Full report chapter 1:Ethereum Cancun Upgrade Brings Potential Investment Opportunities

Shanghai Upgrade

Upgrade Content

• Introduction: Shanghai Upgrade is currently the biggest narrative and public expectation in the market. Before the upgrade is launched on the mainnet, there will be 3 upgrade tests on the testnet (Zhejiang → Sepolia → Goerli). Sepolia’s upgrade was successfully activated, and if the previous rhythm of upgrading every 3 weeks continues, Goerli, as the most anticipated and highest participation testnet, will be activated on March 14th. This means that the Shanghai Upgrade on the mainnet may occur in April.

According to the announcement by Sepolia Shapella on February 21, 2023, Ethereum will upgrade the following proposals:

• EIP-3651: Warm COINBASE — — Proposal that affects the incentive transaction type

-Introduction: The first transaction in a block is a special transaction called a coinbase transaction, which was originally designed for miners to collect gas fee income for mining.

-Warm and cold refer to whether there is preloading when executing this transaction, which affects the gas fee for miners to pack coinbase transactions. If there is no preloading, it is cold, and the gas fee is higher; if there is preloading, it is warm, and the gas fee is lower.

-Usefulness: Transactions packaged by miners may be used for more purposes. Before EIP-3651, it was more incentivized to use ETH as a payment method. After EIP-3651, it is more incentivized to use ERC20 as a payment method. The income of miners is more diversified, and it can serve ERC4337 wallet users landing.

• EIP-3855: PUSH0 instruction — — Proposal to reduce meaningless GAS consumption

-Introduction: in the EVM, which is the Ethereum virtual machine (the system that executes contract code), there are multiple instructions designed. However, the push0 operation instruction, which is specifically for the value 0, was not designed before. This EIP adds the PUSH0 (0x5f) instruction, which pushes the constant value 0 onto the stack, and this instruction requires 2 gas.

-Previously, the lack of push0 resulted in many operations that relied on 0 as an offset, such as remote call invocation and return, and many parameters were 0. To operate on 0, only the PUSH1 0 instruction (i.e., push a number, the number is 0) could be used, which consumed 3 gas. In addition, push1 and 0 each occupy a byte of storage in the initialization code, and one byte consumes 200 gas (?), resulting in the cost of deploying this contract being increased by 2*200 gas.

-According to EIP-3855, about 11% of the execution instructions on the mainnet currently need to push PUSH0. Therefore, after this proposal is put forward, one-tenth of the execution instructions can save 200 gas (this may change).

-Usefulness: It can save a certain amount of gas and slightly increase the existing TPS of Ethereum.

• EIP-3860: Limit and meter init code The maximum deployable smart contract size limit is doubled, and some gas costs are added

-Premise:

EIP-170: limits the size of a smart contract to 24.576kb

EIP-3855: see above

EIP-3756: sets a protocol upper limit for gas limits, which is 30,000,000

-Introduction:

When a contract is deployed, there is an initialization code size. Based on EIP 170 (https://eips.ethereum.org/EIPS/eip-170), the initcode size is limited to 24,576 bytes. Now, the maximum initcode size limit is increased to 49152 bytes, which doubles the size of the initcode, and an additional 2 gas cost is applied for every 32-byte initcode block. At the same time, every 32-byte initcode chunk introduces a cost of 2 gas to represent the cost of jumpdest analysis. Because during contract creation, the client must perform jumpdest analysis on the initcode before execution. The execution work is linearly related to the size of the initcode.

The current code of only 24kb in size makes it difficult to use a contract to implement a system. The previous temporary solution was to deploy multiple contracts and call each other, but cross-contract references are obviously a high gas cost thing.

-Usefulness: The gas fee for contract deployment is slightly increased, but the contract size can be extended, which can alleviate the problem that the current bytecode length limit of smart contracts causes some complex contracts to be split into multiple contracts before they can be deployed to the mainnet. Contract developers can deploy larger and more feature-rich contracts.

• EIP-4895: Beacon chain push withdrawals as operations The core upgrade will make withdrawals an operating instruction on the beacon chain

-Introduction: The implementation is the operation of withdrawing ETH pledged. The system-level withdrawal instruction is introduced based on the beacon chain (consensus layer) information, which directly controls the ETH balance of the specified address without any conditions. There are many ways to perform withdrawal operations. The characteristics of this withdrawal operation are as follows

It is initiated by the system itself, not by any user, making it more concise and easy to review.

There is no gas fee consumption. The system initiation is subject to the withdrawal limit of the consensus layer, and there is no need to use gas to prevent DOS attacks.

The balance of the execution layer is updated directly without EVM execution process, using the simplest implementation strategy.

