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What is Proof of Liquidity?

Berachain's Proof of Liquidity (PoL) is a cutting-edge approach to blockchain governance that aims to address challenges faced by decentralized networks, using economic incentives in a novel fashion. The model focuses on solving two main objectives:

  1. Building systemic liquidity
  2. Aligning stakeholders

This is accomplished with a three-token model ($BERA, $BGT, $HONEY), separating the token responsible for gas and security ($BERA) from the token used for governance and chain incentives ($BGT).

Proof of Stake vs Proof of Liquidity

Proof of Stake

Proof of Stake (PoS) is a consensus mechanism whereby token holders have the ability to 'stake' the network token as collateral. These stakers have a chance to propose new blocks (and receive corresponding rewards) based on the value of the amounts staked. Delegated Proof of Stake (DPoS) is a variation which enables network participants to delegate their voting power to validators.

Shortcomings of PoS

  • Improving the security of the chain leads to a reduction of available liquidity on the chain (due to staking token being locked up by validators)
  • Protocols have little opportunity to improve the security of the chain they're building on
  • Validators receive little upside from the protocols that they are ultimately running infrastructure for

Proof of Liquidity

Proof of Liquidity (PoL) extends PoS and addresses its shortcomings. Let's walk through how PoL works:

Proof of Liquidity Overview

  1. Prospective validators must provide a $BERA bond to be eligible to produce blocks, and direct $BGT emissions to pools of their choosing, when they are selected to proposed a block.
  2. By providing DeFi liquidity, users can earn $BGT, the governance token used to control chain incentives/inflation.
  3. All validators have an equal chance of producing blocks. However, the amount of $BGT emitted for a block is proportional to the amount of $BGT delegated to the proposing validator.
  4. Protocols can provide incentives to encourage validators to direct $BGT emissions to their pools - these incentives flow back to $BGT delegators.

Separation of Concerns

$BGT is non-transferable and can only be earned through the mechanism of providing liquidity, as described above. $BERA emissions are obtained only by burning $BGT in a one-way process.

Therefore, those that choose to participate in deciding the flow of chain incentives (with $BGT) relinquish the ability to contribute to the security of the chain (with $BERA). This separation of concerns is a key feature of PoL, and increases the effectiveness of ecosystem participants.

Decentralizing Inflation

Emitting new $BGT to liquidity providers is also what allows Proof of Liquidity to address the second issue with Proof of Stake, that being stake centralization. Now that stake is not going directly back to the stakers, but instead is given to separate market participants, who are performing common on-chain actions, the new inflation of tokens is more fairly distributed than in traditional Proof of Stake networks.

Aligning Protocols and Validators

Lastly, the third and fourth issues with Proof of Stake are addressed simultaneously as Proof of Liquidity incentivizes protocols and validators to work together in order to:

  • Have validators incentivize a protocol's LP pool via $BGT.
  • Have protocols help those validators accumulate $BGT rewards emited to pools by re-delegating the $BGT accrued in proportion to the incentive provided.