Ethereum Shanghai Upgrade – What it Means For Staking ETH
Key Points
- Since Ethereum’s Shanghai upgrade on April 12th, the total amount of ETH staked has decreased by ~450K (~2% decline in total ETH staked).
- Another ~490K ETH is slated to be withdrawn over the coming weeks. But it is unclear how much new ETH will be staked and thus offset these impending withdrawals.
- The secular trend towards more ETH being staked over time remains fully intact. On a relative basis, ETH staking yields remain attractive.
Ethereum Shanghai Upgrade Debrief
Via its Shanghai upgrade on April 12th, 2023, withdrawals of staked ETH were enabled for the first time on Ethereum.
As expected, the world did not end.
From a price perspective, ETH is trading around the same price it was at pre-Shanghai. It went into Shanghai at ~$1,900, briefly surpassed $2,100 the day after Shanghai, and it currently stands at ~$1,850.
The total amount of ETH that has been unstaked (on a net basis) stands at ~450K.
- There were ~19.3M ETH staked going into Shanghai, and there are ~18.9M currently staked.
- As a percentage of staked ETH, this ~450K ETH represents a ~2% decline.
- As a percentage of all ETH in circulation, this ~450K ETH represents just ~0.3%.
This ~450K decrease can also be decomposed into changes in staked ETH deposits and rewards:
- Deposits: ~0.5M ETH of net new deposits have been staked.
- Rewards: ~1.0M ETH of staked ETH rewards have been withdrawn.
For those that read our prior Shanghai article, that should not be surprising. In the article, we said that staked ETH deposits were akin to rent-generating property. While Shanghai has enabled property owners (i.e., stakers) to sell their property (i.e., staked ETH) for the first time, it is not surprising that, in aggregate many have declined to even put their properties on the market (i.e., withdrawn ETH).
In that article, we also stated that staked ETH rewards were similar to uncashed rent checks earned by the property owner. They were not earning a yield. So, once they could be withdrawn, we expected them to be.
Pinpointing Large Movers
Take a look at the chart below. It shows withdrawals by type (excluding the net impact of any inflows) across top entities since Shanghai.
Collectively, centralized exchanges account for ~81% of all staked ETH withdrawals seen to date. Unsurprisingly, Kraken and Coinbase are among the biggest “unstakers.” The United States Securities and Exchange Commission (SEC) has been critical of staking products offered by these firms and alleged that they represent sales of unregistered securities. So, it is not surprising that a big chunk of staked ETH deposit withdrawals are coming from these entities.
How many more withdrawals will there be?
A quick look at the exit queue for ETH staking withdrawals shows that there is another ~490K ETH pending withdrawal.
While a meaningful amount of withdrawals have already been processed, we would not be surprised to see sustained withdrawals over the coming weeks and months. Why?
First, it takes time to process withdrawals. The withdrawal queue (i.e., the amount of time it takes to withdraw staked ETH) stands at 2-5 days for rewards. The withdrawal queue for deposits stands at ~11 days. These queues intentionally draw out the “unstaking” process to maintain network stability.
Second, centralized exchanges still stake a large percentage of ETH and could continue to see material outflows. For example, Coinbase accounts for ~18.5% of these pending withdrawals in the queue and still stakes 2.3M ETH (~12% of all staked ETH).
Finally, liquid staking protocols could emerge as big “unstakers” over the coming weeks. Lido will enable withdrawals sometime in May.
While users staking with Lido have had the ability to sell their liquid staking tokens (in this case, stETH), there is likely some pent-up demand for users to get their funds out of Lido by withdrawing underlying ETH. After all, Lido does charge a 10% fee on its staking rewards.
The Big Picture
Over a longer time horizon, the “reshuffling” caused by Ethereum’s Shanghai upgrade will be tough to notice.
Take a look at the chart below. It shows the total amount of ETH in the deposit contract on a monthly basis.
(How’s that for up and to the right?)
Throughout the turmoil of 2022, the amount of ETH staked has been on a secular uptrend. And let’s not forget, things got pretty bad in 2022: Terra, the largest algorithmic stablecoin, collapsed. FTX filed for bankruptcy. BlockFi filed for bankruptcy. Genesis filed for bankruptcy. The SEC ramped up enforcement actions against centralized exchanges offering staking products.
(OK, we’ll stop there)
While Shanghai has briefly pushed the “pause button” on net increases in the total amount of ETH staked, all signs point to that being a short-lived phenomenon.
Why, you may ask?
In short, ETH staking yields remain attractive.
What Sets ETH’s Staking Yield Apart?
Ethereum stakers currently earn a yield of ~5% on their staked ETH. In other words, if you staked 100 ETH on January 1st, you would end the year with ~105 ETH.
That doesn’t sound too shabby.
But in comparison to other nominal staking rates offered by other layer-1 networks, it doesn’t look like anything special.
What the chart above shows are nominal yields.
In other words, these yields do not take into account the rewards which are paid out due to inflation (i.e., new tokens being issued into supply). Similar to how a tech firm issuing more stock does not magically make its company more valuable, a crypto network issuing more tokens does not make its network more valuable.
So, when it comes to assessing the profitability of different staking opportunities, (trying to) pinpoint real yield is a valuable exercise.
What’s a Network’s Real Yield Potential?
The best way to assess how real of a yield a network is capable of generating is by looking at transaction fee revenue.
If a crypto network does not generate transaction fee revenue, its only way of distributing yield to stakers is by inflating the token supply. That means creating new tokens “out of thin air” or taking tokens that are currently locked and distributing them to stakers.
(The tokens gotta come from somewhere!)
