The Ethereum Shanghai Protocol Upgrade marks the final chapter in the Ethereum proof-of-stake vision. Get ready for a sea of change, as 16.4 million and counting staked ETH ($26 billion) become eligible for withdrawal in late March.
What does that mean for institutional adoption and the broader financial ecosystem emerging on Ethereum infrastructure?
While the upgrade allows for withdrawals, the trend points rather upward. With the increasing number of ETH being staked post-Merge and likely to expand post-Shanghai, along with growing adoption of the Ethereum network and a rising ETH price, Ethereum staking is positioned to become a trillion-dollar industry.
At Staking Rewards, we’re thrilled to announce our upcoming event, “Institutional ETH Staking Post-Shanghai.” Join us on March 14th, 2023, at 10:00 AM EST as we gather top industry leaders to discuss the future of Ethereum staking.
Ethereum staking has the potential to become the risk-free rate of a decentralized financial ecosystem; it’s a must-attend event for any financial institution looking to stay ahead of the curve.
The Shanghai upgrade massively de-risks staking, thus making it increasingly attractive to institutions wanting long-term bets on the blockchain ecosystem.
The Ethereum ecosystem continues evolving. The upgrade is set to change the trajectory of Ethereum’s Future forever. The impact of this upgrade on institutional staking is crucial to understand for any institution considering staking.
With “Institutional ETH staking Post-Shanghai,” we’ve invited some of the brightest minds in the industry, including Ethereum researcher Justin Drake, SSV Network, Obol, Rocket Pool, Bridgetower, Alluvial, Stakewise, Bitcoin Suisse, ConsenSys Codefi, Attestant, Eigenlayer, and more. These experts will delve into the future of ETH staking, institutional support for network decentralization, ETH liquid staking, making staking compliant, and the opportunities and impacts of withdrawals post-Shanghai.
ETH staking is an exciting and rapidly evolving area, and this event will be a valuable opportunity for anyone interested in understanding its impact on institutional staking.
If you are considering staking and want to hear from industry leaders, we encourage you to join us for one of the most critical conversations of the year in staking. Register now for free and join us on March 14th, 2023 to learn about the impact of the Shanghai Upgrade on Institutional Ethereum Staking!
Now stay with us as we dive in to On-Chain Staking Data for Ethereum ahead of Shanghai.
Key Takeaways
- The Shanghai Upgrade de-risks ETH staking as it improves liquidity and reduces lock-up requirements by initiating the withdrawal process
- Institutions are likely to reduce the risk profile of ETH staking given withdrawal functionality and, in the best case, may see ETH staking rewards as a risk-free rate within a decentralized financial ecosystem
- Regulatory clarity will further accelerate institutional adoption in tandem with the Shanghai Upgrade as regulatory guidelines are adequately established for institutions to feel comfortable enough to devote capital, resources, and time to staking operations
- Staking regulatory issues currently revolve around businesses providing retail-facing staking services that change staking rewards beyond network-determined yields and thus face securities issuance questions. These likely won’t negatively affect institutions looking to run ETH validators themselves
- Staked ETH and validator count continue to grow with revitalized momentum after the Merge in September 2022
- Despite narratives concerned about sell pressure when withdrawals begin post-Shanghai, holders continue to stake more ETH pre-Shanghai
- Of the 16.4M staked ETH, 59% of stakers are in the red, and 40% of them are down over 40%
- The $1.5k to $1.7k ETH price range is vital as a significant portion of stakers initially staked tokens within the range
- Staked ETH returns (relative to price when staked) range from -80% to 240%
- Institutions are likely to participate in ETH staking if the Shanghai Upgrade is successful, regulatory clarity continues developing and doesn’t affect validators, and if ETH doesn’t face significant sell pressure post withdrawals
Shanghai Upgrade Overview
Ethereum’s latest Shanghai (execution layer) and Capella (consensus layer) upgrades are coming in March/April 2023. Put simply, the upgrade enables withdrawals of staked ETH. Despite narratives predicting withdrawals from the Shanghai Upgrade will dump price, the number of validators and staked ETH continues to rise. Withdrawals will process in the following manner:
- Initially, only validators who update withdrawal credentials to the required format can withdraw through partial or full withdrawals.
- Active validators can withdraw rewards earned (automatically), while validators no longer active can opt to withdraw their total balance.
- Withdrawals are not immediate; withdrawals are processed through a shared queue.
- Most partial withdrawals come from Lido, which plans to spin up new validators with withdrawn ETH.
- The queue process and Lido’s significant withdrawal share will drastically slow down any sales pressure from withdrawals.
