From "King of Shanzhai" to "Paradise for Institutions"? Can Pectra's upgrade reshape the Ethereum ecosystem?

The future short-term North Star for Ethereum may be ETF staking, which could elevate Ethereum's price expectations to a level of importance equivalent to the implementation of Bitcoin's strategic reserves.

Author: YBB Capital Researcher Ac-Core

1. Background of the Pectra Hard Fork

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The Ethereum Pectra upgrade went live on March 5, combining the Prague and Electra updates to optimize Ethereum's execution layer and consensus layer. The Pectra fork is a significant upgrade to the Ethereum network aimed at enhancing the ETH staking experience, improving Layer 2 (L2) scalability, and expanding network capacity by introducing 11 Ethereum Improvement Proposals (EIPs). The upgrade process will first be implemented on the Holesky testnet before February 24, 2024, with the final plan to deploy Pectra on the mainnet on April 8, 2024, provided that both the Holesky and Sepolia testnets successfully complete the upgrade.

Pectra follows the Dencun upgrade scheduled for March 2024. According to content from ethereum.org (see reference 1), the Ethereum Pectra upgrade is expected to integrate several important Ethereum Improvement Proposals that will collaboratively address challenges related to scalability, security, and user experience. The Pectra upgrade will be implemented in two phases:

Phase 1: Mid-March 2025

● Double the Layer 2 Blob capacity: Increase the Blob capacity in each block from 3 to 6, reducing congestion and lowering fees;

● Account abstraction: Allow the use of stablecoins like USDC and DAI to pay gas fees, providing more payment flexibility;

● Increase validator staking limits: Raise the staking cap from 32 ETH to 2,048 ETH, allowing for large-scale staking operations;

Phase 2: End of 2025 or Early 2026

● Implementation of Verkle trees: Replace Merkle-Patricia with a more efficient data structure to improve data storage and synchronization;

● Peer Data Availability Sampling (PeerDAS): Improve scalability by allowing nodes to verify transaction data without storing all data.

2. Specific Content of the 11 Improvement Proposals in the Pectra Upgrade

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The Ethereum Pectra upgrade includes 11 EIPs (Ethereum Improvement Proposals) aimed at enhancing the network's scalability, security, account abstraction, and validator staking mechanisms. Below are key proposals (different researchers may have varying opinions on key proposals; the following are my personal views on important proposals) and my perspective on their impact on Ethereum's development.

1. EIP-7702: Account Abstraction

Content: This proposal allows externally owned accounts (EOAs) to execute certain smart contract functions, making account operations more flexible, such as batch transactions and sponsoring gas fees. This greatly enhances wallet functionality, enabling support for more operational modes.

Perspective: This proposal undoubtedly makes account abstraction wallets more powerful, allowing not only regular transfer operations but also advanced functions like batch transactions or letting others pay your gas fees. (Related EIP-7840 provides broader account functionality extensions, potentially allowing users to customize more complex account behaviors.)

2. EIP-7251: Increased Validator Staking

Content: The maximum staking balance for validators is raised from 32 ETH to 2048 ETH. This simplifies validator management and allows for larger validator nodes, thereby reducing management complexity.

Perspective: The significant increase in staking amounts undoubtedly raises the centralization of Ethereum; the more concentrated the nodes, the easier it is to act maliciously. It also increases the difficulty of profitability in the Ethereum market, as the costs for nodes and MEV arbitrage will rise significantly, making it less suitable for "ordinary people" and more suitable for institutions.

3. EIP-7002: Withdrawal Improvements

Content: Allows execution layer addresses to trigger withdrawal operations, reducing trust assumptions between the consensus layer and execution layer, simplifying the withdrawal process, and increasing network flexibility.

Perspective: This mainly simplifies the withdrawal operation, eliminating complex steps. Validators can withdraw directly from staking, reducing intermediaries.

4. EIP-6110: Validator Activation Delay Optimization

Content: The activation delay for validator deposits is reduced from about 9 hours to about 13 minutes, greatly improving validator participation efficiency and flexibility.

Perspective: The speed at which new validators join the network is significantly accelerated, reducing costs from a storage management and contract storage perspective, shortening the time from 9 hours to just 13 minutes. This also somewhat enhances Ethereum's resource utilization.

5. EIP-7691: Data Block Expansion

Content: Increases data block capacity by 50%, meaning the network can handle more transactions, enhancing overall scalability and transaction throughput.

Perspective: With a 50% increase in Ethereum's block size, the network can handle more transactions, especially during peak times, reducing congestion and speeding up transaction times. (Related EIP-7742 can dynamically adjust Blob capacity, targeting the maximum and desired number of Blobs per block, especially for L2.)

6. EIP-7516: Increased MEV Transparency

Content: Provides more information and transparency regarding the maximum extractable value (MEV), helping users and developers better understand and monitor MEV activities on the blockchain.

Perspective: Increased transparency regarding MEV, similar to EIP-7251, raises the difficulty of arbitrage but significantly ensures fairness in transactions at a higher cost.

