Research Study

Shanghai/Capella Rehashed

Education and Insights

by Max Wadington

With the Shanghai and Capella upgrades successfully completed on April 12, 2023, we’ll recap how the upgrades have affected the Ethereum network, withdrawals processing, validator activity, price, and some longer-term implications to staking.

Overall, the upgrade was a major success. Following its completion, withdrawals were immediately processed, withdrawal credential changes promptly updated and the Ethereum blockchain finalized as expected. While some minor issues were observed following the hard fork involving higher latency and missed proposals, fixes were quickly implemented and validator performance has recovered to pre-upgrade levels. This network adjustment’s success officially marks the completion of The Merge and a significant decrease in the risks of validating the Ethereum blockchain. By taking a closer look at the on-chain data, we can begin to paint a clear picture that appears to reinforce validators’ long-term intent of staking on Ethereum.

Withdrawals Breakdown

When it comes to withdrawals, validators essentially have one option called a voluntary exit. A voluntary exit allows validators to completely withdraw their principal—plus rewards accrued—and cease validator operations. On the other hand, partial withdrawals occur automatically for validators with at least 32 ether (assuming they’ve updated their withdrawal credentials) and, currently, there is no mechanism to manually initiate a partial withdrawal. The network continuously scans through the validator set, processing both types of withdrawals as they become available.

While the occurrence of either transaction type does not signal a direction on the validator’s behalf, we have observed two key points that help to summarize Ethereum validator activity since the Shanghai/Capella upgrade:

  1. Partial withdrawals signify an increase in capital efficiency for validators that have successfully accrued rewards exceeding their initial 32 ETH deposit. These entities may be likely to re-stake their rewards due to their success in accruing rewards and relatively lower validator costs compared to other digital asset security providers.
  2. Full withdrawals by validators have mostly consisted of entities that have been required to cease operations with a small portion potentially opting to exit due to poor performance or switching staking services.

Of the total 2.8 million ether withdrawn from the consensus layer as of May 22, 2023, we see a breakdown of 37% partial withdrawals and 63% full withdrawals.1 Most of the partial withdrawals seen to date occurred within the first week after the upgrade, which could be a signal that validators are looking to put previously dormant capital back to work. Most full withdrawals have initially come from Kraken. As of May 22, 2023, Kraken makes up 32% of full withdrawals, which have exited the largest number of validators by far.2 This seems to be forming a mostly positive narrative around ETH staking sentiment. A significant portion of ETH staking fund withdrawals is being done by those required to do so. In Kraken’s case, they have been forced to wind down operations because of regulatory enforcement. As proposed in our previous piece covering Shanghai/Capella, all signs still point to an increase in staked ether. We have yet to see a mass exodus or elevated selling pressure in ether and it appears that validators are looking to stake their previously inaccessible rewards. While withdrawals only paint half of the picture, overall sentiment of staking on Ethereum may be best measured by staking entries and exits.

Entries and Exits

Since the Shapella upgrade, we have seen maximum two-way churn of the validator set. The entry queue (validators waiting to begin staking) has remained at capacity since April 13 and the exit queue (validators waiting to exit the validator set entirely) has diminished after four weeks. As of May 22, 2023, the network has seen a net increase of 17,000 active validators, or a 3% increase since the upgrade.3

Area chart showing count of validators in entry and exist queues from April 12 to May 21, 2023.

The chart above speaks to two clear validator paradigms. Firstly, the increase in capital efficiency and dramatic decrease in liquidity and technical risks may be factors propelling new and existing stakers to drum up more nodes. Secondly, as previously mentioned, entities that have been met with legal scrutiny for their staking operations make up a large portion of those exiting and appear to have been exhausted, at least in the short-term.

A lesson to be learned by those using a third-party staking service provider is the importance of regulatory clarity or jurisdictional decentralization (in the case of staking protocols). Time spent having to exit and re-stake elsewhere adds technical risk and decreases overall returns based on node uptime.

Breaking down entries and exits by entity since Shapella, staking providers Lido, Kiln, and Rocket Pool hold the top three spots in terms of staked ether net inflows, contributing to over 1 million net staked ether as of May 22, 2023.4 This inflow/outflow dynamic has resulted in a widely spread staking landscape, which highlights the benefits and drawbacks of each staking option.

Line chart showing net flows of staked ether by entity as of May 22, 2023.

Ethereum staking sentiment appears to be positive so far in part due to the large outflow of ether from centralized exchanges associated with regulatory actions, notably the Kraken SEC staking settlement. This dynamic is especially notable because yields available in the traditional finance markets are historically high and relatively attractive at the time of writing. It is possible that Ethereum’s network effects have driven community members to view staked ether as the foundational rate in the digital assets ecosystem. Of course, there are still risks present in this seven-year-old ecosystem, but time and code ossification may drive more users to view it as such.

Price Action and the Bitcoin Ratio

Dual axis chart showing Ethereum market cap ratio of Bitcoin from Jan 2021 to  May 2023.

In our previous piece we proposed that price action may be largely muted due to ether withdrawals being re-staked and the lower operational costs compared to proof-of-work mining. Since the upgrade, the price of ether is down 6% as of May 22, 2023. Although down overall, this upgrade did not necessarily fall under the “buy the rumor, sell the news” paradigm that has been prevalent this past year when compared to the rest of the digital assets market. In fact, ether’s price movement has looked relatively positive when compared to the rest of digital assets with the ETH/BTC ratio up 7% since the upgrade.

Long-Term Implications

Even with the validator life cycle officially complete, there is still plenty of work being done to continue to innovate and provide additional value to node operators and token holders alike. In the short-term, liquid staking tokens (LST’s) could continue to be a dominant force given the extra utility for holders and fee streams for node operators. The dual-natured benefits of LST’s make solo-staking a less economically rational act, which drives the importance of removing trust and technical risk from staking service protocols because network security largely relies on these middlemen/protocols. Lido is one of the last known entities to allow access to withdrawals as they have worked through extensive audits, which may set an industry precedent. With a large portion of stake at risk, it is important to prioritize security in an industry so accustomed to moving fast.

In addition to the continued rise of LST’s, we look forward to newer innovations hitting the market, such as re-staking (built by Eigenlayer and not to be confused with standard re-staking of rewards) and distributed validator technology, which looks to further increase the utility and decentralization of nodes respectively.

What’s Next?

With The Merge officially in the rear-view mirror, the next huge step in Ethereum’s roadmap focuses on scaling through Ethereum improvement proposal 4844. This means lower fees may be finally coming, directly reducing costs impacting layer 2 platforms settling to Ethereum. This upgrade is a high priority and will impact nearly every participant in the Ethereum community. 

During the Shanghai/Capella watch party, Vitalik stressed the importance of figuring out scaling before the next bull run. He suggested that this may be possible, highlighting the fast-moving environment with multiple teams working on lowering fees both inside and outside of the core developer group.5



3Source: Glassnode as of 05/22/2023



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