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In just shy of two weeks, if all goes to plan, Ethereum’s eagerly anticipated Shanghai upgrade will go live, enabling the withdrawal of staked ETH from the blockchain network and effectively completing its years-long transition to proof of stake.
Since December 2020, when Ethereum began that journey to a proof-of-stake model—in which users stake cryptocurrency with a network to validate on-chain transactions, and then are rewarded for that participation with newly generated cryptocurrency—network participants have deposited over $32.95 billion worth of ETH with the network.
In September, Ethereum’s merge event successfully upgraded the network’s mainnet to a proof-of-stake consensus mechanism, forever changing the way Ethereum transactions are processed and reducing the network’s carbon footprint by 99%, according to figures from the Ethereum Foundation.
But the merge did not grant stakers on the network the ability to withdraw deposited ETH or the rewards generated by those deposits. Those funds remain captive on Ethereum; Shanghai will finally, after over two years, make them accessible.
On April 12, at 11:27 pm UTC, Shanghai will activate. What will that seismic moment in Ethereum’s history mean for the network, for its participants, and for the broader crypto ecosystem?
ETH better have my money
As a technical matter, Shanghai will be less involved than one might expect. The vast majority of Ethereum stakers, who have deposited their ETH with the network through intermediaries like Lido and Coinbase, won’t need to do anything on their ends once Shanghai goes live—besides wait.
Staked ETH, and the rewards generated by those funds, will be made available for withdrawal by intermediaries at varying dates following Shanghai’s successful implementation. Lido, the largest ETH staking intermediary, recently announced that such capability will be introduced about a month after the upgrade, after a series of audits and safety checks.
Coinbase, meanwhile, has not offered a firm timetable for rolling out staked ETH withdrawals, saying the process could take up to several months for some customers. All Ethereum network participants staking via third parties should check with those companies as to when their funds will be made available.
For the smaller number of independent validators who have staked directly with Ethereum (that pool is smaller because Ethereum requires validators to deposit at least 32 ETH, or just over $58,000 at writing, to stake with the network), matters will be only slightly more hands-on.
Validators must first provide a withdrawal address for staked funds to be sent to; typically, most validators already submitted that address during the staking deposit process. Once a withdrawal address has been submitted to Ethereum, it cannot be changed.
Validators can then opt for either a partial or full withdrawal. A partial withdrawal will send all funds and rewards generated beyond the minimum deposit amount of 32 ETH to a validator’s withdrawal address. If a validator’s withdrawal credentials are updated, then partial withdrawals will be sent to their withdrawal address automatically.
Independent stakers can also opt for a full withdrawal, which removes a user’s full stake, including original deposits of 32 ETH, from Ethereum, ending a validator’s participation in the transaction validation process. To fully withdraw from Ethereum’s staking process, a validator need only send a single exit message to the network using their validator keys and validator client.
Partial and full withdrawals will be processed in the order they are received by the network; based on the expected amount of traffic to come immediately following Shanghai’s implementation, that initial queue could last up to 2 to 3 days.
What will Shanghai mean for the Ethereum ecosystem?
While Shanghai will certainly be a notable event for individual stakers, and carries great symbolic significance as the culmination of Ethereum’s transformation to a functional proof-of-stake network, the upgrade will not meaningfully change the way that users interact with Ethereum, nor the underlying economics of the network itself.
“Most people have been able to sell [staked ETH] for quite some time, because the majority of ETH is being staked through platforms with liquid staking tokens, like Lido or Rocket Pool,” Jacob Cantele, head of product at Ethereum layer-2 Mantle, told Decrypt. “So I don't actually think [Shanghai] represents a major shift in the economics of Ethereum.”
The vast majority of ETH staked with Ethereum has, up to this point, been deposited with the network via third-party intermediaries, including staking pools like Lido, Rocket Pool, and Stakefish, as well as centralized crypto exchanges such as Coinbase, Kraken, and Binance. This is largely due to the fact, as mentioned above, that an individual validator must possess 32 ETH, or just over $58,000 at writing, to stake directly with Ethereum. Intermediary staking services generally allow for ETH deposits of any amount, in exchange for a small service fee.
