Ethereum's Super Saiyan Moment

Hey everyone,

Ethereum has officially levelled up.

The "Shapella" upgrade (combining the Shanghai and Capella hard forks), implemented successfully last week, was the final step in its journey to becoming a full-on Proof-of-Stake (PoS) network. 

In this post, we cover the path to “Shapella” and what the upgrade entails, map out Ethereum’s roadmap for the future, highlight the key narratives at play in Ether’s (ETH) investment thesis and look at the relevant headwinds facing the asset.

FYI, for any terms you aren’t familiar with, we’ve linked to relevant resources to help fill the gaps.

Let’s get into it.

Ethereum's Super Saiyan Moment

The first major milestone in Ethereum’s journey to PoS was The "Merge", which merged the Beacon Chain with the old Proof-of-Work (PoW) chain. That went to plan in September 2022, despite multiple delays. Until this point, though, staking has been one-way. ETH holders could only deposit into the Beacon Chain and earn rewards without the ability to withdraw anything.

That's where "Shapella" comes in. The upgrade enabled validators to withdraw their staked ETH for the first time. The TL;DR of it is that the upgrade was a massive success. And, by success, we mean that the market didn't have ~$2 billion of ETH (which is 12% of daily trading volumes) being dumped on it all at once. 

The fear running rampant that newly unstaked ETH would cause significant sell-pressure never materialised. By April 17th 2023, over one million ETH had been withdrawn. However, on April 18th, staked ETH deposits surpassed withdrawals, marking a net positive flow of 68,000 ETH. 

This may be the first sign of the emerging "staking super cycle" - something many ETH bulls are convinced will happen post-Shapella. 

The thesis originates from looking at ETH's relative supply stake rate on the blockchain. This sat below 15% going into "Shapella" - miles below the ~60% average for the top 20 PoS networks. Until now, this was likely because of technical and liquidity risks with pre-Shapella staking. So, many believe that “Shapella” de-risks ETH, leading to a staking boom and closing the supply gap with other PoS chains.

It's still too early to tell, but the tiny net staking inflow on certain days tells us there is growing confidence in Ethereum's staking mechanism.

The reality is that the backlogs of "Shapella" still need ironing out. For example, validators seeking to exit face a 17-day wait to retrieve their staked ETH. While this may put investors off, there is the belief that the new ability to allow staking withdrawals may encourage investors to allocate more capital towards it. 

Grayscale analysts Matt Maximo and Michael Zhao note that early outflows of staked ETH have been slower than expected and do not necessarily signal an intent to sell, merely being a reallocation to different staking providers. They believe the Shapella upgrade is a bullish event for Ethereum, as reducing staking risks could boost demand for ETH.

At a high level, another major upgrade signifies tangible progress in Ethereum's evolution to become the de-facto smart contract platform. Moreover, it potentially attracts another swathe of institutional investors with unreasonably deep pockets seeking a secure protocol with solid staking yields.

But before we get into the long-term investment narratives for ETH, let's do some analysis of the technical and on-chain data driving the asset’s price right now. 

Technical Analysis

At the time of writing, ETH has lost daily support at ~$1,930 and is heading down to the 12-hour range low support at ~$1,854.

Our expectation is that this level will hold over the coming day. Therefore, $1,850 should be a good entry point for any short-term longs investors want to take.

When jumping to the weekly chart, we see that ETH still has legs to move up to the $2,300-2,500 region (Approx. Point D above) before rejection should occur. If BTC rejects at that level, a coupled retrace between the two assets could play out. 

Watching the weekly StochRSI on both pairs is essential here. If BTC retraces to the $25,000 region, ETH may well rally. 

However, any consolidation in BTC will likely see ETH take the lead on further rallies. A force playing a part in this is the decoupling of correlations between the two assets.

BTC's correlation with ETH has dropped to its lowest level since January, per Kaiko. Moreover, the correlation has been particularly volatile over the past seven months after it hovered around 90% for most of 2022. The trend could suggest that investors increasingly perceive BTC and ETH as diverging assets, with more interested capital looking at ETH.

On-chain Analysis

Strong on-chain fundamentals oppose the technical retracements we’ve seen in ETH's price. So let's put on our blockchain-sleuth hats for a second and dive into the Ethereum chain.

Ethereum's Shapella upgrade was activated without material issues when looking at the network. Although the level of missed block proposals (i.e. the number of transactions being processed on-chain) briefly rose around the event, this recovered to the average by Thursday afternoon.

While exact figures are difficult to quantify, the total number of active validators has remained relatively constant since Shapella was implemented - highlighting the growing confidence in ETH staking.