How does one generate transaction fee revenue, you may ask?
In short, by cultivating large ecosystems of users and decentralized applications.
What Makes Ethereum’s Ecosystem Different?
For anyone that is paying attention to crypto, it is pretty clear that Ethereum has a large and burgeoning ecosystem.
- Uniswap, the top decentralized exchange on Ethereum, has processed more spot trading volume in certain months than centralized crypto exchanges such as Coinbase.
- Top lending and borrowing protocols on Ethereum, such as AAVE, have facilitated billions of dollars of crypto loans.
- All of the top NFT projects, such as CryptoPunks, Bored Ape Yacht Club, etc., call Ethereum home.
While other layer-1 networks are supporting similar types of activity, none of them are doing it at the same scale as Ethereum.
So, it is not surprising that Ethereum is in a league of its own when it comes to transaction fee revenue – especially since the cost to make a transaction on Ethereum layer-1 remains high.
Take a look at the chart below. It shows the total aggregate transaction fees paid on different layer-1 networks over the past 365 days.
Over that time span, users have spent ~$2.0B in transaction fees on Ethereum. That is far more than users have paid on alternative layer-1 platforms (e.g., TRON, BNB Chain), far more than users have paid on Bitcoin, and a hell of a lot more than other layer-1s (e.g., Filecoin, Avalanche, Solana).
Ethereum has a big leg up on other layer-1 networks in terms of organic revenue, which it can use to reward stakers (on a sustainable basis).
But there is one other major factor that sets it apart from the pack.
Not That Many People Actually Stake Their ETH
An overlooked feature of staking rewards is that they are, unironically, only paid out to people who actually stake native tokens.
So, if a network has a low staking participation rate, the gross amount of tokens (in this case, ETH) that need to be paid out to generate a given yield for stakers is lower.
When it comes to Ethereum, only 14.9% of all ETH in circulation is currently staked. So, rewards only need to be paid out to a small percentage of token holders.
Putting It Together
Given this combination of high organic fee revenue and a low percentage of ETH being staked, Ethereum stakers earn a real yield that is increasing the value of their holdings over time. Still not convinced?
Take a look at the chart below. It shows the increase in ETH supply since the network activated transaction fee burning through EIP-1559 and after the network fully transitioned from proof-of-work to proof-of-stake with “The Merge.”
In years past, ETH’s supply has inflated by double digits. But after these upgrades, inflation is running much, much lower. ETH supply has actually declined, not increased, on certain days.
The benefits of this low inflation accrue to stakers – they get a nice real yield. But even for those that are not staking, this reduction in ETH inflation is a positive development. Those that are not staking are not seeing the real value of their holdings eroded by high inflation.
Could it really be that good?
Yes, for now, at least. For the time being, the combination of Ethereum’s high fee revenue, low percentage of tokens staked, and innovative token economic model is delivering real benefits to ETH holders.
But what about these other chains that have low transaction fee revenue and a high percentage of total tokens staked?
Everyone Else
In short, (pretty much) all of the other layer-1 networks analyzed need to issue new tokens into circulation to make up for this “revenue shortfall.”
Take Solana, for example.
- Its current staking APY is ~6.6%.
- Transaction fees totaled just ~$16M over the past 365 days. Relative to SOL’s $8.6B market cap, that’s just 0.2%.
- A large percentage (~72.2%) of SOL is staked.
Based on some back-of-the-envelope math, one can safely assume that the supply of SOL is being inflated by at least ~ 4.6% per year. That’s the network’s staking yield (6.6%) times its staking participation rate (72.2%).
In reality, inflation is likely much higher as new tokens can come into supply for a myriad of reasons (e.g., venture capital investor token unlocks, ecosystem grants, etc.).
Does this mean that SOL is a bad asset that can’t go up? In short, no.
The staking and supply dynamics of Solana are in line with all other layer-1 networks out there. Take Cosmos Hub, for example. Its staking yield is ~22%, it does not have material transaction fee revenue, and a large percentage of ATOM are staked. So, it’s safe to say that if you are holding ATOM and not staking it, you are being diluted to the tune of ~22% per year. (Ouch!)
It is worth mentioning that the bulk of networks analyzed have only been in operation for a handful of years. They could very well end up generating material fee revenue or even “maximum extractable value” rewards which would accrue to stakers. And over the long term, many of them could cultivate large ecosystems that deliver stakers sustainable staking rewards.
But when it comes to real yield today, ETH is in a league of its own.
Closing Thoughts
On the whole, the Shanghai upgrade has made staking ETH less risky:
Stakers can now withdraw staked ETH whenever they want. They no longer have to worry about long and indefinite lock-ups.
Large price divergences between liquid staking derivatives and underlying ETH are much less probable. While tokens such as stETH could still trade at a discount, chances are that any discounts will be shallow and short-lived.
But, staking ETH is still also not without its risks:
If the validator that a staker is using goes offline or behaves maliciously, stakers could see their stake “slashed” and realize real losses.
If stakers are using custodial staking products, there is a risk that intermediaries could run away with your coins or go bankrupt.
(Not your keys, not your crypto also applies to staking ;))
Updates: Page updated on 5/5/2023 to clarify that Lido is not re-staking rewards. To date the only rewards it has re-staked have been execution layer rewards – not consensus layer rewards.
Disclaimer
This article is for informational purposes only and should not be relied upon as a basis for investment decisions, nor is it offered or intended to be used as legal, tax, investment, financial or other advice. You should conduct your own research and consult independent counsel on the matters discussed within this report. Past performance of any asset is not indicative of future results.
Authors of this report hold assets mentioned in this report including: ETH, SOL, ATOM.
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