Ethereum Shanghai Hard Fork: Will it lead to a huge sell-off or just minor price turbulence?

5 Apr 2023

The Ethereum Shanghai Hard Fork, set to take place in April 2023, is an exciting upgrade for Ethereum stakeholders. It will allow access to staked assets for the first time. The withdrawal functionality being added will enable users to withdraw staked ETH from the Beacon chain to the execution layer, which means that staked ETH will finally be owned by the users who staked it. However, the upgrade can only be done with a simultaneous Beacon chain upgrade, and there may be a period of turbulence and market unpredictability following the upgrade. This upgrade is an essential step toward a sustainable and scalable Ethereum network and a necessary step after The Merge was successful last year.

One of the important recent event announcements for the Ethereum network, the so-called Shanghai Hard Fork (SHF), is set for April 12, 2023. This upgrade plays a major role in every ETH holder’s decision-making process. Once finished, the Shanghai Hard Fork will allow access to staked assets for the first time in the history of Ethereum.

Although it’s certainly exciting for anyone owning any amount of ETH, especially if you’re one of the people eager to withdraw their staked crypto, this network upgrade might open the door for a period of turbulence and market unpredictability in the forthcoming period.

What is the ETH Shanghai Hard Fork?

A “Hard Fork” is a network upgrade that leads to the nodes no longer accepting any of the older versions of such an upgraded blockchain. This somewhat radical change requires updating every node and synching up with the latest protocol. This permanently severs all of the custodians within a blockchain from all of the previous iterations of said blockchain. These changes might come from developers as well as be requested by the stakeholders. Most of the time, network and protocol updates result from new rules miners or stakeholders impose.

Ethereum stakeholders are now eagerly expecting the SHF since the update, and its technical improvements are bound to change the entire ecosystem while finally granting the opportunity to unlock access to their staked ETH.

ETH staking began in December 2020, which means that more than two years have passed, while all the staked ETH has been locked in a special, dedicated pool so now, once the developers are done implementing the update, all of the owners will have the opportunity to take their ETH coins from the staking pool and manage a vista style, expose it to the market, or put it back into circulation. Apart from that, users can still stake their coins again to gain further rewards.

The Withdrawal functionality, which will be added within the SHF update, will enable users to withdraw staked ETH from the Beacon chain (which is a mechanism responsible for creating and validating new blocks) to the execution layer, which means that staked ETH will finally once again be owned by the users who staked it. It is an important step forward toward a sustainable and scalable Ethereum network, never before seen.

Still, the SHF upgrade can be done only with a simultaneous Beacon chain upgrade. In other words, Ethereum developers will update the entire consensus layer (also known as Capella) almost simultaneously as the SHF implementation.

Why is the network upgrade required now?

The Ethereum protocol has two layers – a consensus layer and an execution layer. The consensus layer ensures that validators will respect the rules within the network, while the execution layer is where the smart contracts are being kept.

Since these layers serve entirely different purposes, the developers must initiate separate updates for each layer in order to perform the upgrade on the network as a whole. Hence, the consensus layer will have a Capella update, while the SHF is intended for the execution layer. If you ever run into the term “Shapella,” don’t be confused, as it’s only the community slang that unites these two names into one expression.

So, what exactly is about to happen?

Before any significant update, Ethereum must undergo a test phase to ensure the success of the SHF update. By now, two tests have been completed, while a third (and final) one is due to begin in April.

The Ethereum testnet was successful in replicating a withdrawal of staked ETH, which makes the network one crucial step closer to the actual update going live. Still, it’s important to stress that the Sepolia testnet, where this test took place, is the smallest possible testnet with regard to the number of validators involved.

Before that, a simulation of the ETH withdrawal was simulated on the Zhejiang testnet, where the Ethereum developers were also successful in following the process through all the way. 

The final test is going to take place on the Goerli testnet. If everything goes according to the plan, the main Ethereum network will be processing the first actual withdrawals of staked ETH rather soon.

How does the Shanghai Hard Fork relate to The Merge?

