A Deep Dive Into Berachain’s Proof-of-Liquidity
Almost all L1 blockchains today run on various iterations of the same consensus mechanism: Proof-of-Stake (PoS). With its novel Proof-of-Liquidity (PoL) mechanism, Berachain is changing this.
This article delves into PoL, the philosophy behind it, and how it fundamentally differs from PoS.
Remonder: Citadel.one supports the Berachain testnet as a validator. We are excited to provide ongoing validator service and community support in our TG chat
The challenges with the Current State of PoS chains:
To understand PoL, it’s important to first examine the current design of PoS, the value flow in POS chains and the dynamics between its participants.
In PoS, value flow is unidirectional: revenue generated from activities on the chain (users and applications) flows towards validators and their stakers, similar to emissions. This model inherently excludes applications and users from the reward distribution at the protocol level, leading to several issues:
- Misalignment Between Validators and Applications: Validators are incentivized solely through staking rewards, which do not directly benefit the applications running on the chain.
- Discouragement of Application Usage: Since staking is more profitable, users are less incentivized to engage with applications on the chain, leading to decreased activity and innovation in the ecosystem.
How can we fix this? The fat Bera thesis
Berachain’s philosophy challenges the unidirectional flow of value in PoS, which excludes both applications and their users from protocol incentives as this exclusion is deemed unsustainable in the long term.
How? Berachain introduces Proof of Liquidity (PoL), a new consensus mechanism designed to ensure that protocol rewards flow towards all participants: users, applications, stakers, and validators.
The Core Idea of Proof of Liquidity
With the current design of PoL there is always a limit to the growth of any App, no matter how successful they get. The main reason here is that revenues generated from App-related activities flow towards the chain and its stakers. You can think of this as rent paid by the App to benefit from the network effects provided by the chain ( Users, security etc…)
But what happens when the App outgrows the chain from a user base perspective? By this we mean the App isn’t dependant on the chain for users. One could argue that at this point the App is leaking value unnecessarily to the chain, at which point migrating to an independent App-chain would make more sense for the App. This is something that’s already happening with Maker, the protocol behind $DAI, the biggest CDP Stablecoin on Ethereum.
Maker is the first App to make this move but it certainly won’t be the last. And the current value flow of incentives on existing chains is the reason why. Berachain understands this challenge, amongst others, and aims to fix it with PoL:
The core idea behind PoL is simple: protocol rewards should be distributed to all participants in the ecosystem.
Berachain achieves this through a tri-token model, with each token serving a specific function. The three tokens powering Berachain are:
- BGT (Berachain Governance Token): This token is essential for governance within the ecosystem.
- BERA (Network Token): The primary token used for network transactions.
- HONEY (Liquidity Token): A token used to incentivize liquidity provision.
The Role of BGT
BGT is only obtained as a reward for providing liquidity on Berachain applications. But where do these rewards come from, and who decides which applications are rewarded?
Unlike PoS, PoL does not distribute inflation to validators. Instead, protocol emissions are directed towards applications chosen by validators. This shift in reward distribution is crucial for aligning incentives across all participants.
Value Accrual for Stakers and Validators
You might ask how does this benefit stakers and validators? Holding the voting power to influence future emissions unlocks two revenue streams for validators and their stakers:
- Directing Incentives to Apps They Use: Validators can vote to direct protocol emissions to the applications they use, thus directly benefiting from increased application activity.
2. Bribes from Applications: To bootstrap liquidity, new applications may bribe validators to redirect future emissions towards them. This attracts users to the application to acquire BGT rewards, creating a symbiotic relationship between validators and applications.
Guaranteeing Full Alignment
By allocating all protocol emissions to applications, giving validators the power to influence future emissions, and making BGT non-transferable, Proof of Liquidity ensures full alignment between all participants on Berachain. This alignment isn’t a new concept; it has been a catalyst behind major DeFi players like Curve.
Berachain takes this idea further by embedding PoL into the consensus layer, unlocking new and exciting possibilities by making sure all participants ( Validators, Apps and users) are actively deciding on the optimal distribution of future $BGT emissions.
The Fat Bera Thesis
The philosophy behind Berachain and PoL can be further understood through the “Fat Bera Thesis,” which draws inspiration from the “Fat Protocol Thesis” proposed by Joel Monegro in 2016. Monegro observed that in the Web2 era, leading applications captured far more value than the protocols they were built on. The Fat Protocol Thesis suggested a reversal of this trend in crypto, where protocols (like Layer 1 and Layer 2 chains) would capture more value than the applications built on top of them.
Berachain’s Fat Bera Thesis could be understood as a counter thesis to both ‘Fat Protocol thesis’ and ‘Fat App thesis’. Where instead of Protocol/ App capturing most value, all value captured is optimally shared between all participants.
This is achieved by aligning incentives at the protocol layer, ensuring that providing liquidity and participating in governance are meaningfully rewarded activities. In this way, Berachain aims to create a more balanced and sustainable value flow within its ecosystem.
Will this work?
All of this sounds good on paper, but how will this play out once Berachain launches?
There is no lack of experimentation with Proof of Liquidity at the App level but never at the protocol level, making predicting the outcome of such design somewhat difficult.
Berachain has been up and running on Testnet for a while now, let’s take a look at the activities so far in an attempt to answer this question.
Users
The number of Berachain testnet active users have been steadily rising since its launch, with over 866k daily active addresses on the 21st of July, 2024.
Applications
Even at this early stage, there is a significant number of high-caliber projects already building on Berachain.
$BGT emission dynamics
Even on testnet, the PoL dynamics are at full play. The race to attract delegators has started and we can already observe which gauges are capturing most emissions.
A few observations:
- Amongst the top 3 validators on Bera testnet, 2 are projects building on Berachain. A positive indicator for PoL as it shows that validators are invested in driving growth to the chain.
- Almost a third of $BGT emissions are directed towards deposits on BEND, the native CDP stablecoin on Bera; $HONEY. This large share of emissions to $HONEY is a clear indicator for growth as the stablecoin it powers all DeFi activities on the chain ( Main liquidity pair on BEX, collateral asset on BERPS…)