As a fundamental change to the Ethereum network, Shanghai will be implemented as a hard fork.
Validators are users (also known as nodes) of Ethereum who create blocks and verify that the blocks and transactions are correct on the network. To ensure they are acting honestly, they put up a stake of 32 ETH which can be slashed (taken away) if they do not operate in the best interest of the network. This stake is deposited onto Ethereum’s Proof of Stake chain, called the Beacon chain, where it remains locked. In return for performing this service, they can receive staking rewards.
The Beacon chain: Ethereum’s Proof of Stake chain
For most of its existence, Ethereum existed solely as a Proof of Work (PoW) blockchain—like its predecessor, Bitcoin. However, in December 2020 Ethereum’s Beacon Chain was created, bringing Proof of Stake (PoS) to the network.
Upon release, the Beacon chain didn’t replace the PoW, instead operated alongside the primary PoW chain. Those who wished to become validators of the Beacon chain could stake 32 ETH and contribute to the security of Ethereum’s PoS alternative. This allowed developers to confirm the operability of a PoS consensus mechanism before combining Ethereum’s mainnet with the Beacon Chain. This change formally transitioned Ethereum from a PoW network to a PoS network in September 2022 in an event known as “The Merge.”
Although the Beacon chain let users receive ETH rewards for validating the chain through staking, it did not allow validators (or stakers who may not run their own node) to collect these rewards or withdraw their ETH deposits. Despite this, more than 16 million ETH were locked in the Beacon chain contract by February 2023.
Shanghai
Ethereum’s Shanghai Upgrade (also called the Shanghai Update or Shanghai Fork) includes five different Ethereum Improvement Proposals (EIPs).
EIP-3651, EIP-3855, EIP-3860, and EIP-6049 are all designed to lower gas costs for network developers. EIP-4895, which is considered to be the most important proposal, will introduce the capacity for stakers to withdraw their ETH from the Beacon chain.
Shanghai will be paired with another upgrade called Capella. While Shanghai is the update on the execution layer (where transactions take place), Capella will enable the update on the consensus layer (where nodes run the Proof of Stake Beacon chain).
Withdrawal process
Shanghai will enable two types of withdrawals: partial withdrawals and full withdrawals.
In a partial withdrawal, a validator will be allowed to collect any ETH above the 32 ETH staking minimum, typically the staking rewards. These are automatic as long as the validator has their withdrawal credentials set to an Ethereum address
In a full withdrawal, or unstaking, a validator may remove both the staking rewards and their full 32 ETH stake from the Beacon chain. Unlike partial withdrawals, the process is not automatic and there is a limit to the number of validators that can perform a full withdrawal per epoch (defined as 32 blocks). In fact, validators who want to fully withdraw their stake must wait in an “exit queue” before completing this function. In other words, all staked ETH cannot be withdrawn simultaneously, which would otherwise disrupt the performance of the blockchain.
Anticipated effects of the Shanghai Upgrade
Staking ETH enables users to participate in the security of a network while earning rewards for doing so. Prior to the Shanghai Upgrade, however, the stakes were locked as the rewards remained on the consensus layer. Shanghai enables the flow of assets from the consensus layer to the execution layer and thus allows stakers and validators to unlock their staked ETH and collect their rewards.
Because Shanghai would provide more certainty about the ability to withdraw staked funds, many believe the upgrade may increase the proportion of total ETH that is staked, hypothetically increasing the security of the network and potentially drawing users from other chains to Ethereum.
Although Shanghai offers potential benefits in the form of increased security and adoption, some worry about the effect on the price of ETH as validators may withdraw their stakes and sell their ETH on the open market. However, there are rules built into the withdrawal process that would limit this risk.
What were some of Ethereum’s past and future upgrades?
Through September 2022, there have been sixteen upgrades to Ethereum. Shanghai will be the seventeenth. Frontier was launched in 2015 as the first implementation of Ethereum, and the details of the subsequent changes that pre-date Shanghai can be found on Ethereum.org. Some of the most important ones are:
- Frontier thawing (2015): changed the gas limit for transactions and introduced the difficulty bomb, ensuring a Proof of Stake model in the future.
- Homestead (2016): included 3 different EIPs, which prepared Ethereum for future upgrades.
- DAO fork (2016): resolved a hack of a smart contract to recover hacked funds in order to return them to their original owners; it also resulted in the creation of Ethereum Classic when a significant contingent of Ethereum users did not adopt the fork.
- Byzantium (2017): reduced block mining rewards, delayed the difficulty bomb, and paved the way for layer 2 solutions.
- London (2021): implemented EIP-1559, which introduced a new fee structure to Ethereum and included the deflationary effect of “burning” ETH paid as transaction fees.
- Paris, also known as “The Merge” (2022): completed Ethereum’s transition from Proof of Work network to Proof of Stake.
Ethereum is a continuously evolving blockchain. While the Shanghai Upgrade will take effect after Paris, according to Ethereum founder Vitalik Buterin, future phases include:
- The Surge: implementation of a technology called sharding to improve scaling on the Ethereum network.
- The Verge: introduction of “proofs” that will aim to reduce data usage and make Ethereum more efficient.
- The Purge: decrease the amount of historical data that nodes must store.
- The Splurge: various upgrades aimed at improving the previous four phases.
Shanghai upgrade essentials
- Ethereum’s Shanghai Upgrade is a hard fork that will allow for withdraws of staking rewards—and unstaking—from the Beacon chain
- Shanghai includes five Ethereum Improvement Proposals (EIPs), the most significant of which is EIP-4895, which introduces withdraw functionality for network validators
- Although some believe this upgrade will upset supply-demand market dynamics, disrupt the security of the blockchain, and potentially devalue ETH, withdrawal limitations are intended to address this risk