What is Proof-of-Liquidity?
The Berachain economic model is a cutting-edge approach to blockchain governance that aims to address the critical challenges faced by decentralized networks. The model focuses on three high-level objectives:
- Systemically build Liquidity
- Solve stake centralization
- Align protocols and validators
What's the difference between Proof of Stake and Proof of Liquidity?
Proof of Stake
Proof of Stake (PoS) is a consensus mechanism used in blockchain technology that aims to balance security, speed, and decentralization. In this model, all token holders have the chance to be chosen to validate transactions and create new blocks based on the amount of cryptocurrency they hold and are willing to 'stake' as collateral.
Instead of Proof of Stake, most networks use a variation known as Delegated Proof of Stake (DPos). The delegation feature enables network participants to vote to elect nodes, often known as 'delegates', to validate transactions and produce new blocks on the blockchain.
DPoS is an alternative to Proof-of-Work (PoW) and Proof-of-Stake (PoS) models and was designed to be more efficient and democratic, promoting more active user involvement in the network's functioning.
Downsides to Proof of Stake
- Improving the security of the chain leads to a reduction of liquidity on the chain for actions such as transactions, LP pools, etc.
- Stake becomes centralized due to newly minted tokens always going to the same network participants
- 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) builds on-top of the concept of Proof of Stake in order to address these downsides. Let's walk through it.
- By providing liquidity to the BEX liquidity pools, users earn BGT, the Bera Governance Token used for delegating in Proof of Liquidity
- Users delegate their BGT to validator(s)
- Validators produce blocks based on their proportional weight of BGT delegated to them. Delegators & Validators in turn receive rewards from the chain
- Validators vote on future BGT inflation across any number of liquidity pools
- Bribes are distributed from validators to their delegators (if the validator has created them)
Increasing Security by Increasing Liquidity
As shown above, Proof of Liquidity addresses the first issue with Proof of Stake through two mechanisms:
- The delegation token (BGT) is separated from the gas token of the chain (BERA)
- The only way to earn new BGT is by providing liquidity to the BEX
This means that the token used for staking is no longer the same token used for many on-chain actions. Additionally, further liquidity is incentivized by that being the only mechanism to earn new governance tokens.
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 stake via bribes