Many of those intermediaries have issued tokens representing staked ETH to their customers, meaning that a sizable portion of the capital supposedly held captive in Ethereum’s staking deposit contract has been traveling freely around the crypto ecosystem for years. And with Ethereum’s internal mechanisms fully converted to proof of stake since September, the network looks poised to chug along post-Shanghai without much noticeable difference.
“Shanghai’s very exciting, but I do think it's just another step in the progression forward,” Alison Mangiero, executive director of Proof of Stake Alliance, an advocacy group for proof-of-stake blockchain networks like Ethereum, told Decrypt.
What will Shanghai mean for the broader crypto climate?
But whereas matters within Ethereum appear likely to look largely unchanged following Shanghai, the political landscape beyond the network’s virtual borders may be much more substantially impacted by the upgrade.
In the last year, and particularly since the stunning collapse of crypto exchange FTX in November, American regulators have cracked down heavily on crypto companies, most recently those offering staking services. In February, the SEC hit centralized crypto exchange Kraken with a $30 million fine, alleging the company’s intermediary staking services constituted illegal securities offerings.
Kraken competitors like Coinbase took the opportunity to clarify that their own staking services did not determine rates of return on staked deposits in-house, as Kraken’s had, and therefore should not be considered yield products. Last week, regardless, the SEC issued Coinbase with a Wells Notice, alleging that company’s staking services also constitute unregistered securities. Such a notice indicates that an enforcement action in the form of a lawsuit from the SEC is likely forth-coming.
Shanghai’s implementation alone may not immediately change the calculus of the SEC’s escalating war with staking intermediaries. But it could place another, much larger staking-related target in the federal agency’s crosshairs: Ethereum itself.
The very day the merge successfully transitioned Ethereum to proof of stake in September, SEC chair Gary Gensler, according to the Wall Street Journal, told reporters that proof of stake networks could be considered securities offerings due to their rewards mechanisms, all-but calling out Ethereum by name. Since that date, Gensler has slowly but surely built the case that ETH is likely a security, primarily by suggesting that “only Bitcoin” is a commodity.
It is possible that the SEC—which has long-defined “investment contracts,” a type of security, as investments made with an “expectation of profits to be derived from the efforts of others”—might use the implementation of Shanghai as evidence of the fulfillment of a securities arrangement between ETH stakers and the core Ethereum team that implemented the upgrade.
“People aren't going to get the [Ethereum] that they've earned as staking rewards, unless the Shanghai upgrade is successful,” Michael Selig, an attorney specializing in crypto regulation, who previously worked for the CFTC, told Decrypt. “Who's coordinating that? The SEC might have a list of people. It’s the essential efforts being performed by these guys to make it happen.”
While Selig adamantly believes such a move on the SEC’s part would constitute a misinterpretation of securities law, particularly given the decentralization of the Ethereum core development team, he fears it may be a path forward to censoring the Ethereum network as a whole.
“What do they have to say? ‘Look, these are investment contracts, and here’s evidence that there’s management or efforts being made by certain people,’” Selig said.
Such an argument would not likely be made until withdrawals are enabled on Ethereum, and the theoretical contract between Ethereum and its users is fulfilled. Should the Shanghai upgrade fail—an unlikely scenario, given the diligence and track record of Ethereum’s core developers—the SEC would have an even better case, arguing on behalf of swarms of disgruntled stakers that the network failed to fulfill its end of an investment bargain.
It remains to be seen whether the SEC’s appetite for crypto regulation might have grown so large as to attempt to snuff out one of the linchpins of the entire blockchain ecosystem. But whereas April 12—the date of Shanghai’s implementation—will remain a largely symbolic milestone within the crypto industry, symbolism can often have much more tangible repercussions in the realm of politics.