Ethereum’s Shanghai Upgrade Explained

Ethereum, the second-largest cryptocurrency by market cap, is set to undergo a major upgrade, known as “Shanghai”. 

Anticipated for Q1/Q2 of 2023, the Shanghai upgrade will formally end the indefinite lockup period for staked ETH. Shanghai also implements technical changes to help lower the cost of transaction (gas) fees and increase the network’s transactions per second (TPS) capacity. 

The Shanghai upgrade stands as the most significant since the transition to Ethereum 2.0 in 2022.

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From Ethereum 2.0 to Shanghai 

In September of 2022, Ethereum successfully transitioned from a proof of work to a proof of stake (POS) consensus mechanism, or Ethereum 2.0. Under this new system, validators who have staked 32 ETH are randomly assigned the task of constructing new blocks, validating transactions, and securing the network. The staked ETH serves as collateral to prevent validator misbehavior. 

Although Ethereum 2.0 launched in 2022, the opportunity to stake ETH was available since late 2020. That’s because the staked ETH and validators needed to be in place before the transition could occur.

Investors had the opportunity to make north of 4% APR on their staked ETH. And many took it. In fact, approximately 15% of ETH’s total supply is currently locked on the network. But, the major catch has always been that this staked ETH would remain locked indefinitely until some point after the transition to Ethereum 2.0 was complete. 

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Shanghai Upgrade Details

The Shanghai upgrade improves Ethereum by bringing an end to the indefinite lockup period for staked ETH, lowering the cost of gas fees, and increasing the network’s TPS. 

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ETH Lockup Period is Ending

Most of the attention towards Shanghai is focused on the lockup period ending.

After implementation, stakers will regain full control of 15% of ETH’s total supply, currently valued at $26.5 billion. What stakers choose to do with their unlocked ETH is subject to much speculation. 

Here’s a breakdown of the various perspectives:   

1. Price goes down. Some think a significant portion will be unstaked and sold, due to a 2.5 year period of pent-up sell-side demand. 
2. Price remains steady. Others say Shanghai won’t effect ETH’s value. The idea is that no mass exodus is likely because the market has already priced in the event, the staked ETH to overall supply is relatively low, and the staking APR remains attractive.
3. Price goes up. And then there’s a group who believe Shanghai will cause the amount of staked ETH to actually increase because investors will no longer be deterred by an indefinite lockup period. 

As is with most things, only time will tell.

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Lower Gas Fees and Higher Transactions Per Second 

Shanghai’s other improvements are largely focused on lowering gas fees and increasing the network’s TPS capacity. 

ETH gas fees currently hover around $1. This appears cheap, but it’s expensive compared to competitors like Cardano and Solana. And historically, Ethereum has experienced periods when gas fees spiked into the hundreds of dollars. So, it’s understandable that the Ethereum community has been pushing for technical solutions, and Shanghai is part of the response. 

It’s the same story with Ethereum’s TPS. Right now, the network is processing approximately 11 TPS. This pales in comparison to Cardano and Solana. Thus, Shanghai is also aimed at boosting TPS.

Keep an eye on gas fee and TPS metrics after Shanghai is implemented. It will be interesting to see how these metrics change.    

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Final Thoughts

The Ethereum network is set to implement the Shanghai upgrade within the next few months. This upgrade stands as the most significant since the transition to Ethereum 2.0 in 2022.

Notably, Shanghai will unlock all the ETH currently staked to the network. Thus, stakers will regain full control over their assets. Currently, approximately 15% of ETH’s total supply ($26.5 billion) is locked in staking contracts. It’s unclear how stakers and ETH’s price action will respond after the upgrade is implemented.

Additionally, Shanghai is aimed at lowering ETH gas fees and increasing the network’s TPS. Ethereum backers support these improvements as they make the blockchain more competitive against its primary competitors, Cardano and Solana.

After Shanghai is implemented, investors and analysts will next turn their attention to Ethereum sharding upgrades, which are scheduled for late 2023 and 2024. Sharding will allow Ethereum to achieve “parallel processing”. Ethereum developers say that a successful implementation of sharding will dramatically lower gas fees and increase TPS on the network.