Proof of Liquidity is a novel consensus mechanism pioneered by layer-1 blockchain Berachain. It uses network incentives to align the interests of ecosystem participants, such as validators, dApps, and users. Participants are incentivized to provide and circulate liquidity on the blockchain.
PoL aims to bolster liquidity in its DeFi protocols and application layer while simultaneously securing the blockchain.
In this article, we explore Berachain’s Proof of Liquidity, considered to be an extension of Proof of Stake, how it works, and the interaction between its network participants.
How Berachian’s Prood of Liquidity Works
PoL modifies the staking process and reward distribution by integrating a multi-token system; security and governance token. Some of the key components and participants in Berachain’s PoL:
Two-Token Model
Although Berachain has three tokens—$BERA, $BGT, and $HONEY—only $BERA and $BGT are involved in the consensus process. Let’s quickly expand on each:
$BERA
This token is tradable on exchanges, used to pay for gas fees across the network, and staked for blockchain validation.
$BGT
The Berachain Governance Token (BGT) is non-tradable and can be burned for $BERA on a 1:1 basis. It is used for voting on governance proposals and can be delegated to validators for rewards.
It is important to note that $BERA can not be converted or swapped into $BGT, finally $HONEY is the network’s stablecoin and it is tradeable.
Validators and Block Production
Validators stake $BERA to secure the network, validate transactions, and produce new blocks.
They earn $BGT rewards based on successful block production and distribute a portion of their $BGT rewards to reward vaults to attract liquidity. Now they can receive bribes from protocols seeking to influence and attract validators’ $BGT distribution to their protocols’ reward vaults.
Reward Vaults
Reward vaults are smart contracts dApps deploy to receive $BGT emissions from validators. Users deposit PoL-eligible assets (usually LP tokens) into these vaults to earn $BGT rewards.
The staking mechanism ensures liquidity providers (LPs) contribute to the network while receiving governance power through $BGT.
Source: Berachain
Liquidity Providers (LPs)
Liquidity providers provide and lock assets in different protocol pools to receipt receipt tokens which they can use to earn $BGT by locking receipt tokens in reward vaults after which they can delegate $BGT earned to validators.
They can also burn $BGT earned from reward vaults for $BERA, allowing them to reinvest or transact within the ecosystem.
Protocols and Incentive Mechanisms
DApps and protocols incentivize validators to direct BGT emissions to their reward vaults by offering them Bribes in the form of native tokens to attract validators.
Summary of PoL Interaction Between Participants
Source: Coingecko
Users (Liquidity Providers)
- Provider liquidity to protocols to earn receipt tokens
- Stake receipt token to earn $BGT.
- Delegate $BGT to validators or burn it for $BERA.
- Participate in governance decisions by holding $BGT.
Validators
- Validate transactions and propose new blocks.
- Earn $BGT rewards and distribute portions to reward vaults.
- Partner with dApps to receive bribes and optimize earnings.
Protocols (dApps and DeFi Platforms)
- Deploy reward vaults to attract liquidity providers.
- Offer incentives (bribes) to validators enticing them to direct $BGT to their vaults.
- Enhance liquidity by leveraging validator relationships.
See here to learn more about Berachians’s Proof of liquidity.
Closing Thoughts
Proof of Liquidity is still in its early stages, and one notable aspect of Berachain’s implementation is the high cost of becoming a validator. To participate, validators must stake a minimum of 250,000 BERA and a maximum of 10,000,000 BERA.
At the current price of $6.91 per BERA, this translates to an entry cost ranging from $1,727,500 to $69,100,000. Such a high barrier to entry raises concerns about centralization, as it may limit validator participation to only a few well-funded entities.
Proof of Liquidity represents a novel approach that aligns the interests of users, validators, and decentralized applications, striving to enhance both participation and liquidity. While Berachain’s PoL system offers a promising balance between network security and fluid capital, its real-world performance remains to be proven.
[Author’s Note: This article does not represent financial advice, everything written here is strictly for educational and informational purposes. Please do your own research before investing.]
Author: Godwin Okhaifo
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