What is Ethereum’s Shanghai Hard Fork?
Hard work within a blockchain is a network upgrade leading to nodes no longer accepting the blockchain’s older version. Such radical network upgrades require all nodes within the network to upgrade to the newest protocol, permanently separating all blockchain custodians from the previous versions of the blockchain. These changes can be initiated by developers or demanded by stakeholders, and in most cases, the new protocol updates reflect new rules established by these parties.
Ethereum stakeholders have been anticipating the blockchain’s Shanghai Hard Fork, as the technical upgrades that will occur within the network will change the entire ecosystem and give holders the long-awaited opportunity to unlock access to their ETH crypto.
Photo illustration: Freepik
Ethereum staking began back in December 2020, meaning it’s been over two years since the first stakeholders had access to their staked assets. All staked Ethereum has been locked into a pool since the staking began, and after the developers complete the upgrade, holders will finally be able to take ETH coins out of the staking pool and put them back in circulation. On top of that, users will still be able re-stake to earn more rewards.
The withdrawal functionality added through the Shanghai Hard Fork will enable investors to withdraw funds from the Beacon chain to the execution layer, which is an essential step towards a sustainable and scalable Ethereum we’ve never seen before.
Still, the Shanghai Hard Fork could be executed only if a simultaneous upgrade occurs on the Beacon Chain (the mechanism responsible for creating new blocks within the network and ensuring their validity). In other words, Ethereum developers will schedule this consensus layer upgrade, known as Capella, around the same time as the Shanghai fork.
Why is the Capella upgrade necessary?
The Ethereum protocol has two layers – consensus and execution layer, both of which have different functions. A consensus layer exists to ensure the validators are following all network rules. The execution layer, on the other hand, is where the smart contracts reside.
Photo illustration: Freepik
But because they have an entirely different purpose, developers must initiate separate updates for each layer. That said, the consensus layer will undergo the Capella update, while the Shanghai fork is for the execution layer. And if you hear the term “Shapella,” know that the community merged these names, creating the one that refers to both upgrades.
One More Test to Go, and Then We Wait for the Main Event
Before initiating such a substantial upgrade, Ethereum has to go through the testing phase to ensure the ultimate success of the Shanghai fork. That said, two tests were already completed, and the third test is scheduled for April.
Sepoila, the second Ethereum test network, also referred to as testnet, successfully replicated staked ETH withdrawals, getting the network one step closer to the Shanghai fork. Still, it’s worth noting that Sepolia was the smallest testnet in terms of the number of validators performing within this test network.
Additionally, Zhejiang was the first testnet on which the Ethereum developers simulated the first withdrawals of staked ETH, and the third and final upgrade will occur on the Goerli testnet. The developers will likely test the Goerli network right before the Shanghai upgrade. And if everything goes as planned, the leading Ethereum network will process staked ETH withdrawals in no time.
The Correlation Between the Shanghai Upgrade and the 2022 Merge
Since 2015 when Ethereum went live, this blockchain has been operating under the Proof-of-Work (PoW) consensus mechanism. However, that all began changing on December 1st, 2020, when Ethereum developers created the Beacon Chain.
Now, until The Merge was put in motion, Mainnet was the main Ethereum production blockchain where all the transactions occur. Once Ethereum introduced the Beacon Chain, it ran in parallel with the Mainnet. So, instead of processing transactions within the Mainnet, the Beacon Chain was a separate „body“ reaching consensus within its own borders. But, after extensive testing, the Beacon Chain took over as the consensus engine processing all data residing on the network. The Merge, essentially the integration of the Beacon Chain, which was Proof-of-Stake (PoS), with Ethereum’s Mainnet, made Ethereum’s switch from PoW to PoS possible.
Photo illustration: Freepik
The Ethereum 2022 Merge was necessary for a variety of reasons. For example, the PoW Ethereum wasn’t sustainable or energy-efficient, and the gas fees were increasing due to the network’s incapacity to support more users and process more transactions. The Merge turned the Ethereum fate upside down, and now the blockchain operates using over 99% less energy than during the PoW era.
Why am I mentioning The Merge now?
Well, validators on the Beacon Chain, which triggered the Merge, placed a specific amount of ETH into smart contracts back in 2020 when the Beacon Chain was created and won’t be able to withdraw their coins until the Shanghai fork was completed.
The Shanghai upgrade is necessary because users supporting Ethereum during the Beacon Chain testing might prefer more control over their funds, especially after the 2022 market disasters. More importantly, the proof-of-stake Ethereum hasn’t reached its full potential since The Merge – it requires the Shanghai update to finalize the shift. And now that the update will make un-staking possible, the transformation will come full circle, and the pioneers who volunteered their ETH for staking purposes will, once again, have complete control over their funds and rewards.
What Happens After the Shanghai Fork?
Staked Ethereum has been locked for over two years now, and some are afraid that the un-staking will wreak havoc on the market.
In December 2020, ETH was valued at around $500-$600 per coin. At the beginning of March 2023, the ETH price rests around $1,600. And those who will finally have access to their staked coins after the Shanghai fork could make a good profit from selling their holdings.
So, the question is, could the Shanghai fork initiate a massive sell-off?
That is unlikely to happen, and here’s why.
The Shanghai fork will allow users to withdraw their holdings (over 17 million ETH coins), but the network will impose a limit of 43,200 ETH a day, preventing holders from flooding the market. So, even if investors decide to sell their crypto, the staked coins will be gradually introduced to the market.
We should also factor in the 2022 market crash and the fact that ETH was worth around $3,700 at the beginning of that disastrous year. It’s realistic to assume that the ETH price could rise to similar heights as the market slowly recovers.
Source: Yahoo Finance
The majority of ETH holders will most likely keep the coins to themselves until the market conditions improve. In addition, ETH is often referred to as a safe haven for investors, meaning there’s also a possibility that the majority will at least consider keeping their staked funds in the staking pool to keep the network running and reap additional benefits in terms of staking rewards. That said, it’s too early to worry about the potential ETH sell-off and another market disturbance.