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Ethereum’s Dencun upgrade: EIP-7514 and its impact on ETH price

ethereums-dencun-upgrade-eip-7514-and-its-impact-on-eth-price
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Ethereum’s Dencun upgrade: EIP-7514 and its impact on ETH price

Ethereum core developers have included EIP-7514 in the upcoming Dencun upgrade. This proposal slows the growing ETH staking while allowing developers to explore long-term solutions for unchecked staking.

EIP-7514 is an Ethereum Improvement Proposal co-authored by Tim Beiko and Dapplion that is meant to slow down the rate of Ether (ETH) staking. 

The proposal is part of Ethereum’s Dencun upgrade slated for activation in October 2023, and it is essentially an attempt to buy the community time to come up with a more practical reward scheme for stakers on the network.

According to some Ethereum developers, if the pace of staking remains unchecked, it will be possible to witness half of all ETH staked by May 2024, which could escalate to three-quarters by September 2024 and potentially hit 100% by December 2024.

While at first glance, this might appear positive, it could apply undue pressure on the network and render the rewards for staking less attractive.  

EIP-7514 is meant to bring changes to the way new validators, those responsible for processing transactions and creating blocks, can join the network. 

It is a temporary fix to manage the increasing number of validators while also allowing developers to look for more permanent solutions. These future solutions could lead to big changes in Ethereum’s economic rulebook, potentially sparking a new age of staking in the system.

So, how did it get to the point where a squeeze on ETH staking became necessary? And more importantly, what are the possible future ramifications of EIP-7514 on the price of ETH? Read on to find out more.

The Merge and the staking surge

In 2022, the Ethereum network successfully executed a large-scale software upgrade, commonly referred to as the “Merge,” that moved it from the energy-intensive proof-of-work (PoW) consensus mechanism to the more sustainable proof-of-stake (PoS) mechanism.

For those not in the know, a consensus mechanism is a protocol used in a blockchain network to ensure all computers or nodes making up the network agree on a single data set. It serves as the standard for verifying and approving each transaction on the blockchain.

The Ethereum upgrade involved merging the original Ethereum mainnet with a separate PoS blockchain called the Beacon Chain, allowing the network to transition from a mining-based PoW blockchain to a staking-based PoS model.

Staking is when users lock up their ETH tokens as a way of validating transactions on the network. In return, these validators are rewarded with more ETH tokens.

This feature is central to Ethereum because it provides the mechanism for achieving consensus in the network. It encourages security by ensuring validators have a vested interest in the network, particularly since they risk losing their staked ETH if they try to cheat the system. 

To become a validator requires staking a minimum of 32 ETH, which is worth approximately $52,000 at current rates.

Staked ETH withdrawal and the rise of liquid staking

The introduction of staking was met with soaring demand, sparking concerns regarding the potential for the Ethereum network to become overly congested. 

Driving this fervor for staking was EIP-4895, introduced as part of the April 2023 Shanghai upgrade, which allowed validators to withdraw staked ETH and staking rewards.

According to Dankrad Feist, a researcher at the Ethereum Foundation, while the implementation of EIP-4895 was anticipated to grow Ethereum’s validator network, the widespread impact of liquid staking was not fully realized at the time.

Liquid staking is a solution that allows users to stake their ETH directly on Ethereum in exchange for an ERC-20 liquid staking token (LST) that represents their staked ETH. It enables the staked ETH to remain liquid or movable rather than locked on the blockchain.

The three biggest liquid staking derivatives (LSDs) on the Ethereum mainnet are stETH by Lido, rETH by RocketPool, and SETH2 by Stakewise. They allow users to stake and unstake any amount of ETH without waiting for a specific unlock period.

In Feist’s opinion, the unwillingness of staking pools to self-regulate, especially those holding a dominant position in the liquid staking arena, could potentially jeopardize Ethereum’s decentralization. 

The researcher suggested a governance attack on a major staking protocol might pose significant challenges for Ethereum.

ETH developers foresee exponential growth in validator sets

In the PoS version of Ethereum, validators are randomly chosen to confirm transactions and create a set of consecutive blocks called an epoch.

An epoch is important as it helps in the management of the blockchain, ensuring not all validators are active at the same time, which would be inefficient and unnecessary. Each epoch lasts about 6.4 minutes and is made up of 32 slots, with each slot allocated 12 seconds.

At each slot, the system allows a validator to propose a block, even though not all slots may contain a block.

