply has been staked in a deposit-only staking system. Next week, Ethereum will implement the Shanghai hardfork that will allow users to withdraw these assets, worth almost $32B. If you’ve been lurking in the bad parts of crypto Twitter, you might think that this newly unlocked supply will flood the market as stakers seek to sell. As always, the devil is in the details.
*record scratch* *freeze frame* You’re probably wondering how we even got here in the first place. It all began when the Beacon chain was introduced in December 2020 as a separate proof-of-stake (PoS) blockchain that ran in parallel with the Ethereum mainnet. To secure the Beacon chain, validators were able to stake ETH and earn rewards, but they could not withdraw the staked ETH or the rewards. When the Merge occurred in September 2022, the Beacon chain merged with the Ethereum mainnet as the latter transitioned to a proof-of-stake mechanism. With the Shanghai hardfork scheduled to occur next week, validators will be able to withdraw their staked ETH and rewards. Some of these validators have been waiting for more than 2 years to gain access to their ringfenced ETH and a majority of these assets are currently underwater at a price of $1,800 per ETH.
While this chart may induce panic at first glance, this doesn’t necessarily mean that validators will rush to cut their losses. Note that a majority of staked ETH comes from liquid staking protocols (Lido, Frax, etc.) and centralized exchanges with a liquid token (Coinbase, Binance, etc.). For these, the cost basis is largely irrelevant since holders have always had the option to sell the liquid token and exit their position. Moreover, there are several restrictions placed on the ability of validators to withdraw ETH.
We cover the Shanghai hardfork in further detail in our report, published exclusively for Delphi Pro members in March 2023 here. Here’s an edited snippet from the report.
“Shanghai is a hard fork tentatively slated for the second week of April that will enable withdrawals of validators from the Beacon Chain for the first time. The Beacon Chain has been in deposit-only mode since it went live at the end of 2020, and over the past 2+ years has had ~17M ETH deposited (in 32 ETH increments) and ~1M of accrued staking rewards earned. Immediately after the hard fork, this ETH can be unstaked/withdrawn, but with notable caveats.
First, staking rewards and the deposited 32 ETH/validator are considered separately. Staking rewards fall into the “partial” withdrawals bucket. These will be automatically swept to an Ethereum address after Shanghai and be able to be spent as soon as received. Withdrawing the rewards and the 32 ETH balance falls under a “full” withdrawal. These have stricter rate-limiting rules (i.e., churn) on the amount that can exit per day.
Partial rewards will have an immediate impact on ETH’s circulating supply, while full withdrawals will be a more drawn-out process with counteracting forces.”
So where does that leave us? After the initial shockwaves, Shanghai may actually cause an increase in the amount of ETH staked. With withdrawals successfully enabled, Ethereum’s transition to proof-of-stake will be complete and the duration risk of staking will be taken off the table. Currently, Ethereum lags behind other PoS blockchains with only 15% of supply staked. While others such as Solana and Avalanche have much higher portions of supply staked at 73% and 62% respectively, Ethereum is unlikely to reach those levels. At levels higher than 30%, the staking APR for ETH is no longer as lucrative.
While liquid staking protocols may lose their appeal as a tool to negate duration risk, they will still enable investors to bypass the 32 ETH staking requirement. Currently, the largest liquid staking protocol and the largest entity to stake ETH is Lido. The protocol holds nearly 75% market share among all liquid staked ETH and 31% market share among all staked ETH. As Shanghai takes away the duration risk of staking, more investors will prefer to stake ETH rather than keeping their assets idle. Liquid staking protocols, including Lido, are in the best position to capture these flows.
The second largest entity to stake ETH is Coinbase with almost 13% market share among all staked ETH. With the exchange’s recent launch of Base, an optimistic rollup built using the OP stack, Coinbase is positioning itself as the gateway for new participants to securely interact with DeFi protocols. In a world where Coinbase’s more than 100M users begin transacting on-chain, cbETH (the liquid token of Coinbase) stands to benefit from their DeFi adoption. This space will also continue to see innovations, such as the liquid staking token from Frax Finance. By introducing an ETH stablecoin that leverages CRV and CVX rewards, sfrxETH’s higher return will entice users and continue to attract deposits.
Shanghai marks a pivotal moment in Ethereum’s history, as it officially transitions the chain into its PoS future. With $32B of assets coming into play, there are sure to be some fireworks, and we’ll be ready with the popcorn.
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