As of last week, 5.5k validators had fully exited, while 17k validators are in the queue. This, coupled with the quick return to "business as usual" for the network, signals that fundamental interest in ETH remains.

Within the first 12 hours of Ethereum's Beacon chain withdrawals opening, initial withdrawals peaked at nearly 12k ETH (~$25 million) before trending downwards. After that, ETH staking remained less consistent but experienced noticeable peaks compared to pre-Shanghai deposits. 

In the first 36 hours, 65% of withdrawals were sent to Lido, and 79% of unstaked ETH went to institutional addresses. 

Most initial withdrawals took out only accumulated rewards, with 97% being 5 ETH or less.

While the strength in ETH's on-chain data is evident post-Shapella, there are potential drawbacks to the "staking super cycle" if it does take off.

Hal Press of North Rock Digital has warned that a higher staking participation rate potentially damages ETH's long-term promise. 

Basically, the higher staking participation goes, the lower the staking yield will be (because staking rewards programmatically decrease when the total balance of validators increases to balance the security and efficiency of the network), and the greater the ETH supply inflation will be (as more rewards will be issued to the higher number of stakers). 

However, staking participation is far from the long-term peak, so there is no imminent danger to ETH.

ETH Narratives at Play

As we begin to shift the focus to the longer term, there are two notable narratives that we believe will play their part in making or breaking ETH's performance over the next bull run.

If they pay off, these narratives will be the thrusters to the rocket ship that's going to get ETH to the moon.

Layer 2s

Ethereum co-founder and leader Vitalik Buterin made a stark warning that Ethereum's network must solve its scaling issues for ETH to be relevant in the next bull run.

The unfortunate reality is that, without a good scaling solution, users may, once again, be paying $100 in gas for $10 transactions.

Not ideal.

We're already seeing this happen with the euphoria from the run-up in the $PEPE memecoin. This is 2023's replacement for Dogecoin and another addition to the list of "Things we didn't expect this year" - which is up around 300% in the last week and causing gas prices to spike. 

So, Ethereum's answer to the problem? Layer 2s (L2s).

L2s are separate blockchains linked to the Ethereum mainnet. Because of this link, they inherit Ethereum's network security and are specifically optimised for off-chain transaction processing, making them faster and cheaper. 

Think of the Burj Khalifa, the world's tallest building. Ethereum's mainnet is the foundation - you don't see it, but it keeps the thing standing up straight. L2s are the upper floors - where all the business deals are done, and the champagne is sipped.

In this case, the elevators connect the mainnet and the L2s, allowing users to move between them seamlessly.

The most popular floors in the Ethereum building until now have been Polygon, Optimism and Arbitrum (whose recent airdrop solidified the return of degeneracy in Cryptoland).

However, the newest floor in the building that people are going crazy for is zkSync - a network that uses zero-knowledge proofs to compress transactions off-chain and post them on the mainnet. Basically, its transaction speed is super-duper fast.

These L2s are the ones working to solve Ethereum's scaling issues and will be front and centre when the next bull run arrives.

The main problem for them to solve, keeping with the Burj Khalifa analogy, is the problem of getting people to the 163rd floor as quickly as possible. Unfortunately, the ground floor is overcrowded, and nothing productive happens there.

One company that is doing its bit to bring the user interface of Ethereum's network closer to this vision is Argent. Through their multi-signature, socially recoverable wallet, they're making crypto wallets simpler and building direct on-ramps to zkSync's ERA L2 protocol, already eliminating a tonne of friction for users.

More of that before the next bull run, please and thank you. 

Liquid Staking

This is the second thruster for Ethereum's rocket ship. Liquid Staking gives ETH users the ability to stake and lock up their assets to earn yield, receive liquid staking derivatives (LSDs) (basically tokens that mimic the underlying staked ETH), and put those LSDs to work in the ecosystem - all while capturing the core staking rewards.

Put simply; these derivatives allow you to have your cake and eat it too.

However, the potential for outsized reward comes with its fair share of risks. The underlying staked assets are lost if the derivative token is lost. So, be careful when you're going about your crypto shenanigans.

Liquid Staking gives Ethereum's rocket ship an outsized boost because it removes a sizeable portion of ETH from the circulating supply. With the beauty of the forces of demand and supply, the more supply of ETH is removed from the system, the more upward pressure on the asset price.

Now, when it comes to the playground of Liquid Staking providers, there is only one popular kid you need to make friends with - Lido.

They're not only Ethereum's largest liquid staking provider but are also the biggest Decentralised Finance (DeFi) protocol in the entire crypto-economy, with nearly $12 billion in total value locked (TVL). 

