Welcome Anon, today we are going to dive into one of the most anticipated events of the year which keeps the market on edge. Buckle up!
Among the most underrated feats that have been taking place is how smoothly the merge went without any complications. With that behind us, the major catalyst that is coming into play is the Shanghai Upgrade which is keeping a large majority of market participants on edge.
What is it and how can you play the event accordingly?
What implications will it have for Ethereum and other related protocols now and in the future?
Let’s find out.
What is Shanghai?
The Shanghai Upgrade is an Ethereum hard fork that will enable the withdrawal of previously staked ETH. One might wonder why that’s a big deal so let’s take a look.
Towards the end of 2020, the Beacon chain was created (the Proof-of-Stake chain we are currently operating on). The creation of this chain allowed Ethereum holders to stake their tokens (through a validator) on the Beacon chain while Ethereum still was operating on Proof-of-Work. This allowed long-term Ethereum holders to earn a “staking yield” on Ethereum, however, they were not able to withdraw these tokens and still can’t today. The Shanghai upgrade will allow the tokens that have been locked since then to become liquid which keeps the market on edge in case of a dump.
How much ETH is staked?
As it currently stands, 13.84% of the total Ethereum supply is staked which amounts to 16.6M ETH. However, people tend to forget that a large cohort of these stakers are underwater from their ETH deposits and might not necessarily feel the need to sell.
The first batch of lockers in December 2020 and January 2021 is the main concern as they are among the sole 15% of lockers of all deposited ETH that are currently in profit. The remaining 85% is underwater. The higher likelihood is that some of the rewards accumulated might be sold to hedge and balance one’s portfolio. Otherwise, there is a high likelihood of relocking taking place, more on this later.
However, taking these 16.6M ETH into consideration, 43% of these tokens are already liquid through liquid staked derivatives as they are staked through Lido, Rocketpool, Coinbase, etc. These users are in no rush to dump their tokens as they have been able to freely use them on-chain throughout this whole process. It’s the other 57% that people should be “concerned” about although that is already a stark reduction in ETH coming into the market. 0.57 * 16.6M = amounts to 9.46M, less than the average volume ETH trades for daily.
However, it’s also important to factor in the people that are staking ETH. The people in staking pools and others make up an interesting component of the Shanghai standoffs. These make up 18.6%, and a cohort of these will amount to home stakers, hard-core ETH people. The average person does not run their own validator due to the complexity that comes with it if you’re not technically savvy.
Also, everyone can’t unstake at once as that would compromise the security of the network. The rule is that only 6 validators can unstake at the time and as the general requirement to run a validator is 32 ETH, the maximum amount of ETH that can come into the market every epoch (6.4 minutes) is 32 * 6 = 192 ETH.
Meanwhile, the die-hard people will determine how the Shanghai upgrade plays out along with who will benefit the most from the upgrade.
Which protocol will benefit the most?
In the current scenario, Lido has the largest market share as 29.23% of all staked tokens are staked through Lido and in the LSD market Lido has a 73% market share.
Lido faced some criticism for this last year as it can be deemed as a security risk for Ethereum that such a large number of tokens are staked by one entity. However, people tend to forget that what Lido did was crucial as Ethereum would have been captured by centralized exchanges otherwise. Factor in that Kraken got into trouble with the SEC due to their staking services and you can imagine how paramount this was. Luckily, Coinbase is standing its ground and is willing to take the fight to the SEC (which makes sense considering staking makes up 10% of their revenue).
This indicates that Decentralization maximalists will take necessary action to protect Ethereum by diversifying from Lido into Rocket Pool to spread out the staking market share. Rocket Pool also lowers the barrier of entry to stake from 32 ETH to 16 ETH making it easier for a larger amount of people to stake through their services.
Rocket Pool plays a crucial role because the majority of validators (nodes) that the Beacon chain uses are currently run on Prysm (ETH2 node implementation). This is not a problem as long as Prysm works as expected. However, if Prysm would go down it would affect the whole network as the concentration of nodes on Prysm amounts to 43% of the network, which is better than in 2021 when it was at 66% and a real concern. Rocket Pool has very small Prysm usage, which is beneficial for the decentralization of the network. This is why Rocket Pool has an important part to play in the decentralization of the network along with diversifying market share from Lido.
How to view the LSD market
As alluded to Lido is leading the market and I expect its market share to decrease. However, considering only 13.8% of the current ETH supply is staked, I expect this number to severely increase over the coming quarters. Why? 13% is incredibly low in comparison to other blockchains and when the average consumer knows that they can withdraw at all times without any complications, the staking rate is bound to increase on Ethereum. Other Proof-of-Stake chains are averaging a staking rate between 50-70% and there is no reason why Ethereum will be any different.
So even though Lido might lose some of its dominance in regard to market share, its revenue won’t be severely impacted as the general staking rate increases.
Insurgents in this table are new protocols that will emerge after the release of Eigenlayer as people will be willing to take on more risk. Towards the end of 2025, people are expected to return to Lindy protocols that carry less risk as a “safe haven” to stake their ETH. Also, if people's aim is to decentralize the network further over time, I have made the assumption that getting Lido below 50% market share will be the initial target.
Note: You will probably have to click on the table to get a proper view of the model.
This is based on the current supply of ETH which amounts to 120M. More people will be comfortable with staking it without being liquid when withdrawals are enabled, the liquid staked market is estimated to capture a third of the staked ETH market.
Rocket Pool will most likely be a big winner and steal significant market share from Lido relative to their current position. It would not surprise me to see Coinbase's staking rate increase as well considering the interest of institutional investors (although this might be delayed due to the SEC).
Considering you also need to buy RPL tokens to stake your ETH on Rocket Pool (10% of the value of ETH you’re depositing into Rocket Pool), the RPL token has a good chance of being the major winner of the Shanghai Upgrade. It is one you should keep your eyes on. RPL is required for staking as insurance for the protocol in case your validator gets slashed when you’re staking, in that case, the RPL is used to compensate for the slashing and sold for ETH via auction.
LSD Protocol Value Accrual
How do the LSD protocols make money?
They take a cut on the staking rewards generated by the validators (on average 10%) which is what makes it such a lucrative business with the high number of ETH that is bound to be staked over time with an increased staking ratio.
As alluded to, despite the diversification of the market share when the withdrawals are enabled due to the Shanghai upgrade, the LSD protocols will most likely do well anyway with the expected increased share of ETH that will become staked over time. This incredibly profitable business model won’t go away anytime soon.
If you want to go through the full financial model and play around with the numbers, it has been attached below:
Feel free to play around with the numbers depending on your personal assumptions concerning how you think the market will develop.
If Shanghai leads to a sell-off it is most likely an opportunity you don’t want to go to waste as it might mark a generational bottom. Act accordingly.
If you are uncomfortable with which direction ETH will go during the date of the upgrade, picking up some VOL will probably be a good hedge, and CVOL by CVI isn’t a bad idea.
Either way, you now have the full playbook in regard to how to play the Shanghai upgrade.
I hope you enjoyed the post. Don’t forget that you are more than welcome to leave feedback or drop any questions in the comment section.
Disclaimer: All Content on this site is information of a general nature and does not address the circumstances of any particular individual or entity. Nothing on the site constitutes professional and/or financial advice, nor does any information on the site constitute a comprehensive or complete statement of the matters discussed or the law relating thereto. I am just a random degenerate sensei sharing an opinion.