Ethereum Shanghai upgrade could benefit liquid staking providers and cement ETH’s layer-1 dominance

Ethereum’s upcoming Shanghai upgrade will allow users to withdraw staked Ether (ETH), increasing the network’s liquidity and competitiveness while also boosting its staking ratio closer to its competitors.

The Shanghai upgrade is a hard fork of Ethereum tentatively scheduled to occur in March. It implements five Ethereum Improvement Proposals, the headliner being EIP-4895, which allows users to withdraw their locked-up tokens representing staked Ether from the Beacon Chain.

The ability to withdraw staked Ether could increase market liquidity and make it easier for users to access their funds. Ethereum liquid staking platforms, which largely emerged to alleviate the blockchain’s prohibitive lock-up and staking requirements, could also benefit from the upgrade.

Since the Ethereum network moved to proof-of-stake (PoS) in September 2022, increasing the percentage of staked Ether has become important to help secure the protocol. But many have hesitated to stake their ETH due to the unavailability of withdrawals. Consequently, only around 15% of ETH is currently staked, while all other major layer-1 networks have a staking ratio above 40%.

Top crypto assets by staking market cap. Source: Staking Rewards

According to The DeFi Investor, many investors will opt for a liquid staking option following the Shanghai upgrade, as they can utilize liquid staking derivatives on other decentralized finance networks without forfeiting their staking yield.

The DeFi Investor went on to say that once staked ETH becomes available for withdrawal, the revenue of liquid staking providers will likely significantly increase, which may positively impact their token prices.

Furthermore, the increased competition between these platforms will likely benefit their users through lower fees and additional perks in exchange for their loyalty.

Lido is the largest liquid-staked ETH provider and is a market leader in its segment. Other notable liquid staking providers include Rocket Pool, Ankr, Coinbase and Frax Finance, all of which are anticipated to enjoy an increase in usage post-Shanghai.

Ethereum leads in liquid staking activity

Ethereum Beacon Chain deposits across all staking providers have been on the uptrend since the chain officially opened for deposits in late 2020, indicating a strong, sustained interest in staking ETH following the Shanghai upgrade. While Lido captures the lion’s share of liquid staking on Ethereum, the competition is heating up, with various providers unveiling product improvements, potentially reducing the risk of any single staking provider being a point of centralization for the Ethereum network.

Total ETH staked over total Ethereum validators. Source: Dune/@hildobby

It is possible to liquid-stake the tokens of other layer-1 networks as well. For example, Polkadot’s DOT (DOT) can be liquid-staked via Ankr, Cosmos’s ATOM (ATOM) through StaFi, and Solana’s SOL (SOL) on Lido and Marinade Finance.

While competing networks have budding liquid-staking solutions of their own, Ethereum maintains the lead, with over 7 million ETH liquid-staked across all sources. By comparison, at least 3.6 million SOL is liquid-staked — 1.21 million SOL via Marinade Finance and 2.39 million SOL through Lido.

Liquid-staked ETH balances comparison by provider. Source: Dune/@Ratedw3b

Liquid staking and staking pools provide Ethereum a leg-up on competitors by improving interoperability for decentralized applications in the ecosystem. This increased participation strengthens the security and utility of all protocols using Ethereum’s PoS consensus mechanism.

Providers like Lido and Rocket Pool remove the barrier to entry for ETH holders to stake without committing to 32 ETH or running a validator node.

That brings Ethereum closer to networks like Solana, which has a lower barrier to entry for staking.

While the concentration of ETH staked through third parties raises concerns over decentralization at Lido and Coinbase in particular, there has been a roughly 9% increase in total validator nodes in the network in the past 30 days, raising the total number of Ethereum nodes to 11,786 at the time of writing. That means centralization issues are simultaneously growing and decreasing.

Total Ethereum nodes from Feb. 6 to March 8, 2023. Source: Etherscan/Ethereum Node Tracker

With the Shanghai upgrade derisking staking through improved liquidity and reduced lock-up requirements, institutions may also view Ethereum staking and ETH as an asset in a more positive light.

However, the United States Securities and Exchange Commission has recently been cracking down on staking protocols it sees as investment products. While providers like Lido are working toward greater decentralization, it is still to be determined whether they will be classified as securities by the SEC and how an unfavorable verdict could affect the shuffling of ETH staking providers.

A turbulent macro outlook also looms over crypto in 2023, which may lead to more ETH holders un-staking and selling onto the open market after the Shanghai upgrade — though the Ethereum Foundation limits how much ETH can exit daily.

Nevertheless, Ethereum staking deposits have continued to grow regardless of the source, and savvy investors will likely find solutions to whatever regulatory hurdles challenge the space.