As mentioned previously, validators earn their status by staking ETH, and the potential for profit has seen more and more users joining as validators and increasingly staking higher amounts of ETH.

However, this rapid growth in validators has raised a couple of issues. First, it could burden Ethereum’s peer-to-peer (P2P) networking infrastructure, increasing the chances that nodes making up the network may fail due to higher computational and bandwidth demands caused by increased “gossip messages” among validators. 

Secondly, the expanding number of validators could complicate Ethereum’s attempts to achieve single-slot finality, the quest to make a transaction final and irreversible in just one slot.

There are currently more than 795,000 active validators. With the next upgrade following Dencun not anticipated until May 2024 at the earliest, Dankrad Feist fears there may be more than 2 million validators by then. 

Moreover, he believes that the Ethereum community will find itself in uncharted waters if the combined LST market cap surpasses that of unstaked ETH.

“This technical problem is exacerbated by an economical one: liquid staking tokens exceeding the remaining (unstaked) Ether market cap brings us in an untested economic regime. A point of no return might be reached when incentives lead to them having similar liquidity and utility in DeFi – even a staking yield close to 0% (but still positive) might be enough to keep the LST attractive”

Dankrad Feist, Ethereum Foundation researcher

At present, approximately 25.8 million ETH, representing 21% of all ETH in circulation and equivalent to a staggering $41.8 billion, has been staked, per data from beaconcha.in.

According to projections by Ethereum developers Tim Beiko and Dapplion, should the current momentum persist, the percentage of staked ETH in relation to total ETH supply could mushroom to 50% by May 2024 and escalate to 100% by the end of that year.

Ethereum’s Dencun upgrade: EIP-7514 and its impact on ETH price - 1
Projected validator set | Source: ethereum.org

If Beiko and Dapplion’s projections were to hold true, the Ethereum network might find itself devoid of ETH, meaning that users will have no way to pay for transactions on the network.

The EIP-7514 solution

EIP-7514 doesn’t directly address the potential technical and economic problems emanating from the unprecedented growth of ETH staking. Instead, it seeks to buy the Ethereum community a bit of time to find lasting solutions for them.   

It essentially puts the brakes on the growth of staked ETH by restricting the churn limit, which is the number of validators that can enter or exit the network during an epoch.

Usually, Ethereum’s churn limit is dynamic, determined by calculations based on the total number of active validators divided by 65,536. As of Sept. 11, 2023, the upper churn limit was 12 per epoch, with the next determination set for Oct. 4.

Beiko and Dapplion’s proposal seeks to do away with the dynamic calculations and instead establish a fixed maximum churn limit of 8 per epoch. 

In so doing, EIP-7514 could theoretically extend the time it would take for staked ETH to reach 50% of total ETH supply by at least one year and as many as four years for it to get to 100%, therefore giving the community enough time to find lasting solutions for the imperfections in the validator reward system.

This proposed cap will not interfere with the churn limit that controls validator exits. That limit will keep adjusting dynamically, maintaining a balance with the expansion of the validator set. 

The goal is to prevent a scenario where the staking withdrawal queue is constantly full, therefore complicating the efficient administration of validator rewards.

While the proposal has largely been positively received, some sections of the Ethereum community have been critical of its rushed nature and have suggested it could compromise Ethereum’s neutrality.

https://twitter.com/ryanberckmans/status/1702336972700942366

Potential EIP-7514 impact on ETH price

The immediate impact of EIP-7514 on the price of ETH is unclear at this point, but some market watchers think it could have a noteworthy long-term effect. 

The proposal is intended to slow down the rate of ETH staking, which, in turn, could potentially influence the coin’s supply-demand dynamics.

If successfully executed, EIP-7514 could significantly reduce the amount of ETH being staked, therefore alleviating the potential pressure on the Ethereum network and making staking rewards more attractive.

Some analysts believe the enhanced attractiveness of staking rewards and the reduced supply of ETH in the market could potentially increase its price.

However, the proposal is only a temporary fix for managing an increased number of validators, and the Ethereum community will still have to find a more permanent solution. As such, the long-term effects of EIP-7514 on the price of ETH may be speculative at best, depending on what these future solutions could be.

If they result in a more efficient and secure network, it can potentially boost Ethereum’s overall value, resulting in a price increase for ETH. Conversely, if these changes are not well-received or cause network instability, it could put downward pressure on the ETH price.