Ethereum is set to undergo its eagerly anticipated Shanghai upgrade in just under two weeks, which will allow the withdrawal of staked ETH from the blockchain network, effectively completing its years-long transition to proof of stake.
Since December 2020, Ethereum has been making the journey to a proof-of-stake model, in which users stake cryptocurrency with the network to validate on-chain transactions, and are then rewarded for that participation with newly generated cryptocurrency. Network participants have deposited over $32.95 billion worth of ETH with the network since then.
In September, Ethereum’s merge event successfully upgraded the network’s mainnet to a proof-of-stake consensus mechanism, which forever changed the way Ethereum transactions are processed and reduced the network’s carbon footprint by 99%, according to figures from the Ethereum Foundation.
However, the merge did not grant stakers on the network the ability to withdraw deposited ETH or the rewards generated by those deposits. Those funds have remained captive on Ethereum for over two years, but Shanghai will finally make them accessible.
On April 12, at 11:27 pm UTC, Shanghai will activate. So what will that mean for the network, its participants, and the broader crypto ecosystem?
For the vast majority of Ethereum stakers, who have deposited their ETH with the network through intermediaries like Lido and Coinbase, Shanghai will be less involved than one might expect. They won’t need to do anything once Shanghai goes live, besides waiting.
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, matters will be only slightly more hands-on. Validators must first provide a withdrawal address for staked funds to be sent to, which most have already submitted during the staking deposit process. Validators can then opt for either a partial or full withdrawal, with partial withdrawals being sent to their withdrawal address automatically if their credentials are updated.
Full withdrawals remove a user’s full stake, including original deposits of 32 ETH, from Ethereum, ending a validator’s participation in the transaction validation process. 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.
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.
According to Jacob Cantele, head of product at Ethereum layer-2 Mantle, “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. 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. These intermediaries have made staking more accessible to individual investors, who otherwise may not have been able to meet Ethereum’s minimum deposit requirement of 32 ETH. The intermediaries also allow for ETH deposits of any amount, in exchange for a small service fee.
However, the regulatory landscape for staking services has become increasingly complicated in the US. In February 2023, the SEC hit Kraken with a $30 million fine, alleging that the company’s intermediary staking services constituted illegal securities offerings. Kraken’s competitors, including Coinbase, responded by clarifying that their own staking services did not determine rates of return on staked deposits in-house, as Kraken had done. Despite this, the SEC issued a Wells Notice to Coinbase, alleging that the company’s staking services also constitute unregistered securities. Such a notice indicates that enforcement action in the form of a lawsuit from the SEC is likely forthcoming.
The implementation of the Shanghai upgrade may not immediately change the SEC’s stance on staking intermediaries. However, it could place a much larger target in the federal agency’s crosshairs: Ethereum itself. On the day the merger successfully transitioned Ethereum to proof of stake in September 2022, 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 then, Gensler has 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” 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.
Attorney Michael Selig, who specializes in crypto regulation and previously worked for the CFTC, believes that 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. However, he fears that it may be a path forward to censoring the Ethereum network as a whole.
Concluding with all of this, while the Shanghai upgrade may not fundamentally change the way users interact with Ethereum, it has significant implications for stakers, intermediaries, and potentially the broader crypto ecosystem. The upgrade’s success and the subsequent withdrawal of staked ETH will be closely monitored by the SEC, which may use it as a basis for its regulatory crackdown on staking intermediaries and potentially even the Ethereum network itself.