Ethereum’s Shanghai Upgrade Will Permanently Alter ETH Economics

An Ethereum transformation is on the horizon, and no one is sure how the market will respond. In time the “Shanghai” upgrade may be remembered as a uniquely bullish event for ether (ETH), the world’s second-largest cryptocurrency by market value.

In the short term, however, a number of the world’s leading Ethereum quant traders who historically have outperformed ETH staking yield believe price action will be neutral to potentially bearish due to the expected large increase in circulating supply of ETH after investors are finally able to withdraw their stakes.

James Hodges is the managing partner of Amphibian Capital, an ETH-based fund of funds.

Over a longer time horizon Ethereum’s total switch to proof-of-stake is likely to only benefit the network and ETH’s price – enough so to possibly dethrone bitcoin (BTC) as the world’s largest cryptocurrency by market cap.

Amphibian Capital, my firm, takes this logic further and predicts ETH may reign supreme as one of the world’s top three most valuable assets in the next decade. The Shanghai upgrade is a crucial step in that direction, which will likely increase liquidity and trading of ether and possibly attract more institutional capital into the crypto economy.

First, the Shanghai upgrade will enable users to participate in Ethereum's validation process through the implementation of the Beacon Chain mechanism, making staking more accessible and efficient. The Beacon Chain mechanism will democratize the staking process and allow for greater participation in the network, leading to increased security and decentralization of the network – a bullish sign.

Second, the “Merge” upgrade transitioned the Ethereum blockchain to a proof-of-stake consensus system, and the implementation of EIP-1559 turned ETH into a deflationary asset. EIP-1559 introduced a more predictable and stable transaction fee mechanism and enabled the burning of a portion of transaction fees. These features will continue to make ether even more deflationary, thereby increasing its value over time.

All of this lays the groundwork for increased institutional adoption of cryptocurrencies. We are already seeing growing interest in ether from institutional investors who are increasingly looking to diversify their portfolios and hedge against inflationary pressures. The Merge upgrade addressed Ethereum’s concerns that kept many investors out.

Once staking withdrawals are unlocked, institutions will be able to stake and earn a yield that will resemble fixed financial instruments such as bonds in traditional capital markets. After the Shanghai fork, staking yields from ether could be synonymous with the risk-free rate that traditional capital markets use to price their assets.

Investors may be scared off from the idea that the Shanghai upgrade could cause a large sell-off of ETH, some of which has been staked since 2020. However, data suggests this analysis is overstated.

CryptoQuant has noted that 60% of the staked ETH supply, or approximately 10.3 million ETH, is currently at a loss. Meanwhile, Lido DAO, the largest Ethereum staking provider, holds 30% of all staked ETH at an average loss of $1,000. Typically, selling pressure arises when participants have large profits, which is not the case for staked ETH currently. This suggests there may be limited selling pressure on the Ethereum market in the near term.

Furthermore, as reported by Santiment, nearly 90% of all supply of ETH is in self-custody. Holders of crypto have been increasingly moving towards self-custody since September 2022. When the FTX exchange collapsed in November the trend accelerated, leading to a massive drop in ETH supplies on exchanges. This reduces immediate sell pressure as capital moves to the sidelines, and future sell-offs are expected to be limited.

See also: Ethereum's Shanghai Upgrade Will Help Layer 2 Networks, Investor Says

As cryptocurrency continues to evolve, investors are constantly seeking new ways to accumulate more ether. Currently yields on liquid staking provider Lido sit at 5.4% APR. There is also the option to become a solo validator on the Ethereum network, which requires users to invest 32 ETH. Others choose boutique systems such as investing in ETH-denominated quantitative hedge funds, which offer higher rewards in exchange for more risk and fees.

All of these strategies have their pros and cons, and it ultimately comes down to personal preference and risk tolerance. It is important to thoroughly research and understand the potential risks and rewards before making any investment decisions.

In either case, we at Amphibian Capital remain extremely bullish on ETH’s long-term prospects, both from an ecosystem perspective as well as a price and market cap perspective.