The original text is from Galaxy Research
Compiled | Odaily Planet Daily Golem (@web3_golem)
Editor’s note: The Ethereum Pectra upgrade is expected to activate on the mainnet in early 2025. Galaxy Research released a report yesterday detailing the content and development process of the Pectra upgrade, as well as its expected impacts on Ethereum's price and its stakeholders, while also introducing the Fusaka upgrade related to the Pectra upgrade and other anticipated protocol developments that may influence Ethereum's value, such as historical expiration, proposer-builder separation (ePBS), and Verkle tree migration.
Due to the length and extensiveness of the original content, Odaily Planet Daily has streamlined this report to focus on the 10 EIPs included in the Pectra upgrade, explaining the role of the Pectra upgrade in fixing network flaws, improving UX, and increasing DA capacity, while also analyzing the impacts of these upgrades on ETH prices and stakeholders.
Overview of the Pectra upgrade
As of October 2024, developers have agreed to expand the scope of the Pectra upgrade, which includes an additional code change, EIP 7742. Including this code change in Pectra allows developers the potential to include blob capacity increases in addition to the current 9 EIPs. The Pectra upgrade is tentatively scheduled to activate on the mainnet in early 2025 and may include the following 10 code changes:
Overall, Pectra includes a series of updates to Ethereum that are expected to achieve three outcomes:
Fixing the key flaws of the proof-of-stake blockchain;
Improving the user experience (UX) of interacting with smart contract applications on Ethereum;
Increasing Ethereum's data availability (DA) capacity.
On the surface, UX improvements and enhancements to Ethereum as a DA layer appear to be at odds, as improvements to Ethereum as a DA layer aim to encourage end users to interact with smart contracts on rollups in a cheaper manner rather than directly on Ethereum. However, the improvements to Ethereum's UX may create a 'trickle-down effect,' meaning that because they are implemented on the mainnet, they are likely to be adopted by rollups, thereby benefiting both rollups and Ethereum's end users.
It is worth noting that there are no code changes in Pectra that target strengthening ETH as a 'sound currency' or store of value. Furthermore, no EIPs directly improve Ethereum's quality as a censorship-resistant blockchain, a problem that has become a higher priority for developers to address since the Merge upgrade due to the increase in the number of known regulated entities participating in the block-building process.
Over 50% of blocks on Ethereum are generated by relayers that comply with OFAC requirements, meaning entities responsible for creating these blocks deliberately exclude transactions interacting with Ethereum addresses listed on the U.S. OFAC sanctions list.
Developers are working to integrate code changes in future upgrades to reduce ETH issuance and enhance censorship resistance. However, these are not the focus of the Pectra upgrade. Next, we will provide a specific categorization of the above 10 EIPs and state their expected impact on ETH and stakeholders.
EIP 7251: Critical fixes for the Ethereum network
All critical and non-critical fixes will be implemented in the first part of the Pectra upgrade in Q1 2025.
One EIP activated in Pectra is crucial for Ethereum's operation as a proof-of-stake blockchain. EIP 7251 increases the maximum effective balance of validators from 32 ETH to 2048 ETH and allows existing validators with maximum effective balances of 32 ETH to merge their stakes. This is expected to reduce the number of validators on Ethereum, which exceeded 1 million as of September 2024.
Ethereum Foundation (EF) engineers' simulations show that Ethereum encounters serious network issues at 1.4 million validators. EIP 7251 is expected to alleviate network pressure by encouraging the merging of staked ETH.
The rationale for setting the validator staking cap at 32 ETH
The Beacon Chain was originally designed for validators with a maximum effective balance of 32 ETH, as protocol developers wanted to encourage broad participation in the proof-of-stake consensus protocol. Developers conservatively estimated that with 32 ETH, the Beacon Chain would attract approximately 312,500 validators, whose aggregated cryptographic signatures would be sufficient to secure the nascent chain.
When the Beacon Chain launched in December 2020, the price of ETH was around $600, allowing users with less than $20,000 in funds to operate their own validators and independently earn staking rewards. At the time, staking rewards did not include transaction fees or MEV rewards, and there was considerable risk in staking as users could not withdraw funds.