-Contents: Three key functions related to withdrawals will be provided

Update withdrawal credentials: can update the withdrawal credentials of Ethereum validators from the old 0x00 type (derived from BLS keys) to the newer 0x01 type (derived from Ethereum addresses).

Partial withdrawal: periodically “withdraw” the validator balance (i.e., the pledge profit) that exceeds 32 ETH, and can continue to use 32 ETH for pledging

Validators who have a withdrawal credential of type 0x01 can partially withdraw their validator balance every 2 to 5 days

Full withdrawal: the full exit of validators who have a withdrawal credential of type 0x01 is expected to take at least 28 hours.

• EIP-6049: Deprecate SELFDESTRUCT — — Related to reducing gas fees

-It is just a deprecation warning. The team hopes that the semantics of SELFDESTRUCT will change in future network upgrades, but the behavior of the opcode will remain unchanged in the Shanghai Upgrade.

LSD Track

• Why is it good for the staking track:

-Currently, Ethereum staking accounts for about 14.83% of the total Ethereum supply, compared with other major public chains such as Polkadot (48.45%), Solana (71.41%), and Avalanche (52.84%). There is still much room for improvement in Ethereum’s staking ratio.

-The high staking ratio of many major public chains is mainly attracted by high annualized returns, which will cause the value of staking tokens to shrink. After the Ethereum merger, it has essentially entered a deflationary stage. With the continued prosperity and development of the Ethereum ecosystem, the economic incentives for Ethereum staking are highly sustainable and attractive, and it continues to attract more and more institutions to participate.

-The security of public chains is closely related to the staking ratio, because for POS ecology, the funds required for a 2/3 attack = public chain coin market value * staking ratio * 2/3. Therefore, in order to develop the security of Ethereum, the official must increase investment in future staking directions.

• The projects worth paying attention to in the Ethereum staking track have entered white-hot competition, and future innovations will mainly focus on Restaking:

-LSD Staking:

-Lido: The industry leader with a high market share, difficult to shake its dominant position.

-SSV: The market value is still acceptable ($286m), and it will be doubly beneficial after the Shanghai Upgrade is launched on the mainnet in June. It is currently in an overbought state.

-SWISE: Low market cap ($39.8m), advantage in token economics with 90% of profits distributed to stakers.

-Obol: A staking protocol similar to Lido, with the innovation of Distributed Validation Technology (DVT) that allows Ethereum PoS validators to run on multiple nodes or machines. The project is currently in the testnet phase and progress is slower compared to its competitor SSV.

-Rocket pool: Another leader in the liquidity staking space that ensures protocol safety by requiring node operators to stake RPL tokens and penalizing them in case of incidents. A community proposal to limit Ethereum staking ratio has already been passed.

-Diva: A project that combines SSV/OBOL multi-signature and Lido/RocketPool liquidity pools for ETH 2 staking, while also lowering the staking threshold. It is a promising early-stage project with over 100% growth potential in the staking market.

Restaking — Eigenlayer

Proposed a novel re-staking scheme that allows users to stake ETH, lsdETH, and LP Tokens on other public chains, oracles, middleware, etc. The future of this scheme is highly promising. Advantages and Innovations:

Creating a sustainable value flywheel: Because the funds from re-staking will be used to protect any new applications or middleware created using EigenLayer, stakers will be able to choose the projects they want to re-stake and provide security for them while earning staking rewards. This will greatly enhance the security of the Ethereum consensus layer, which is tied to Eigenlayer’s security, and the more valuable the services created by EigenLayer, the higher the returns for ETH stakeholders. Therefore, Eigenlayer — Ethereum consensus layer — dapp will form a positive value flywheel.

Large potential market: After Ethereum’s open extraction, its potential market is not only for ETH staking, but also for corresponding derivatives staking.

Can improve Ethereum’s bandwidth: According to Blockworks Research’s article, Eigenlayer’s first product is EigenDA, which is Ethereum’s data availability service. It can increase Ethereum’s data bandwidth from 80 KB per second to 15 MB, an increase of nearly 200 times.

LSDs:

Frax: An algorithmic currency system based on partial collateralization mechanism. Its advantages mainly come from a more capital-efficient currency mechanism and a flexible currency policy based on the AMO module.

Yearn: In February 2023, Yearn officially announced the launch of a new product “yETH”, which aims to cover a basket of LSD assets in the form of yETH tokens to diversify risks and increase returns. It is speculated that yETH may be built based on first-layer LSD assets such as stETH and frxETH.

Pendle Finance: A DeFi protocol that tokenizes the future income of certain assets and allows users to sell them.

Aura Finance: An ecological governance platform based on Balancer, which enables LSD protocols to launch liquidity flywheels for LSD asset dollar trading pairs and altcoin trading pairs.

