Learn: A few things to know about Ethereum's Shanghai Upgrade

It is the biggest transition for Ethereum since its “Merge” upgrade last year, when the blockchain overhauled the way it operated.

Before the “Merge,” Ethereum relied on so-called “miners,” who use computers to solve complicated mathematical puzzles to secure the blockchain. Now, the network counts on validators, or ether holders who stake, or lock up, their coins to verify new transactions. These validators are rewarded with certain amounts of new coins, which allow them to earn passive income without selling the coins they hold.

The “Merge” allowed Ethereum to reduce its energy consumption by over 99%, according to the Ethereum Foundation.

But there was one problem — holders who staked their ether were unable to unlock their coins. The Shanghai upgrade solves the problem and could encourage more investors, especially institutions, to participate in staking

Here are four things to know about Ethereum's Shanghai upgrade and how it will impact the Ethereum ecosystem.

Finalization of the Move to Proof-of-Stake

Shanghai is the final step in Ethereum's move from proof-of-work (PoW) to proof-of-stake (PoS) consensus mechanism. Proof-of-stake is considered a more energy-efficient way for verifying cryptocurrency transactions where validators are randomly selected based on the staked ETH as opposed to all validators competing to verify blocks first in proof-of-work.

Ethereum started as a PoW network but its PoS-based Beacon Chain, which ran along the live, PoW blockchain, was first launched in December 2020, and a merger between those two chains, known as The Merge, took place in September 2022.

While Ethereum users have been able to stake their ETH since the launch of the Beacon Chain, they have not been able to unstake their ETH. The Shanghai update changes that in the form of EIP-4895 and finalizes this transition to PoS.

Investors Worry About Staked ETH Coming to Market

The ability to unstake ETH and their associated staking rewards earned so far has some investors worried, as it could enable many users who were previously unable to sell their staked ETH to dump their holdings on the market. Currently, roughly 15% of the total ETH supply is staked on the network.

According to a report from CoinDesk, as much as $2.4 billion worth of selling pressure could hit the ETH market as a result of Shanghai.

That said, it should be noted that all of this staked ETH cannot be unstaked all at once. There is a limit to the amount of staking withdrawals that can take place per block, and one February estimate from Into The Block points out it would take around 60 days for 20% of validators (stakers on the network) to unstake their ETH.

Crypto's Environmental Impact Debate in Focus

Shanghai's completion of Ethereum's transition to PoS also brings up crypto's ongoing debate about its potential environmental impact. PoW requires miners to prove their reliability to the network through the use of computer hardware, while PoS opts for an approach involving the staking of a crypto asset. For this reason, PoW uses much more energy than PoS.

PoS proponents often refer to PoW as wasteful, while proponents of PoW, which is used in bitcoin and is unlikely to be removed from that crypto network, view PoS as less secure and prone to centralization.

Technical Upgrades for Ethereum Transactions

Of course, the ability to unstake ETH is not the only change included in the Shanghai hard fork. For example, there is also EIP-3651,8 EIP-3855, and EIP-3860,which are all intended to improve the efficiency of transactions on the Ethereum network and lower gas fees for various decentralized applications (dapps).

It should also be noted that there are a number of consensus-layer changes included in Wednesday's hard fork in the form of an upgrade known as Capella. For this reason, many Ethereum developers are referring to the combination of these two upgrades as Shapella (a combination of Shanghai and Capella).