- For a more detailed description, we recommend WesiteCapital’s thread on Twitter or the Ethereum website.
With the massive changes the Shanghai Upgrade enables, it begs the question of how institutional participation adjusts. Successful implementation of Shanghai Upgrade, paired with international crypto regulation efforts and Ethereum’s value, will determine institutional participation in ETH staking. Are we about to hit an inflection point if institutional participation picks up, or will post-Shanghai Upgrade withdrawals stunt upward momentum?
In addition, consider the profile of ETH stakers, some who even staked as early as 2020. Early stakers are unlikely to exit ETH positions – given the confidence required to stake ETH before withdrawal functionality even existed. We suspect staked ETH will increase dramatically after functional withdrawals arrive since risk-averse investors and likely more institutions will begin participating. ETH staking ratio sits at 14.5% as of February 2023, significantly below the 59% average amongst top PoS protocols (November 2022). There’s significant room for staking to increase (see data below from our 2022 Staking Ecosystem Report).
Institutional Participation
De-risking Ethereum Staking Through the Shanghai Upgrade
Staking Ethereum in the past two years required a risk profile willing to lock in an investment in a risk-on asset, technically not entirely liquid since withdrawals don’t exist. Shanghai presents the functionality to proceed with withdrawals, derisking lock-up periods, and creating liquidity for investors. With liquidity unlocked, ETH de-risks, and risk-averse institutions will open up to running ETH validators, given attractive yields. Further, ETH is currently deflationary, making the real yield even more attractive. Institutions historically adopt new technologies as they mature further, and the Shanghai Upgrade is a significant milestone for ETH. A successful upgrade is likely to attract institutional interest.
Legal Landscape on Staking
We anticipate legal clarity is in store for 2023. Brad Garlinghouse, CEO of Ripple, points out on Twitter several developments moving crypto regulation forward:
- Dubai published an extensive set of tech-agnostic rulebooks for crypto market participants, including compliance, advertising, issuance, and more
- Australia’s Treasury plans to reform licensing and custody for crypto and improve customer protection – recently publishing a token mapping consultation looking for public input
- UK government intends to build a clear framework for crypto to allow firms to innovate while maintaining financial stability
- South Korea’s Financial Services Commission published guidelines defining a security token vs. a payment token and how they are separately governed
And, of course, there are the recent events with Kraken, in which the SEC abruptly ordered to shut down Kraken’s retail-facing staking services. Although this comes off as SEC being anti-staking, it seems it’s a Kraken-specific issue rather than an industry-wide staking issue. The SEC claims Kraken fundamentally changed the staking process and procedure, making it a different product from staking directly. Second, Kraken was heavily involved in setting the yields beyond on-chain rewards determined by software. MeatTC_on Twitter provides an excellent summary of SEC’s complaint. At the same time, the Chief Legal Officer at Coinbase further provided insights into what a fully compliant staking operation looks like here. All this to say that the SEC isn’t necessarily out to get staking. Gary Gensler outlines the SEC’s current issues with staking-as-a-service Providers here. However, the SEC must clarify what is and isn’t legally acceptable for staking-as-a-service. Providers such as Kraken could have avoided fines or needing to shut down staking if regulations were clear. Coinbase further asserts the SEC is making misinformed assertions about staking, and a lot of FUD needs to be addressed. Read the response from Coinbase.
For institutions looking to operate validators to stake-owned ETH, issues Kraken faced don’t necessarily apply. If institutions are looking to provide retail services for staking, working frameworks exist, i.e., Coinbase. Momentum is growing for more crypto regulatory clarity worldwide, signaling to institutions that regulation is on the way.
Ethereum Value
Lastly, institutions must be attracted to Ethereum as a worthwhile investment opportunity. There are several factors to consider here; for example, are reward rates worthwhile, is there interest by users to stake ETH, and does the adoption of Ethereum continue to grow? Lastly, where is ETH price headed? ETH has declined over 65% since its peak in 2021. Is it worthwhile to accumulate ETH now?
Many are still undecided whether the Shanghai Upgrade will positively or negatively affect price impact. Korpi on Twitter does a great job at estimating how much ETH will be withdrawn after the Shanghai Upgrade, predicting anywhere between 3M to 6M and the sale of 436K to 2.9M ETH. We add to the analysis by exploring the current returns profile of different ETH stakers. With this information, we can see how many stakers are underwater, how many tokens are making a profit relative to price when staking, and how many token rewards have been earned thus far. Based on returns information, we can see how in the green or red stakers are. Let’s dig in.
