Ethereum’s Shanghai upgrade will dump huge sums of Ether into the market. Here’s everything you need to know

The giant token unlock marks the completion of Ethereum’s most significant upgrade to date—the Merge. Most significantly, the Merge cut ties with warehouses of crypto miners by combining the old blockchain with a new network that runs on an environmentally friendly transaction-validation mechanism called proof of stake.

The new proof-of-stake method gives out freshly minted ETH as a reward for those who “stake” (lock up) their crypto in Ethereum smart contracts. The more ETH a blockchain validator stakes, the more likely the Ethereum network will pick that validator to process a transaction, increasing the chance the validator will earn newly issued ETH.

To encourage validators to support proof of stake, Ethereum has since late 2020 offered interest rates up to 5% to anyone who parked huge amounts of ETH in its smart contracts. The ploy worked, and Ethereum developers implemented the Merge without a hitch last September, but there was one catch for investors: Those who staked ETH couldn’t withdraw it fund until the developers gave permission.

32 ETH

Shanghai is that permission. The upgrade grants about half-a-million validators—each had to provide at least 32 ETH (now about $57,000)—the right to withdraw their funds. So far, stakers have earned about a million ETH in rewards—about 0.9% of Ethereum’s total market capitalization.

The total number of individual stakers is far higher than that half-a-million figure; plenty of them pooled ETH from regular investors who couldn’t afford to meet that 32 ETH requirement, staking the funds on their behalf in return for a cut of the nearly 5% annual rate. Right now, Lido, the largest decentralized finance protocol that allows for the delegation of ETH, holds about 31% of all staked ETH, according to crypto analytics site DeFiLlama.

What else does Shanghai do?

Shanghai adds a host of other upgrades, known as Ethereum Improvement Proposals (EIPs). The most important ones, EIP-3651, EIP-3860, and EIP-3855, restrict transaction costs for technical applications, which could go some way to reducing fees on the otherwise expensive Ethereum blockchain. 

And Shanghai only concerns upgrades to the execution layer of Ethereum—the part that handles smart contract and protocol rules. Another set of upgrades, called Capella, will apply to Ethereum’s consensus layer, the part of the network that ensures that Ethereum’s validators are following the rules set forth by the execution layer.

Confusingly, developers are calling the upgrades Shapella—a portmanteau of Shanghai and Capella—despite the proximity to the upgrade. Ethereum’s Merge also changed its name close to completion from Ethereum 2.0 to the all-encompassing “Ethereum upgrades.”

Shanghai is scheduled for the end of April 12, the date the network is expected to process the  6,209,536th “slot.” Ethereum applications shouldn’t feel much of a pinch; although earlier Ethereum upgrades have been beset by delays, often by several years, a series of successful test-nets provide ample reason to believe Shanghai is firmly locked in.

Will prices crash?

Expect to witness a flood of ETH into the market. This is, after all, the first time investors have been able to cash out staked ETH for actual ETH. Before Shanghai, investors could only withdraw tokens that represented staked ETH on platforms like Lido, the equivalent of derivatives claims on ETH. They also could access fees earned during block proposals, such as tips paid to validators during each transaction, but not the newly issued ETH.

Jim McDonald, CTO of London staking firm Attestant, expects the price of Ethereum to dip sharply right after Shanghai as about 50% to 70% of early withdrawers cash out—the price of ETH has more than quadrupled since December of 2020, and there are profits to be had. He said he expects the sell pressure will be worsened by the paucity of new ETH dripping into the market, a consequence of an old upgrade that burned ETH after every transaction.

But McDonald also predicts ETH’s price will rebound quickly as stakers reenter the fray, perhaps after reshuffling providers or reevaluating their positions. New stakers also will join, he thinks, namely institutions that previously had feared staking derivatives services like Lido or RocketPool could burn to ashes, or that Shanghai would be delayed in perpetuity, locking away their funds forevermore. 

“You’re swapping your Ether for magic beans,” McDonald said of Lido. “Now, they’re pretty well-tested magic beans, but trying to sell that to your CFO can be tricky. But after Shanghai, he added, institutions can “retain control” while staking. “You’re not arguing with the taxman that you’ve sold your Ether and swapped it for magic beans.” 

A panel of top liquid-staking derivatives protocols also expect that the upgrade will bring institutions into the fold since they can add and remove funds at will, making Ethereum staking a whole lot more like an interest-bearing savings account than buying shares in a private company pre-IPO. Konstantin Lomashuk, a trader and contributor to Lido who appeared on the panel, told Fortune that Shanghai won’t dent ETH’s price while the wider banking crisis bears its weight on the crypto market. 

How will withdrawals work?

Two types of investors are likely to withdraw: validators, and their 32-plus ETH, and regular investors who delegated funds to these validators. Yet there are reasons to believe that its effect on the market might be muted; Shapella sets some limitations as to how much ETH validators can withdraw at once, and it would take about 18 months for validators to withdraw everything.

Only 1,350 full validators can withdraw their entire holdings each day (the initial 32 ETH investment, plus any accrued rewards), or 43,200 ETH out of a total pot of 17.6 million. It’d be far quicker to remove the cream on the top of the 32 ETH; about 110,000 validators can withdraw their rewards each day. McDonald, of Attestant, expects that about 1.1 million ETH (about $2 billion) will hit the market in the first week after Shanghai.

Lomashuk told Fortune that staking will almost double to 30 million ETH within a year, and that no more than 20% of stakers will withdraw their funds for good. Validators may not want to withdraw their ETH if the variable return rate, currently 4.6%, still beats returns elsewhere. That will grow the Ethereum network, he said, with the increase in transactions burning more ETH, and therefore raising the price “significantly.”

What’s next?

More upgrades are on the way. One of the next major upgrades, Cancun, will introduce “proto-danksharding,” a method of speeding up the blockchain as it accommodates more users by running the network on several smaller chains at once.

Michael Anderson, cofounder of the DeFi-focused VC fund Framework Ventures, told Fortune that proto-danksharding could be even more significant than Shanghai. “A successful implementation could significantly reduce transaction costs on L2s,” he said, referring to layer-2 protocols, “enhancing the average user’s experience and creating a huge competitive risk for a lot of the ‘Ethereum killers’ that dominated the conversation in the last market cycle.”

But those upgrades will have to compete with Arbitrum and Optimism, as well as rival blockchains, that have eaten away at Ethereum’s market share in the past few years. And while Shanghai is great for Ethereum, the Securities and Exchange Commission’s ongoing crypto crackdown might put the kibosh on what early investors can do with their unstaked ETH.

An earlier version of this story stated the price of Ethereum had quadrupled since December. It has been updated to say the increase has occurred since December of 2020.