The choice of a 32 ETH effective balance was made not only to encourage participation but because the original design of the Beacon Chain required each validator to maintain the same effective balance for 'sharding' expansion. Developers worried that if all users maintained balances above 32 ETH, there would not be enough validators to secure the chain. Conversely, if all users kept balances below 32 ETH, there were concerns that there would be an excess of unnecessary validators burdening Ethereum's network layer.
In addition to the maximum effective balance of 32 ETH, developers also set a series of other constants and parameters in the protocol based on rough estimates of future staking demands on Ethereum. Even if the developers' estimates are significantly inaccurate, they believe they can adjust the chain's economics and staking parameters through subsequent hard forks. Today, the rapid adoption of liquid staking solutions like Lido and Coinbase has prompted developers to adjust Ethereum's issuance curve lower.
Finally, there may be erroneous assumptions regarding the true capacity of Ethereum's network layer. Ethereum founder Vitalik Buterin wrote in a 2021 blog that the design specification of the Beacon Chain could support 4.1 million validators or stake the entire ETH supply when the maximum effective balance is 32 ETH. In reality, due to various upgrades and changes in client implementations, Ethereum's network layer is now unlikely to support 1.4 million validators, let alone exceed 4 million.
Implementation details of EIP 7251
EIP 7251 is a complex code change. It fundamentally alters how the protocol calculates validator rewards, penalties, and withdrawals. The protocol does not perform these calculations based on the number of active validators, but rather based on the total effective balance of validators, which can range from a minimum of 32 ETH to 2048 ETH for each validator.
During the process of changing the related penalty mechanisms, developers discovered an extreme case where validators with lower effective balances faced harsher penalties than those with higher effective balances. However, this extreme situation has been resolved in subsequent Pectra testing phases. As of October 2024, developers are still working to resolve errors in the EIP 7251 specification.
In addition to updating calculations, this EIP introduces new operations for validators to merge existing validators and lowers the initial penalty for validators with higher effective balances to encourage merging.
Once the upgrade is activated, it remains unclear how quickly large staking entities will be able to merge their validators and alleviate network pressure. There are concerns that any surge in the number of validators between now and the time the validator merges take effect could negatively impact network health and participants running validators on low-end hardware or in bandwidth-restricted locations.
The table below shows the growth in the number of active validators since the Dencun upgrade. During the Dencun upgrade, the maximum number of validator entries per epoch on Ethereum was reduced from 15 to a constant value of 8. The following graph forecasts the growth of the Ethereum validator set based on the activity of new validator entries since the entry loss rate fell to 8. It is important to note that the following forecast is conservative and does not take into account potential catalysts for future staking demand growth, such as the maturation of re-staking protocols like Eigenlayer on Ethereum.
Other non-network critical fixes EIPs
Apart from EIP 7251, several other EIPs within the 10 EIPs of the Pectra upgrade also address network fixes, although they are non-critical. They include:
EIP 7549, moving committee indexing out of proof: To make the CL client software more efficient, this code change introduces a restructuring of validator proof messages. It is expected to reduce network load on validator nodes, albeit to a lesser extent than EIP 7251;
EIP 6110, providing validator deposits on-chain: This code change shifts the responsibility for validating new staking ETH deposits from CL to EL. By doing so, developers can enhance the security of deposits, reduce protocol complexity in the CL client, and improve the staking user experience by decreasing delays between depositing 32 ETH on EL and activating new validators on CL;
EIP 2935, providing historical block hashes from state: Changes to EL so that proofs for historical blocks can be generated from state. This could provide some extra functionality for smart contract developers as they will be able to access information about Ethereum's state from previous blocks. Primarily, this is a necessary code change to prepare for the Verkle upgrade transition;
EIP 7685, general execution layer requests: Creates a general framework for storing CL requests triggered by smart contracts. As smart contract-based staking pools become increasingly popular, there is a need to allow smart contracts to directly trigger validator withdrawals (EIP 7002) and mergers (EIP 7251) on CL. This code change introduces a protocol framework for storing these types of requests for easy handling by CL.