Shield Protocol: An LSD income aggregator that uses a perpetual contract and a dual liquidity pool model for on-chain transactions. One of its strategies is that pledgers deposit half of their ETH into LDO to receive mainnet node verification rewards while obtaining liquidity staked tokens stETH, and then jointly deposit the remaining half of their ETH into the LP of stETH/ETH on Curve to receive platform liquidity rewards and Curve incentive rewards. This can increase the yield of pure pledging by 20–30%. In addition, if users want to earn higher income, Shield will purchase some of the income to obtain price appreciation benefits from options anchored to the price of ETH. It is a “fixed income +” product in the crypto world.

In addition, there are regular projects such as ANKR, Bifrost Staking, StakeHound, SharedStake, stake.link, ClayStack, etc.

Possible selling pressure issues:

Linear unlocking suppresses a large amount of selling pressure: The most critical content of the Shanghai upgrade is to allow the withdrawal of the 16.97 million ETH locked on the beacon chain since December 2020. However, the current mode is gradual unlocking.

According to the current situation, theoretically, the daily withdrawal limit is about 55,000 ETH. Ethereum can activate about 7.55 validators per epoch (total validators/65,536), and there are 225 epochs per day. That is, currently, about 55,000 ETH can be unlocked per day at most.

Most participants are currently in a loss-making state and may have no intention of selling:

According to CryptoQuant’s analysis, currently, 60% of staked ETH is in a loss-making state, equivalent to 10.3 million ETH. The largest staking pool Lido accounts for nearly 30% of all staked ETH, with an average loss of nearly $1,000, and the average loss of staked ETH is 24%. Usually, selling pressure only occurs when participants have extremely high profits, but this is not the case currently.

Those who remain are mostly supporters of the ecosystem:

Most of the holders of Ethereum are early supporters of the ecosystem, and their selling intentions are generally low. Moreover, most participants use Lido or CEX for staking, and they can exit at any time.

Staking yield can be dynamically adjusted, and the income is relatively stable:

The less ETH is staked, the higher the yield. If the staked quantity drops to a certain level, the yield will rise, which will attract more people to participate. This relatively stable yield will be more attractive in a bear market.

POS is more conducive to empowering Ethereum’s ecology:

Ethereum is currently moving towards deflation, and it has already reduced by 41,000 ETH at the time of merger.

After POS, Ethereum can not only earn profits through staking, but also serve as a guarantee for the security of the entire ecosystem. It will become the underlying asset of the ecosystem in the future and will be supported by more and more use cases.

References

*For Shanghai upgrade specifications, see: https://github.com/ethereum/execution-specs/blob/master/network-upgrades/mainnet-upgrades/shanghai.md#eips-considered-for-inclusion* • *Ethereum Foundation Shanghai upgrade announcement, February 21, 2023: https://blog.ethereum.org/2023/02/21/sepolia-shapella-announcement* • Understanding Ethereum’s “Shanghai Upgrade”: Why is it getting attention from developers? https://news.marsbit.co/20230222082649758342.html (@February 22, 2023) ◦ The Shanghai upgrade will introduce five Ethereum Improvement Proposals (EIPs), including three key Ethereum protocols: EIP-4895, EIP-3855, and EIP-3860. EIP-4895 is for more flexible staking mechanisms for Ethereum stakers. EIP-3855 aims to improve transaction speed on the Ethereum network, and EIP-3860 aims to reduce transaction fees. These improvements will help improve the user experience of the Ethereum network in areas such as DeFi and NFTs, and increase the usability and attractiveness of the Ethereum ecosystem. EIP-4895 is the most anticipated proposal. • *Viewing Ethereum’s Shanghai upgrade from nine perspectives (January 9, 23): https://mirror.xyz/0xC36051E2bb2128c18B6E16e5013355A7D950b3F5/gpFTo3qJkdKJmNwtGqdeHFkxLwU4VRcszKXOPOJSjJA* ◦ Even if the Shanghai upgrade allows for withdrawal functions, the impact on ETH selling pressure is limited. As an event itself, the Shanghai upgrade is beneficial for the long-term development of the Ethereum ecosystem and can be seen as a long-term positive event. However, if a black swan event occurs during this period, it will still affect the market even if there is no staking unlocking. • *From 0 to 1: Understanding Ethereum’s Shanghai upgrade (January 10, 23): https://www.coinvoice.cn/articles/29918* ◦ The main content of the Shanghai upgrade is Withdrawal and EOF, and EIP-4844 will not be included in the Shanghai upgrade. This article analyzes the Shanghai upgrade technical part from the perspectives of Withdrawal and EOF. • After the Ethereum Shanghai upgrade, which tracks will see an outbreak? https://foresightnews.pro/article/detail/23159 (January 10, 23). Three parts: minor improvements, EVM object format and withdrawal, Cancun upgrade, Layer 2 may see a real outbreak.