On-Chain Insights #4: Introduction to the 21Shares Ethereum Withdrawal Simulator (EWS) for the Shanghai Upgrade

Discover How the Network is Designed to Prevent Bank Runs and Preserve Network Security.

Link to the Ethereum Staking and Withdrawals Dashboard:  https://dune.com/21co/ethereum-staking-and-withdrawals

Link to all of our on-chain dashboards: https://dune.com/21co

TL;DR

• The Shanghai upgrade is the world’s first on-chain liquidity event for Ethereum: On April 12, 2023, the Shanghai upgrade will enable validators to withdraw their stakes in Ether (ETH), closing the loop on staking liquidity.
• Withdrawals work with the principle of first come, first served: Based on our assumptions and simulation, we estimate that partial withdrawals will take between 4-7 days to process, while full withdrawals will take between 18 days (3 weeks) and 108 days (4 months) in extreme cases. These results refer to the time it will take to process accumulated withdrawal requests, with the principle of first come-first served. In other words, early requests will be processed faster than late requests.
• Withdrawals are ‘Gas Free’: A withdrawal is considered a balance increase instead of a peer-to-peer transaction, meaning no gas or transaction fee is incurred.
• Staking ratio is low on Ethereum vs other competitors: Ethereum has a lower staking ratio at 14.8% compared to other smart-contract platforms. For instance, Solana has a staking ratio of over 70%.
• The largest staking entities own 66% of the market: Lido, Kraken, and Coinbase dominate the staking market with a lion share of 66% combined.  
• Changing Market Dynamic: Frax Finance is experiencing the most growth, with a 21.7% increase in ETH staked in the last 30 days out of all the Liquid Staking Protocols. Liquid Staking has grown by 1.7% since the fall of FTX. Meanwhile, Centralized Exchanges (CEXs) dominance dropped by 3.6%, while Staking Pools saw an increased demand of 1.1%.

Background

We’re psyched to present our latest dashboard and introduce our Ethereum Withdrawal Simulator (EWS), offering real-time coverage and estimation of the status of staking and withdrawals. We’re offering this high-level overview as anyone will be able to withdraw their staked Ether for the first time since December 2020.

Ethereum is the largest smart-contract platform with $29.2 billion in total value locked – akin to assets under management – across decentralized applications and 5,000+ active developers across the world. As Ethereum gradually moved away from Proof of Work to Proof of Stake, investors went on an indefinite lock-up period to validate the transactions and secure the network through staking. That said, Ethereum’s liquidity event is looming and scheduled for April 12, dubbed the Shanghai upgrade. To make it a reality, Ethereum core developers simulated the withdrawal process on multiple testnets over the last several months to ensure that the withdrawal process is playing out as intended without any unforeseen vulnerabilities.

Be that as it may, Ethereum is finally ready to enable withdrawals on April 12. However, it will follow a strict schedule that we’ll expand on as part of the simulator, which will be covered later in the report. Therefore, we believe it is critical that investors and the community can actively monitor the status and health of ETH staking. For instance, it’s crucial to comprehend the processing time of withdrawals on the network to determine how fast users can get their ETH back. In addition, real-time data can also shed light on the behavior of staking providers. In fact, the Ethereum protocol restricts full withdrawals based on the total number of validators active on the network.

Coverage

• Background of the Shanghai Upgrade
• Methodology of the Withdrawal Simulator (EWS)
• Current Market Landscape of ETH Staking: Lido leading with 33% dminance
• Centralized Exchanges’ Market Dominance on ETH Staking has Decreased by 3.6% since the Collapse of FTX
• Estimation of Full Withdrawals per Validator
• Ethereum has the Lowest Staking Ratio of 14.9% compared to other PoS Networks

Key Takeaways

1. Background of the Shanghai Upgrade

Figure 1: Flow Chart of Partial & Full Withdrawals

Source: 21Shares

• ETH withdrawals are gas free and are considered balance increases: ETH staking withdrawals are transfers from Ethereum’s deposit address to one’s wallet address. This means no gas or transaction fee is required. As such, an ETH withdrawal is considered a balance increase.
• Bank-run proof mechanism on Exit Queue: To become an Ethereum validator, one needs 32 ETH. Withdrawals are considered partial if the validator balance stays equal to or above 32 ETH. In contrast, to maintain network security and prevent bank runs, the Ethereum protocol limits the number of validators that can perform a full withdrawal (i.e., stop validating the network). As of today, the exit limit is restricted to 8 validators per epoch (An epoch refers to the frequency to which a given validator is randomly selected by the protocol to validate transactions every ~6 minutes). As such, full withdrawals are being processed much slower than partial withdrawals.  
• Limits on Withdrawal Queue and missed blocks: Per the Ethereum Foundation, there is a maximum of 16 withdrawals of Ether (ETH) per block of transactions, regardless of the amount of ETH. Given that a block is settled every 12 seconds, there are, in theory, 7,200 blocks of transactions each day (assuming no missed blocks), amounting to a maximum of 115,200 withdrawals per day.

Figure 2: Conversion Chart & Full Withdrawal Rate

2. Methodology of the Ethereum Withdrawals Simulator (EWS)

Missed blocks estimation:

• We consider the number of missed blocks per day to estimate the waiting time for the withdrawal queue accurately:

A. Extract historical data for the number of missed blocks per day on the Ethereum network from Dec 1, 2020 to Mar 22, 2023.