Expected Impact
Affected stakeholders: Validator node operators
Expected impact on ETH: Neutral
The critical and non-critical fixes activated in the Pectra upgrade will primarily impact validator node operators, who will have to update their operations to leverage the higher effective balances introduced by EIP 7251, the efficiency improvements brought by EIP 7549, and the slight user experience enhancements provided by EIP 6110. The other two EIPs, EIP 2935 and EIP 7685, offer almost no direct benefits to node operators.
It is expected that end users and ETH holders will not directly benefit from these five code changes. These code changes primarily benefit the health and resilience of Ethereum as a proof-of-stake blockchain. In the long run, they hold a positive outlook on the protocol's value as they ensure the protocol can continue to operate securely and smoothly. However, they will not introduce new features that significantly improve the user experience for end users, smart contract developers, or aggregators. Therefore, they are not expected to have a substantial impact on the value of ETH.
As with any network-wide upgrade on Ethereum, volatility in ETH may increase during Pectra, and negative price fluctuations may occur if any unexpected errors or failures arise during the upgrade process. It should be clear that, given the extensive real-world testing these code changes underwent before activation on the mainnet, and the rich experience Ethereum protocol developers have in executing such backward-incompatible code changes without disrupting the network, the likelihood of Pectra upgrade failure is minimal.
Therefore, unless there is a temporary fluctuation in ETH shortly before and after the upgrade, the code changes related to fixing various aspects of the Pectra upgrade are not expected to have long-term positive or negative effects on the value of ETH.
User experience (UX) improvement-related EIPs
The Pectra upgrade includes 3 EIPs that will bring user experience improvements for Ethereum's end users and smart contract developers. While Ethereum pursues a rollup-centric roadmap, developers are also working together to enhance Ethereum's value proposition as the leading general-purpose blockchain.
EIP 2537, precompiled operations for BLS 12-381 curve: New functionality has been added to efficiently perform operations on the BLS 12-381 curve, which is widely used in zero-knowledge cryptography. The ability to perform operations on the BLS curve will benefit applications and rollups built on Ethereum that have already been using or seeking to integrate zero-knowledge proof systems into their operations.
EIP 7002, withdraws triggered from the execution layer: EIP 7002 creates a stateful precompiled contract for validator withdrawals, a mechanism that modifies the EVM state. Currently, validators on the Beacon Chain can only exit through the intervention of the validator withdrawal key owner, who is typically the operator of the validator. EIP 7002 introduces a mechanism that allows smart contracts to possess validator withdrawal credentials and use them to trigger validator exits without manual intervention from the validator operator. This will provide more trustless design options for staking applications and allow existing staking applications to eliminate trust assumptions about the honest behavior of their validator node operators, which will also have a trickle-down effect on users of staking applications utilizing EIP 7002, enhancing the security of these applications.
EIP 7702, setting EOA account codes: A new transaction type has been created for end users to add short-term functionalities to Ethereum accounts controlled by them, such as: transaction batching (authorizing multiple on-chain operations from signing a single transaction), sponsorship (paying transaction fees on behalf of another account), and permission downgrading (authorizing specific conditions for consuming account balances).
Given that most users execute transactions on Ethereum through wallet providers, wallet developers will leverage the new transaction type and incorporate these functionalities into their designs in ways that users can easily access.
Expected Impact
Affected stakeholders: End users, smart contract developers
Expected impact on ETH: Positive
Unlike critical and non-critical network fixes, these code changes will directly support the development of more feature-rich applications on Ethereum. EIPs like 7002, 2537, and 7702 will support more trustless staking pool designs, privacy-enhancing decentralized finance protocols, and secure user-controlled accounts.
Data availability (DA) improvement-related EIPs
As mentioned earlier in this report, another code change may be included in Pectra. Developers are considering a slight increase in blob gas targets to enhance Ethereum's scalability as a data availability (DA) layer. A series of larger, more complex code changes are related to increasing DA capacity through EIP 7594 (PeerDAS) upgrade. However, since EIP 7549 will no longer be activated in Pectra, there has been a proposal to introduce a simpler change to reduce DA costs.
Currently, Ethereum can process up to 6 blobs per block, dynamically adjusting the cost of these blobs so that each block averages 3 blobs. Francis Li, a developer from L2 rollup Base, proposed increasing the target number of blobs per block to 5 and the maximum number of blobs per block to 8.