7. EIP-7549: Gas Fee Adjustments

Content: Adjusts the gas fee structure to further optimize the network's fee mechanism, alleviating the network burden during peak times and making transaction fees more reasonable.

Perspective: Adjusting the gas fee structure means that even during busy network times, transaction fees will be more stable, reducing the likelihood of users paying high fees during peak periods. (EIP-6046 also involves adjustments to the gas fee structure, but EIP-7549 proposes a more dynamic and flexible fee adjustment scheme.)

8. EIP-7685: Governance Mechanism Optimization

Content: Optimizes network governance to enhance decentralized governance mechanisms, making governance processes more transparent and efficient.

Perspective: Ethereum's governance may become more transparent and efficient, especially in the review and approval processes for proposals, improving governance efficiency and making community decision-making more flexible.

9. EIP-7021: Validator Penalty Mechanism Optimization

Content: Adjusts the penalty mechanism for validators to ensure their behavior aligns more closely with network interests and reduces the impact of misconduct.

Perspective: The improved penalty mechanism will better constrain validator behavior, serving as a compensatory mechanism for raising the maximum staking balance from 32 ETH to 2048 ETH, balancing network security and validator incentives to ensure consensus layer stability.

10. EIP-7683: Smart Contract Performance Optimization

Content: Optimizes the execution efficiency of smart contracts, particularly in terms of gas consumption, reducing execution costs and improving the operational efficiency of smart contracts on the network.

Perspective: Smart contracts will run more efficiently, consuming less gas, which may essentially improve mechanisms related to Uniswap, lowering transaction costs and increasing transaction speeds, with DeFi applications being the direct beneficiaries.

11. EIP-6123: Cross-Chain Compatibility Improvements

Content: Enhances cross-chain compatibility of the Ethereum network with other blockchains, ensuring future support for more cross-chain operations and promoting interoperability between different blockchains.

Perspective: Enhanced compatibility between Ethereum and other blockchains also optimizes the account abstraction mechanism, making it easier to transfer assets and perform operations across different blockchains in the future, with strengthened customization features.

3. Pectra Dual-Layer Upgrade

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Pectra adopts a dual-layer upgrade approach that merges the execution layer (Prague) and the consensus layer (Electra) to address synchronization issues that may arise from separate upgrades. The execution layer and consensus layer of Ethereum often perform different functions, and historically, these two layers have typically been upgraded separately.

● Execution Layer (Prague): Responsible for processing user transactions, executing smart contracts, and managing state changes. This is the part where users directly interact with Ethereum and is the core layer running all decentralized applications (DApps) and smart contracts.

● Consensus Layer (Electra): Manages validators through a PoS (Proof of Stake) mechanism, ensuring block generation and chain security. This layer is fundamental to maintaining network consistency and security, with validators staking to ensure their actions align with network interests.

Additional notes:

EIP-6110, EIP-7002, EIP-7251, EIP-7549, EIP-7685, and EIP-7691 require changes to Ethereum's consensus layer.

EIP-2537, EIP-2935, EIP-6110, EIP-7002, EIP-7623, EIP-7685, EIP-7702, and EIP-7840 require changes to Ethereum's execution layer.

EIP-7623: Cross-Chain Messaging Mechanism Improvements

Improve the handling mechanism for cross-chain messages to enhance the efficiency and security of cross-chain communication. The Pectra upgrade primarily focuses on improvements within Ethereum's execution layer and consensus layer, while EIP-7623 concentrates on interactions with external blockchains, particularly optimizing cross-chain asset and information transfers.

EIP-2537: BLS12-381 Curve Operations

Introduce support for the BLS12-381 curve in Ethereum for cryptography and zero-knowledge proofs. EIP-2537 is a proposal introduced to support specific cryptographic curves for cryptography, mainly serving verification and privacy-related functions. In contrast, the proposals in the Pectra upgrade more broadly address transaction, gas fee optimization, and validator mechanisms.

EIP-2935: Validator Recovery Mechanism

Provide a more flexible mechanism for nodes that have lost their validator status to regain their eligibility. EIP-2935 focuses on the recovery mechanism for validators, ensuring that under certain specific circumstances, validators can continue to participate in consensus, while EIP-7251 and EIP-7021 in Pectra are more concentrated on improvements to staking limits and penalty mechanisms.

4. Impact of Pectra on Ethereum and the Crypto Market

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DApps

The Pectra hard fork will introduce smart contract functionalities into regular wallets, simplifying the development process and expanding the potential application scope. Features such as social recovery and transaction batching make it easier to create user-friendly DApps, whether in DeFi, GameFi, or other applications, allowing users to expect a more reliable and efficient DApp experience on the Ethereum network.

However, a major dilemma facing Ethereum itself is the overly apparent "parasitic" effect of L2, which has attracted a significant amount of DeFi activity, leading to reduced transaction fees on the Ethereum mainnet and an increase in ETH's inflation rate. While L2 chains are part of the Ethereum ecosystem, their centralized orderers and independent economic models raise questions about the value of the Ethereum mainnet.

