Ethereum Shanghai update could benefit liquid staking providers and solidify ETH’s Tier 1 dominance

The upcoming Ethereum upgrade in Shanghai will allow users to roll back staking Ether (ETH), making the network more liquid and competitive while increasing its staking factor closer to competitors.

The Shanghai update is an Ethereum hard fork that is tentatively scheduled for March. It implements five Ethereum improvement proposals, the main one being EIP-4895, which allows users to withdraw locked tokens representing staked Ether from the navigation chain.

The ability to withdraw Ether wagered can increase market liquidity and make it easier for users to access their funds. Ethereum’s liquid staking platforms, which largely emerged to ease the exorbitant requirements for blockchain locking and staking, could also benefit from the upgrade.

Since the Ethereum network switched to the proof-of-stake (PoS) protocol in September 2022, increasing the percentage of Ether staked has become important for securing the protocol. However, many were hesitant to stake their ETH due to the unavailability of withdrawals. As a result, only about 15% of ETH is currently staked, while all other major Tier 1 networks have staking rates above 40%.

Best crypto assets by betting market cap. Source: Staking Rewards

According to The DeFi Investor, many investors will choose the liquid staking option after upgrading in Shanghai because they can use liquid staking derivatives in other decentralized financial networks without losing their staking profit.

DeFi Investor went on to say that once staking ETH is available for withdrawal, liquid staking providers revenue is likely to increase significantly, which could positively impact their token prices.

In addition, increased competition between these platforms is likely to benefit their users with lower fees and additional benefits in return for their loyalty.

Lido is the largest ETH provider with liquid shares and the market leader in its segment. Other well-known liquid staking providers include Rocket Pool, Ankr, Coinbase, and Frax Finance, all of which are expected to increase usage after Shanghai.

Ethereum leads the liquid staking business

Ethereum Beacon Chain deposits with all staking providers have shown an upward trend since the network was officially opened for deposits in late 2020, indicating strong, sustained interest in ETH staking after the Shanghai update. While Lido takes the lion’s share of Ethereum’s liquid staking, the competition is heating up and various vendors are revealing product enhancements, potentially reducing the risk of any single staking vendor being the focal point of the Ethereum network.

Total ETH rate against all Ethereum validators. Source: Dune/@hildobby

It is also possible to seamlessly bet tokens of other Tier 1 networks. For example, DOT Polkadot (DOT) can be bet seamlessly via Ankr, ATOM Cosmos (ATOM) via StaFi, and SOL (SOL) Solany on Lido and Marinade Finance.

While competing networks have their own promising solutions for investing in liquids, Ethereum maintains its leading position, with over 7 million ETH covered in liquid from all sources. In comparison, at least 3.6 million SOL are bet liquidly – 1.21 million SOL via Marinade Finance and 2.39 million SOL via Lido.

Comparison of ETH balances with floating rates by provider. Source: Dune/@Ratedw3b

Liquid staking and staking pools give Ethereum a competitive advantage by improving interoperability for decentralized applications in the ecosystem. This increased share strengthens the security and usability of all protocols that use Ethereum’s PoS consensus mechanism.

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

This brings Ethereum closer to networks like Solana, which has a lower barrier of entry to betting.

While the concentration of ETH staked through third parties raises concerns about decentralization, particularly in Lido and Coinbase, there has been an approximately 9% increase in the total number of validator nodes on the network over the last 30 days, bringing the total number of Ethereum nodes to 11,786 at the time of writing . This means that problems with centralization increase and decrease at the same time.

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

With the elimination of staking in Shanghai thanks to improved liquidity and reduced lockdown requirements, institutions may also view Ethereum and ETH staking as assets in a more positive light.

However, the U.S. Securities and Exchange Commission recently cracked down on betting protocols it considers investment products. While providers such as Lido are working to become more decentralized, it is still unknown whether they will be classified as securities by the SEC and how the unfavorable verdict may affect the reshuffling of ETH staking providers.

There is also a turbulent macro outlook for cryptocurrencies in 2023, which could lead to more ETH holders abandoning staking and selling on the open market after the Shanghai update — although the Ethereum Foundation is limiting daily ETH withdrawal opportunities.

Nevertheless, Ethereum deposits continue to grow regardless of source, and savvy investors are likely to find solutions to any regulatory hurdles that challenge the space.