Proof of work, and proof of stake are the two general purpose consensus protocols that Blockchain networks have traditionally relied upon. However, for special use cases like DeFi, proof of liquidity offers a novel approach of incentivization, that enhances the proof of stake protocol to bridge the gap between validators and users.
Use Case: Proof of Liquidity
Problem Statement
Traditional consensus protocols like Proof of Stake (PoS) have relied heavily on staking native cryptos and tokens to secure the network. However, while ensuring network security, this staked capital remains idle and does not contribute to the ecosystem’s liquidity. For DeFi applications, this creates a frequent barrier where a high percentage of staked tokens hinder liquidity.
Realization Approach
The Proof of Liquidity (PoL) consensus solves the high stake, low liquidity problem through separation of responsibility that separates token responsibility for gas and security from tokens used to govern chain rewards. These rewards are controlled through reward vaults, which incentivize the validators and liquidity providers.
Solution Space
Proof of Liquidity (PoL) involves the participation and influence of all the chain’s stakeholders. By incentivizing all the ecosystem players to collaborate, a healthier equilibrium can be achieved between project stakeholders, validators, and users when all actors share in the network’s growth.
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In traditional Proof-of-Stake consensus, incentive alignment between network participants is largely siloed between two categories of actors: blockspace producers and blockspace consumers.
Blockspace producers (validators and their delegators) rely on on-chain activity to drive sustainable demand for the blocks they produce but have no way to directly support and incentivize on-chain activity. Similarly, blockspace consumers (applications and their users) rely on secure blocks to facilitate their transactions, but can’t collaborate with blockspace producers to influence on-chain activity.
Proof-of-Liquidity, Berachain’s heavily modified variant of Proof-of-Stake, aims to solve this problem by integrating application incentives into the consensus mechanism itself. If you are new to Berachain, check out our “First Look” article to learn more about the Berachain basics.
The Berachain Tri-Token Model
To enable Proof-of-Liquidity, Berachain uses a tri-token model that separates the native staking and governance asset from the native gas asset:
BGT
As the native staking and governance token, BGT sits at the center of Proof-of-Liquidity. A validator’s weight in consensus is determined by their BGT delegation weight – while all validators on Berachain have the same probability of producing a block, a validator’s BGT delegation weight will determine the amount of BGT they emit. BGT is non-transferable and can only be earned by locking a specific asset (e.g., an LP token) into a reward vault that receives BGT emissions from a validator. BGT can be burned 1:1 for BERA, Berachain’s native gas token.
BERA
BERA is the native Berachain gas token. Unlike BGT, BERA is transferable and can be purchased on the open market. While BGT is the primary token used in staking operations, all validator operators are required to provide an initial bond denominated in BERA.
HONEY
HONEY is Berachain’s native stablecoin. It is the only interest-bearing asset on the BEND and is the base token for all collateral, payouts, and deposits on Berachain’s native perpetual futures platform.
The PoL Incentive Landscape
One of the defining aspects of Proof-of-Liquidity is the broad range of incentives it makes available to participants in consensus. In addition to protocol-enshrined incentives provided to validators, delegators, and liquidity providers, Proof-of-Liquidity also allows applications to create their own incentives to influence the behavior of both validators and users. The categories of incentive available in Proof-of-Liquidity are:
Protocol Fees: Transaction Fees and Block Captured Value
One source of rewards for Berachain validators and delegators is fees generated by the protocol itself. In addition to the priority fee portion of transaction fees, validators and their delegators also earn from Block Captured Value. This category of rewards consists of fees generated by Berachain’s native DEX, stablecoin, and perpetual futures exchange. Protocol fees are distributed to BGT delegators proportionally to their share of their validator’s total delegated BGT.
BGT: Emissions and Reward Vaults
BGT emissions are similar to standard inflationary staking rewards on most Proof-of-Stake chains but are distributed very differently in Proof-of-Liquidity. Validators emit BGT, Berachain’s native staking token, proportional to their BGT delegation weight. However, validators do not earn BGT rewards directly, nor do their delegates – instead, validators earn the right to direct BGT emissions to reward vaults of their choosing.
Reward Vaults are Berachain smart contracts where users can lock one particular asset (e.g., an LP token representing a liquidity position in a specific pool) to earn a share of the BGT the vault receives from validators. Any application on Berachain may create its own reward vault, pending governance approval.
BGT Emissions Flow (℅ Berachain docs)
This mechanism for BGT distribution creates a degree of separation between those who receive BGT emissions (vault depositors, e.g., liquidity providers) and those who direct BGT emissions (validators and delegators). Validators and delegators can capture the BGT rewards they produce and direct, but to do so, they’ll need to lock the appropriate asset in the reward vault their validator directs emissions toward.
Therefore, the BGT rewards earned by a given Berachain participant will depend on three factors:
- The reward vault(s) they lock assets in
- Their share of the assets locked in each reward vault
- The total amount of BGT their reward vault(s) receive
Reward Vault Incentives: Creating a Marketplace for BGT Emissions
A consequence of this BGT emissions mechanism is that applications whose reward vaults receive more BGT emissions from validators will be better equipped to incentivize user behaviors like liquidity provision. However, with only so much BGT to go around over a given period of time, applications need to compete to win BGT emissions from validators.
Incentives provide a mechanism to enable market-based competition for BGT emissions – any application that creates a reward vault may also create an incentive associated with the vault. This incentive is a contract-enforced agreement that establishes an exchange rate between BGT emitted to the vault and some amount of another asset.
Rewards Vault Incentive Flow (℅ Berachain docs)
For example, if a new DEX launches on Berachain, it may create a reward vault where users deposit LP tokens and establish an Incentive that distributes 5 of the DEX’s native token for every 1 BGT a validator emits to the vault. Validators would then weigh the value proposition of this DEX’s reward vault incentive against incentives available from other vaults to determine where they’d direct their BGT.
Figment’s Involvement
Figment currently operates a validator on Berachain’s Bartio testnet and will be live on mainnet on day one. If you’re interested in participating on Berachain, Figment offers a host of services aimed at delivering safe and reliable staking rewards on Berachain for your assets.
For information on how to stake Berachain with Figment, reach out to Figment here to talk it through step-by-step.
This post was originally published in Figment.io.