In his proposal, Li pointed out that even conservatively increasing the target number of blobs from 3 to 4 would help teams building rollups on Ethereum. Developers largely support increasing the blob target in Pectra. However, the confirmation of this view and the formal incorporation of DA improvements in Pectra still await decisions in future ACD calls. Currently, developers have agreed to include EIP 7742 in Pectra, which will pave the way for changing Ethereum's blob capacity through adjustments in CL.
EIP 7742, decoupling blob counting between CL and EL: The maximum and target blob limits are hardcoded in both EL and CL. EIP 7742 enables CL to dynamically adjust the maximum and target blob limits, so future changes in DA capacity do not require hard forks on both layers but can be specifically adjusted through CL.
In addition to EIP 7742 and blob capacity increases, developers are also considering two more code changes related to optimizing Ethereum's DA functionality in the Pectra upgrade or Fusaka upgrade:
EIP 7762, increasing MIN_BASE_FEE_PER_BLOB_GAS: When the demand for blobs exceeds the target rate (currently 3 blobs per block), the protocol automatically adjusts the mandatory base cost of blobs upward. This pricing mechanism is similar to the pricing mechanism for regular Ethereum transactions under EIP 1559. EIP 7762 raises the minimum base cost of blobs so that the blob fee market can be more sensitive to fluctuations in blob demand and achieve price discovery for blobs more rapidly.
EIP 7623, increasing the cost of call data: In addition to blobs, rollups can also use the call data field of transactions to publish arbitrary data to Ethereum. However, generally, using the call data field of transactions is more costly for rollups. EIP 7623 aims to further increase the cost of call data to reduce the size of Ethereum blocks. As Ethereum developers increase block size by adding blob capacity, they are seeking to prevent extreme situations of validators propagating abnormally large blocks containing significant amounts of call data and the maximum number of blobs.
Increasing blob throughput in Pectra is a contentious topic among developers, as it may negatively impact Ethereum's decentralization by reducing the number of independent stakers operating on the network. Independent stakers are users who stake their own ETH and run their staking operations from home or through cloud providers, rather than relying on staking pools or other intermediary services. Compared to other types of stakers, independent stakers run validators on resource-constrained devices.
Increasing blob throughput may raise the computational requirements for operating validators, leading some independent stakers to shut down their machines. On ACDE #197, developers shared evidence that some independent stakers have struggled to operate validators after Dencun. Developers have agreed to conduct data research on the health of independent staking operations before deciding to increase blob capacity in the Pectra upgrade.
Expected Impact
Affected stakeholders: L2 rollups, L2 end users, ETH holders
Expected impact on ETH: Negative
In the short term, Ethereum's DA improvements are expected to reduce protocol revenues from L2s, increase profits for L2 sequencers, and lower transaction costs for L2 end users. These impacts are expected to be similar to the effects observed after the activation of EIP 4844 in the Dencun upgrade.
Conclusion
Although the scope and timeline of the Pectra upgrade remain uncertain, Ethereum continues to lead the way into the Web3 era, where human coordination is primarily conducted through decentralized blockchain technology rather than centralized internet protocols. To achieve this, Ethereum must continue to scale as a decentralized technology while combating centralized forces such as maximal extractable value (MEV) and transaction censorship.
Ethereum continues to maintain the highest network effects among all general-purpose blockchains. For smart contract developers, it remains the most battle-tested blockchain and is the most researched blockchain in addressing challenges related to scalability, MEV, censorship, user experience, and more. However, as Ethereum developers pursue a rollup-centric roadmap, the role of Ethereum as a technology and the importance of Ethereum upgrades should gradually diminish, as solutions to the biggest challenges facing Web3 will be inherited by rollups.
Pectra will introduce UX-focused code changes that are expected to attract new users and smart contract developers into the Web3 space. However, it is likely one of the last upgrades to directly impact users and ETH holders. As users migrate to rollups, protocol revenues are increasingly driven by rollup activity, and the most significant code changes for Ethereum stakeholders will be those related to rollups. For this reason, it is crucial to analyze the maturity of rollups as a technology and their ability to meaningfully inherit Ethereum's security and scale to millions of new users.