B. Calculate the frequency distribution of days according to the number of missed blocks.

Figure 3: Frequency Distribution of days according to the number of missed blocks

          Source: 21Shares, Glassnode

C. Establish three scenarios for the total number of days it will take to withdraw the entire validator set:

• Best Case: To be conservative, we use the average number of missed blocks per day. This is 61 missed blocks per day and happens to be ~58% of the time in the measured time period.
• Base Case: The number of missed blocks per day that has historically been observed 90% of the time. This amounts to 100 missed blocks per day.
• Worst Case (Stress Test): Assuming 2x the highest historical number of missed blocks in a day. This accounts for 1,276 missed blocks per day. On Oct 27, 2021 – the day of the Altair upgrade – we saw the highest number of missed blocks, 638.

Figure 4: Ethereum missed blocks

                  Source: Glassnode

Full withdrawals estimation

• Based on the staking data as of Mar 22, 2023, and historical growth, we estimated the staking data at Shanghai (April 12, 2023). We can expect ~579k validators to have deposited ~18.52 million ETH by April 12, 2023, assuming no slashing.

Figure 5: Ethereum Staking Estimation by Apr 12, 2023

Source: 21Shares, Glassnode

3. Current Market Landscape of ETH Staking: Lido leading with 33% Dominance

Figure 6: Market Dominance of ETH Staking Entities

Source: 21Shares, Dune Analytics

Considering the limitations of staking ETH, investors looked into alternative solutions that allowed them to take advantage of ETH staking yield without locking their capital away for years. In this regard, so-called “liquid staking” providers Lido and Rocket Pool proliferated over the last 18 months as they generated yield for their users in the form of a staking derivatives token that compounded the rewards on a daily basis.

Although users couldn’t redeem the staking derivatives tokens for ETH, they were still tradeable on secondary markets. In addition, due to the composability of stETH and rETH, users can take out loans across the DeFi landscape using those tokens as collateral.

4. CEXs Market Dominance on ETH Staking has Decreased by 3.6% since the Collapse of FTX

Figure 7: Market Dominance by Staking Entities’ Categories

Source: 21Shares, Dune Analytics

Although exchanges lost a lot of confidence from their users as the death spiral of LUNA took place, it wasn’t until the demise of FTX that users felt a massive breach of trust and accordingly started removing their assets from centralized platforms like BlockFi, Celsius, Voyager, and others. The systemic failure reminded everyone of the truth contained in the expression, ‘not your keys, not your coins,’ leading users to look for alternative solutions that didn’t entail giving up ownership of their assets. As shown above, centralized exchanges began losing market share after the FTX debacle, falling from 31.1% in November last year to 27.5% in March 2023.

On the other hand, staking pools such as Staked.Us, Stakefish, and Figment offer non-custodial staking mechanisms, which are considered safer than sending assets to CEXs. As such, these platforms became the preferred provider as we inch closer to the activation of withdrawals and the freeing up of liquidity.

5. Estimation of Full Withdrawals per Validator

We created a tier system for three scenarios. The validators in each scenario will have a randomized percentage (%) of full withdrawals within specific ranges to reflect the unknown unknowns of reality (see Figure 7):

1. Best-case: 0-5% in the best-case scenario. The randomized result was 34,175 full withdrawals (=33,039 + 1,136).
2. Neutral case: 0-10% as a neutral case. The randomized result was 67,570 full withdrawals (=66,434 + 1,136).
3. Worst-case: 0-50% in worst-case scenario. The randomized result was 181,296 full withdrawals (=180,160+ 1,136).

Important to note that bankrupt lender Celsius will withdraw 100% of its staked ETH. Regarding Kraken, the centralized exchange settled with the U.S. Securities and Exchange Commission (SEC) concerning its staking program. Because of this settlement, Kraken has agreed to end its staking services for U.S. clients.

Figure 8: Estimated Full Withdrawals per Validator

Source: Glassnode, Hildobby, Blockworks. Data as of Mar 23, 2023

• We should also note that these figures are conservative, considering that other smart-contract platforms like Solana have a staking ratio higher than 60%, four times higher than Ethereum.

6. Ethereum has the Lowest Staking Ratio of 14.9% compared to other PoS Networks

Figure 9: Estimated Staking Ratio of Ethereum

Source: 21Shares, Dune Analytics

As users are unable to withdraw their staked ETH before the 12th of April, validating the Ethereum network had an implicit liquidity constraint. Investors who wanted to capitalize on the ETH yield must have tolerated long-term commitment, as their capital would be locked away until the Shanghai upgrade. Thus, we expect the ratio of staked ETH to rise significantly from the current 14% figure once withdrawals are enabled and users can remove their staked ETH from the beacon chain.

7. Results of the Withdrawals Simulator

The simulator estimates the number of days it will take to process all partial and full withdrawals. We compute different results based on the best, neutral, and worst-case scenarios for the number of missed blocks per day and the best, neutral, and worst-case scenarios for the estimated full validator withdrawals or exits.

Figure 10: Summary of best, neutral, and worst-case scenarios

Results: Partial withdrawals will take 4-7 days to process, and Full withdrawals will take 18 days (2.6 weeks) and 108 days (3.6 months). These results refer to the time it will take to process accumulated withdrawal requests, with the principle of first come-first served. In other words, early requests will be processed faster than late requests. We should reiterate that this analysis is based on our own assumptions. Investors are free to use the simulator with their own assumptions.

Figure 11: ETH Withdrawal Queue Simulator

Source: 21Shares

Closing Thoughts:

Enabling users to withdraw their locked ETH will mark a significant milestone in the evolution of Ethereum as it is the last critical piece of the Proof of Stake transition. In that view, investors and the broader community can begin treating ETH as a productive asset that generates cash flow for the validators securing the network. Soon, we’ll enter a new era that will put Ethereum on par with bonds and capital goods, guaranteeing the right to a revenue stream.

Link to the Ethereum Staking and Withdrawals Dashboard: https://dune.com/21co/ethereum-staking-and-withdrawals

Link to the Ethereum Shanghai Upgrade https://dune.com/21co