As of February 8, 2023, 16.4M ETH is staked and has earned validators ~1.06M ETH, averaging a 6.6% reward rate. The validator count has grown 23x to 513.9k from an initial 21.3K validators in December 2020.
ETH market cap sits at ~$200B, whereas the Staking Market Cap is ~$29B. ETH staked accounts for about 14.5% of ETH circulating supply. ETH staking ratio has much more room to grow towards the 54% average of top PoS protocols, as discussed in our 2022 Staking Ecosystem Report.
Currently, we’re tracking ETH rewards at 3.86% for running a validator (excl. MEV). Reward rates will likely decline as more ETH continues to stake, but that doesn’t seem to slow down inflows thus far. In fact, one of the most significant single-day staking inflows occurred at the end of January 2023. Since The Merge, the ETH inflation rate has gone deflationary, currently, an inflation rate of -0.20%, leading to a higher real rate than reward rate – an uncommon occurance in most L1s. In addition, commission rates consistently decreased over the past two years as competition grew. For the latest reward rates and staking options, check Ethereum’s page on Staking Rewards.
Since the Merge, ETH staking market cap has grown significantly faster than ETH Market Cap. Staker activity shows positive sentiment towards the upcoming Shanghai Upgrade. Although withdrawals functionality via a successful Shanghai Upgrade is still one to two months away, holders continue to stake.
Since December 1, 2020, $35.56B in value has been staked, worth $29.02B on February 8, 2023. Despite earning rewards, with the price of ETH fluctuating drastically, 59% of stakers need help. The primary cohort of stakers at a loss staked during the bull markets in 2021 and 2022.
Price and timing are the most impactful drivers to whether investors are at a loss or a gain position. Those staking when ETH was at its peak in the $4k range are down 63% today, including rewards. Some of the earliest backers in December 2020 are up over 2x. Since the merge on September 15, 2022, most stakers are in the green.
From an absolute USD value, April 2022 saw the most significant inflow of ETH staked in USD terms, followed by May 2021. Since the market downturn at the end of May 2022, staking value in USD declined drastically as investors became more risk-off. Although Ethereum presented one of the safer crypto investment opportunities, staking ETH was significantly riskier, given ETH is locked-in. Staking momentum is starting to pick up again after an initial jump in inflows during the Merge; we’re still yet to match the 2021 and 2022 levels of inflow in USD terms, however.
On a token basis, September 2022 saw one of the most significant inflows of ETH staking, only second to the first month of staking in December 2020. Monthly staking inflows by the number of tokens outperformed inflows in 2021. Investors are staking more ETH tokens but less in USD terms. This puts further upward pressure on ETH staking ratio despite the lower USD value of ETH.
The value of staked tokens remaining today (including rewards) shows 4.3M ETH tokens worth $7.56B are down over 60%. Conversely, 1M ETH tokens staked worth $1.88B are up 200%. From a returns perspective, these would be two of the most at-risk cohorts of tokens to be sold off after withdrawals are functional since investors are significantly down or in profit.
The largest cohort of ETH stakers staked their ETH between the price of $1,500 to $1,700. Very few had staked when the price of ETH was above $3k. As long as the price hovers around $1.5k to $1.7k, we anticipate less staked ETH will sell off as investors won’t have significant changes to their balance.
Stakers at the $1,500 price staked about $3.8B worth of ETH at the time of stake, which is now worth ~$4B. On the contrary, those staking beyond $3k face some of the most significant drawdowns in USD terms. For example, stakers between $3k-$3.5k staked $8B, which is now roughly worth $4B. A tough decision on whether to continue staking ETH or cut losses from this cohort remains for the 2.8M tokens purchased between $3k-$3.5k.
Conclusions
The Shanghai Upgrade initiates much-needed withdrawal functionality for ETH staking. The upgrade enables further liquidity for stakers looking to run validators directly rather than through liquid staking solutions or staking-as-a-service providers. Institutions with available capital, sophistication, and resources will likely choose to run validators to maximize token rewards and minimize security risk when the Shanghai Upgrade is implemented. On the regulatory front, we see strides made and most staking issues identified don’t affect self-stakers, a positive for institutions running validators. Lastly, the price of Ethereum currently ranges between where most stakers initially staked. Although 59% of stakers are down on their original staking value, only 40% are down more than 40%. Paired with the slow withdrawal process and continuing increase of validators, there isn’t much abrupt sales pressure anticipated. Institutions must decide whether the current prices of ETH are worthwhile to stake and if future catalysts and adoption will continue pushing ETH value upward.
This is not financial advice.