Users can stake with Lido, which issues a derivative token (stETH for Ethereum). Remember, lose your stETH, and you lose your staked ETH. You've been warned.

Like the popular kid on the playground, Lido will continue to be the centre of attention going forward. As withdrawals from "Shapella" continue to be processed, we expect much of the released ETH to get re-staked into Lido, along with the flows from investors coming to staking for the first time. 

To put some figures behind that, Lido consistently sees greater ETH deposits than its competitors, with a ~25k to 40k increase in the past two weeks.

stETH remains the most liquid derivative with a 24-hour trading volume of $43M. This has allowed it to trade closest to the spot price of underlying ETH (one of your risk factors when looking at derivatives), making it popular among investors seeking strong network effects.

Finally, Lido still leads Rocket Pool, another decentralised staking protocol, in its active user base by 100x+. 

As the old adage goes, it pays to be the popular kid on the playground.

What’s Next for ETH? 

While the Shapella upgrade has been a significant milestone for the Ethereum ecosystem, the journey isn't over. Developers are continuously improving the network with a lineup of upgrades akin to the Marvel Cinematic Universe's upcoming releases on the horizon.

One thing where Ethereum's lineup differs from Marvel's is that it's always in flux. For example, sharding is no longer required due to the rapid development of L2s. 

The change of tack allows developers to concentrate on upgrades that directly impact the average Ethereum user.

These include all sorts of technical sci-fi type innovations such as Danksharding, Single Slot Finality, Proposer-Builder Separation, Secret Leader Election, Account Abstraction, Verkle Trees & Statelessness.

We've provided links to each upgrade to avoid turning this post into a Com-Sci Handbook.

While we, as investors, may not care much for these nerdy terms right now. The upgrades in the pipeline will have a substantial long-term impact on Ethereum users. 

For those betting their life savings on ETH, we're sure you'd love to live in a world where Ethereum is faster, cheaper, more secure, and easier to use, right?

Hell, even if you're not betting your life savings on it, that sounds pretty great.

Regulatory Headwinds

While we've painted a pretty rosy picture of Ethereum's potential as a long-term killer investment, there are headwinds investors need to be wary of.

Public enemy number one for ETH bulls, from a regulatory standpoint, is Gary Gensler. He’s the chair of the Securities and Exchange Commission (SEC), the primary securities regulator in the US - crypto's biggest market.

Now, you might be wondering what Gensler and the SEC have to do with Ethereum.

Well, Gensler has been going after ETH for years, as he believes it should be classified as a security, hinting that its move to PoS makes it even more like one.

If it were to be ruled as a security in a court of law, this would have massive implications for ETH. Think more regulation, enforcement, and centralisation, which would hamstring its growth, innovation, and marketability. Not good. 

The positive outcome we all want is for the SEC to agree with the Commodity Futures Trading Commission (CFTC) that ETH is a commodity (like Gold and Bitcoin) - that'll be the "Get Out of Jail Free Card."

This regulatory debate has been going on for years and will likely continue. While we can't speculate on the outcome, it'll be a vital driving force for ETH's potential. 

Flippening Still On?

On the balance of everything, ETH's future as an asset class and long-term investment looks promising.

It continues to be a deflationary asset through its burn mechanism. There is programmatically more ETH leaving the system than entering every day. 

This’ll continue to positively impact the price as supply is removed, with ETH continuing its quest to become "ultra-sound" money.

There's also an argument for Ethereum's PoS consensus mechanism positioning it as the superior decentralised store of value compared to Bitcoin's PoW system. What plays into this is ETH’s cost-effective security, price resilience and decentralisation capabilities on the PoS mechanism.

Couple all that with resolving scalability issues, à la L2s, and a thriving staking ecosystem, and you have something that looks like an attractive decentralised growth stock that can earn you yield.

Pretty strong bull narrative if we don’t say ourselves. 

Whether that means that ETH eventually “flips” BTC, we cannot say. What we can say is that ETH looks more and more like the Super Saiyan of investable assets when compared to BTC.

However, at Snowy Peak, we're not fans of getting lost in the hype. Sure, you can spin a good yarn, but let's not forget our investor hats. We've got to keep an eye on those headwinds, poke holes in our thinking, and dig deep for the honest-to-goodness truth.

That’s what doing the work looks like when building your investment theses.

As we wrap up this thrill ride through Ethereum, remember: no shortcuts or biases are allowed here, friends. We're all about that sweet, sweet truth-seeking.

So, continue questioning, stay curious and keep exploring.

Thank you for reading. Feel free to share the post with a friend if you found it useful.

— Luca