Ever since 2015 and the birth of Ethereum, this blockchain has used the Proof-of-Work consensus mechanism. However, this started to change on December 1, 2020, when the Ethereum developers created the Beacon Chain.

Before the 2022 Merge, Mainnet was the leading Ethereum network, where all transactions occurred. After the Beacon Chain was introduced, the Beacon Chain and Mainnet had been operating simultaneously. Instead of transaction processing within the Mainnet, the Beacon Chain used to work as a separate consensus-achieving entity. Still, after extensive testing, the Beacon Chain took over the role of initiating the consensus mechanism, which is in charge of processing all the data on the entire network. The Merge can be seen as an integration of the Beacon Chain (which relies on Proof-of-Stake) with the Ethereum Mainnet, which enabled the Ethereum blockchain to transition from Proof-of-Work to Proof-of-Stake.

So, the Merge relevance for this latest upgrade lies in the fact that the validators on the Beacon Chain, who were the first to push The Merge back then, staked a certain amount of ETH for smart contracts at the point of Beacon Chain emergence. These stakeholders will be able to withdraw their staked ETH coins only after the SHF is complete.

The bear market of 2022 has also set this upgrade as a high priority since the users supporting Ethereum during the Beacon Chain testing might wish for a better means to attain full control of their funds, especially at times of market uncertainty. More importantly, Ethereum 2.0 still hasn’t reached its full potential after The Merge – and the SHF is required to round off the transition to Proof-of-Stake. So, now when the un-staking (withdrawals) are going to be enabled after this upgrade, the transformation will be complete, and the stakeholders who were the first volunteers to offer their own ETH for staking will be regaining complete control of their staked assets and the rewards that came out of it. 

What’s next for ETH?

Since a number of Ethereum owners have been waiting patiently for more than two years to be able to manage their assets, a question arises if the unlocking of staked ETH could lead to the potential sell-off of large numbers of ETH coins over a short period of time? If this happens, a vast uncertainty lies ahead since such a run could disrupt and introduce chaos of sorts to the entire market.

In December 2020, ETH was worth somewhere between 500 and 600 USD per coin. At the end of March 2023, the ETH price was around 1,700 USD. Those who finally gain access to their staked coins after the completion of SHF could earn a lot just by selling off their assets.

So, will the SHF initiate a mass sell-off? It’s highly unlikely, and here’s why: The SHF will allow users to withdraw their assets (over 17M ETH coins). However, the network will impose a limit of 43,200 ETH per day. This means that the owners won’t be able to instantly overflow the market with all the coins but instead sell their shares of ETH gradually over time in case they decide to sell in the first place.

We must keep in mind the 2022 meltdown, where ETH was worth more than double at 3,700 USD at the beginning of the year before the price plummeted. It’s a ‘reasonable speculation’ to assume that the ETH price is capable of coming back to being that high as the market recovers step by step. Most of the ETH coin holders are likely to keep their coins until the market fully recovers. On top of that, ETH is often being described as a safe haven for investors, which means that there’s a possibility that most of them will be at least considering keeping their crypto in the staking pool (keep it staked, not perform un-staking or in other words withdraw it) so that the network can continue to function. At the same time, they gain rights to additional benefits (staking rewards) after a certain period of time from now.

Hence, it might be too early to really worry about a mass sell-off of ETH, even though major events such as this one are bound to have a sensible potential to disrupt the price and even introduce turbulence to the market in the broader sense.

Final Thoughts

With unpredictability being an inherent property of any currency, it can still be concluded that Ethereum (along with other major cryptocurrencies) is based on a revolutionary technology that has disrupted the traditional financial system by enabling fast, secure, and transparent transactions without the need for intermediaries.

While it has faced its fair share of challenges and criticisms, its popularity and adoption continue to grow rapidly. As the world becomes increasingly digitized and decentralized, cryptocurrencies, including Ethereum, will play a significant role in shaping the future of money and finance. The soon-to-come Ethereum Shanghai Hard Fork event is an essential step towards getting there, as it should increase trust in the network and the cryptocurrency itself.

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