Market View
Ethereum’s Shapella (Shanghai+Capella) Fork will be a major focus next week as the upgrade is scheduled for activation on April 12 at 10:27pm UTC. The network upgrade will enable validators to withdraw their staked ETH, some of which has been dormant on the Beacon Chain since the consensus layer went live in December 2020. The big question is how much selling pressure could materialize once withdrawals are enabled, as there are numerous variables involved in estimating both the supply that could be unlocked as well as the amount that could reasonably be expected to be sold.
We previously laid out our thesis in a report published February 14 (“Staked ETH withdrawals: new math”) that a sell-off on the back of this event should be relatively limited. Our revised estimates are that ETH selling directly from this source could amount to only around 1-2% of total average daily ETH volumes, and we’re biased towards the lower end of that range.
Chart 1. ETH/BTC cross has moved in ETH’s favor ahead of Shanghai Fork
Nevertheless, in our view, ETH performance around the Shanghai Fork will be less strictly dependent on technicals and more contingent on what risk actually does at that time. That is, if the trading environment sees risk assets selling off, people may decide to unstake and sell ETH just to de-risk, while institutions may not step in as aggressively on the buy side. Mid-April holidays may also constrain liquidity, while a lower stablecoin dominance ratio (of 11.2% of the total crypto market cap) suggests a lot of conversion into other tokens already took place in March.
There are however some mitigating factors that could limit the amount of ETH that could be immediately unlocked after the upgrade takes place. First, only 44% of validators have set their withdrawal credential prefixes to 0x01, which is necessary for both partial and full withdrawals to be enabled and funds unlocked. (Note: some of these address changes can only occur once the Shanghai Fork is activated.) Second, full withdrawals are rate limited to 8 validators per epoch at the moment or 1800 validators per day, given that there are around 563k validators at the moment. This figure changes as the total number of validators increases or decreases by 65,536.
Third, staking platform Lido, which represents almost 23% of all staked ETH, has said that their withdrawal functionality will be ready no sooner than early May as they are still preparing their v2 upgrade. Crypto exchange Binance has also set daily ETH redemption quotas for its users with withdrawals only supported one week after the Shanghai Fork takes place. All of this could drag out the timeline for when staked ETH balances could actually be withdrawn. (Incidentally, if users want to unstake their ETH on Coinbase, they will be able to do so soon after the upgrade is complete – waiting periods will be determined by the protocol.)
There’s also the separate but related issue of why people may actually sell the staked ETH that’s deposited into their accounts and how much could make its way onto the market. Pressure on this front could be alleviated by the fact that more than 67% of all staked ETH is currently staked through third-party entities, and a lot of those could use those released rewards to set up new validators. Moreover, around 51% of all staked ETH was locked up at prices higher than they are today, which diminishes the risk of ETH selling to meet tax liabilities.
Chart 2. Amount of ETH staked per price level (ETH/USD)
Finally, we are only considering the withdrawal side of the equation here. But as people withdraw, the base rewards on staked ETH increases which over time should also encourage people to stake ETH. The current staking participation rate in Ethereum is currently only 15% of total ETH circulating supply compared to an average of 65% across the top alternative layer-1s by market cap. That suggests that there is a very big opportunity to grow here, even if the ultimate staking ratio is still under 65% because of the relative amount of organic Ethereum usage.
Web3
NFT marketplaces. Earlier this week (April 4) OpenSea announced the launch of OpenSea Pro, which is effectively a rebrand of Gem, the marketplace aggregator that OpenSea acquired in April 2022. In an effort to recapture market share that OpenSea has ceded to Blur in recent months (discussed in our weekly commentary from late January), OpenSea Pro aims to provide much of the same functionality (as Blur and other competing aggregators) geared towards advanced NFT traders (deep liquidity from 170+ marketplaces, fast transactions speeds, sweeps, batch transfers, real-time data feeds, trends, watchlists, inventory management, instant sales and gas optimization). Further, OpenSea Pro is currently offering zero marketplace fees, but only for a promotional period (eventually returning to 2.5% for all secondary sales).
Notably, OpenSea Pro has taken a different approach with respect to community rewards. While Blur and others have incentivized traction on their platforms via token-based rewards for active traders, OpenSea Pro will offer rewards in the form of NFTs (perhaps in an effort to avoid the regulatory complexities associated with launching a token). The specifics of this NFT-based rewards system are not yet known, but it could potentially mirror the mechanics of Blur’s activity-based tiering system, rewarding the most active users with either a greater number of NFTs or access to more exclusive (limited supply) collections. It remains to be seen whether this alternative approach to incentivizing advanced trader activity will allow OpenSea to recapture meaningful market share, particularly given the removal of marketplace fees (a critical feature for this cohort of traders) is only temporary.
Lightning development. Roughly three years since it was first proposed, the functionality for “blinded routes” has been added to the Lightning Network protocol. While the Lightning Network offers enhanced privacy guarantees relative to transacting on the Bitcoin base layer, the assurance of anonymity has historically pertained to payment senders, but not receivers. The concept of “route blinding” allows payment receivers to obscure the details of the payment path from public view via an encryption technique that derives a “blinded” node identifier for each node in the payment path. This long-awaited functionality represents an important step in enhancing the practicality of the Lightning Network as a payments layer for the Bitcoin network and may help catalyze future adoption from individuals and merchants alike.
For more information on Lightning Network development, please see our recently published report, “Bitcoin’s layers.”
Coinbase Exchange & CES Insights
Volumes on exchange continue to be steady as we head into the second quarter. BTC comprised 40% of total volume on exchange, ETH was 25%, and a broad mix of stablecoins and altcoins rounded out the balance.
ETH is beginning to outperform as we head into the Shapella upgrade. The ETH/BTC cross is up 7% from its March (and 2023) lows. Traders seem to be getting more comfortable with the event risk around the coming upgrade and fears of massive supply hitting the market are subsiding. At the same time, BTC has run into resistance around the $28,000 level leaving traders looking elsewhere for additional upside.
Traditional hedge funds, crypto native hedge funds, and traditional assets managers have been net buyers over the past week. Private wealth was a net seller for the second week in a row. Flows in BTC were balanced while ETH was skewed significantly to the buy side. For the first time in several weeks a broad range of altcoins also saw net buying.
View From Around the World
Asia
According to Bloomberg, Dubai is increasing “scrutiny on crypto license seekers” after FTX’s collapse last year, in its bid to safeguard its business ties with Western jurisdictions like Europe while turning Dubai into a “capital for the digital-assets economy.” Binance is one of the crypto firms that were asked to provide more information on its “ownership structure, governance and auditing procedures.” (Bloomberg)
According to Malaysia’s Prime Minister Anwar Ibrahim, “China is open to talks with Malaysia on forming an Asian Monetary Fund.” The Prime Minister proposed “setting up the fund at the Boao forum in Hainan last week, stressing the need to reduce reliance on the dollar or the International Monetary Fund.” This revives a “decades old proposal to reduce reliance on the dollar.” (Bloomberg)
Europe
A member of the European Central Bank’s supervisory board has warned in a blog that the EU’s incoming regulations for crypto assets “will allow some of the industry’s biggest players, including exchange Binance, to escape stricter supervision and will need to be overhauled.” She added that “traditional approaches to financial market oversight might not work.” Her comment comes after the US Commodity Futures Trading Commission sued Binance last month, “accusing it of illegally serving US clients.” (Financial Times)
