ETH staking and DeFi markets are about to be turned on with the upcoming Shanghai Upgrade.And the best part? We will see huge potential for staking derivatives and DeFi protocols.Will it be the ultimate game changer for ETH staking and DeFi? Find out!🧵👇

Laying out some thoughts here:1️⃣ What is the Shanghai Upgrade?2️⃣ Effects of $ETH withdrawals3️⃣ Effects on Staking Derivatives4️⃣ Effects on DeFi5️⃣ Conclusion

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1️⃣ What is the Shanghai Upgrade?

It is a forthcoming @ethereum upgrade that will allow validators to withdraw their staked $ETH on the Beacon Chain.This will significantly impact withdrawal mechanics, staking derivatives, and broader DeFi markets.

Beacon chain is a proof-of-stake blockchain that is responsible for managing the validation of transactions and the creation of new blocks.@VitalikButerin shares @ethereum's roadmap (refreshing your memory)

https://twitter.com/VitalikButerin/status/1466411377107558402

The problem now in DeFi: $ETH that are staked creates liquidity inefficiencies as it cannot be converted back into circulating $ETH.This led to the rise of liquid staking derivatives (LSDs) like @LidoFinance $stETH, @coinbase $cbETH, @Rocket_Pool $rETH and more.

LSDs offer a way to trade staked ETH, making it accessible to non-validators and widely used in DeFi to earn staking yield.There is a total of $25b worth of staked $ETH since the launch of Beacon chain.LSD unlocks these liquidity.

https://twitter.com/Sherlockrypto/status/1629551461406220289

2️⃣ Effects of $ETH withdrawals

Validators who want to withdraw their staked ETH must go through two queues: the exit queue and the withdrawal queue.If all 500k validators attempt to withdraw, it could take up to 5 days for the withdrawal queue to clear.

However, validators who only want to withdraw their rewards can skip the exit queue.Based on the distribution of validator $ETH positions, an estimated 60K ETH can be withdrawn per day, with an additional 10K ETH if larger validators withdraw on the same day.

Here is an interesting tool created by @velvet_shark in preparation for @EthereumDenver's hackathon.It's an app that reads data from Beacon chain. Quite a neat one if you played around with it.Something that might interest @defi_mochi

https://twitter.com/velvet_shark/status/1629138222881308674

3️⃣ Effects on Staking Derivatives

The Shanghai upgrade will improve liquidity for staking derivatives by allowing for withdrawals of staked ETH.This will reduce friction in converting between derivatives and ETH.

I can think that it could lead to increased participation in derivatives and continued growth in ETH staking.However, there is a risk of price deviations in derivatives if the market perceives they cannot deliver the underlying ETH.

There is a small chance that technical problems during the upgrade could cause the discounts to increase between pegs.Despite this risk, stability has been seen in staking derivatives in recent months and the probability that the LSD depegs from ETH is low.

4️⃣ Effects on DeFi

Staking derivatives' demand is expected to increase. Utilisation rates are expected to increase even beyond the upgrade.This will be fuelled by protocols built on LSDs that allows for profitable borrowing strategies.

13/ Where users supply LSD, borrow ETH, convert to LSD, supply more LSD and so on,Such looped strategies can see significant yields much beyond 5% APY.

There's a low risk of price feed manipulation or malfunction in staking derivative price oracles as a result of the Shanghai upgrade.

At present, I don't think that the risks of oracle exploits or manipulation will be impacted by the Shanghai upgradei.e. price feeds that rely on oracle networks like @chainlink.

@ViktorDefi highlights other possible risks for LSD protocols, such as de-pegging, smart contract, slashing risks.

https://twitter.com/ViktorDefi/status/1612584201467097088

Aside that, @hufhaus9 mentions that there could other macro concerns around $ETH

https://twitter.com/hufhaus9/status/1629925921808433158

5️⃣ Conclusion

Overall, I feel rather bullish for LSDs as it opens up more use cases and increase captial efficiency for DeFi users.Nonetheless, we still have to keep an eye on the developments as it approaches the official launch for the Shanghai update.

Macro sentiments could be important here, which could influence the risk profiles of $ETH stakers: risk-on vs risk-off.Likewise, affecting the general market direction as well.