Long-Term Value of Ethereum

Many Ethereum holders are dissatisfied with ETH's price performance during this cycle, and many view the Pectra upgrade as a hope to change the game for ETH, primarily enhancing staking and L2 scalability. Overall, the Pectra upgrade has brought significant changes to Ethereum, making wallet operations more flexible, allowing for batch processing of transactions or sponsoring gas fees, increasing validator staking limits, and speeding up withdrawals and network participation. The network's block capacity has relatively increased, allowing for faster transaction processing and more stable gas fees that do not suddenly spike during peak times.

The significant increase in staking thresholds has also improved overall MEV transparency, raised MEV costs, and made network governance more transparent and efficient. In terms of smart contracts, execution will be more "cost-effective," and cross-chain compatibility has also been enhanced. However, regarding the fragmentation issue of Ethereum's scalability, should the development path focus on a single network with high throughput rather than relying on the aggregation of multiple chains to solve it? These challenges may also become shackles for Ethereum's future development.

The price surge of Solana is primarily attributed to high throughput, low transaction costs, and backing from U.S. capital. The liquidity of a single chain is complete and unified. Ethereum has solved scalability issues through L2 but has made innovation "fragmented" and "replicated." The superiority of a single network is reflected compared to L2 aggregation paths. From a market perspective, Ethereum's greatest advantage currently lies in having the most complete and decentralized decentralized finance network; DeFi is where Ethereum's greatest value resides.

Compromise on Decentralization

The biggest advantage of this upgrade is undoubtedly the enhancement of Ethereum's overall security and scalability. However, the double-edged sword of EIP-7251 may potentially reduce the operational load on the network by merging the number of validators and alleviating the burden on large storage. On the downside, it undoubtedly deepens Ethereum's centralization, turning Ethereum into a playground for large investors and institutions.

But whether it can attract large capital investments by relying on a massive 2048 ETH stake, cutting off retail participation thresholds, and turning to Solana and Sui to embrace U.S. capital, thereby driving up ETH prices, remains to be seen. The current Ethereum seems to face new dilemmas, with narrative capability, centralized price manipulation, and decentralized PoS staking becoming the "new impossible triangle" problem.

Where is the North Star of the New Narrative?

Ethereum seems to be losing direction, with fragmented ETH currently experiencing annual inflation, and DeFi activities have migrated to second-layer chains, significantly reducing fee capture on the first layer. The second-layer chains are essentially independent blockchains, and centralized orderers can be understood as entirely different blockchain networks. The substantial revenue generated by Base flows to Coinbase, while Arbitrum's profits go to Arbitrum DAO, with profits completely flowing out of Ethereum's first layer.

Bitcoin has a clear North Star of "digital gold," while Solana's North Star is "the Nasdaq on-chain." The blockchain embraces AI, and Solana quickly gained traction with narratives related to DeFAI and AI Agents, making the SOL/ETH exchange rate a reality for the biggest "Ethereum killer," Solana. The ReGenesis plan of Metis will transform into an AI public chain, centered around intention, also combating DeFAI.

So what exactly is Ethereum's North Star? Why do ETFs repeatedly face setbacks? The root cause lies in the lack of staking returns and centralized value attribution. The current form of Ethereum ETFs does not allow investors to participate in staking; holding Ethereum through ETFs misses out on approximately 3.5% returns and incurs additional management fees, making it impossible to gain DeFi returns.

Similarly, in terms of value attribution, Ethereum's strong decentralization makes it difficult to belong to any capital force. "Wall Street capital" has not yet truly "stolen" the fruits of decentralized victory. More support comes through stablecoins and DeFi for DApps, but the Pectra upgrade has raised the maximum staking balance from 32 ETH to 2048 ETH, seemingly using staking as an exposure to support large institutional participants bringing real assets into Ethereum, developing a version of RWA more aligned with Ethereum. Therefore, the short-term North Star for Ethereum may be ETF staking, which could elevate Ethereum's price expectations to a level of importance equivalent to the implementation of Bitcoin's strategic reserves.

References:

(1) https://eips.ethereum.org/EIPS/eip-7600

(2) https://ethroadmap.com/?ref=bankless.ghost.io#pectra%20sticky

(3) https://eips.ethereum.org/EIPS/eip-7742

(4) https://eips.ethereum.org/EIPS/eip-7702

(5) https://eips.ethereum.org/EIPS/eip-7685

(6) https://eips.ethereum.org/EIPS/eip-7251

(7) https://eips.ethereum.org/EIPS/eip-7002

(8) https://eips.ethereum.org/EIPS/eip-6110

(9) https://eips.ethereum.org/EIPS/eip-2935

(10) https://eips.ethereum.org/EIPS/eip-2537

(11) https://www.galaxy.com/insights/research/ethereum-all-core-developers-execution-call-187/