By Camila Ramos
Compiled by: TechFlow
Long Game
Liquidity is the lifeblood of on-chain activity. In past cycles, we have witnessed many short-term methods of acquiring liquidity, many of which revolve around points and grants. Sometimes, this liquidity is used effectively for the ecosystem, but most of the time, it is only used to meet certain centralized exchange (CEX) listing indicators or to stimulate a short-lived wave of on-chain activity in the hope of ultimately affecting token prices. The industry is essentially dominated by mercenary actors and related incentive designs. Berachain believes that to build an ecosystem that will stand the test of time, we must optimize for the long game from the beginning.
Recent token generation events (TGEs) have highlighted the asymmetric relationship between those who provide liquidity and the protocols that reward them, especially evident in the recent LRT launch. Protocols lock up liquidity, benefit from it, and decide how to reward liquidity providers (LPs). Some teams may take user frustration for granted as airdrop farmers, but other teams recognize that protocols use this deposit data to demonstrate the appeal of private fundraising and forming partnerships without actually finding ways for these users to be rewarded.
Aside from irritating users and undermining public sentiment (which tends to affect price action), one of the biggest problems with the current model is that after launch, hired users will simply withdraw their funds and move liquidity to the next farm. When a new protocol emerges, liquidity is sucked away from the existing ecosystem as users rush to extract new value, sometimes aptly described as “new coins are good, old coins are bad”. Few protocols are able to capture liquidity and users for the long term because of the high opportunity cost of locking up hired capital without earning rewards. Obviously, this is a great strategy for rapid user acquisition, but a terrible one for user retention.
So, how to finally solve this problem?
Berachain sees this as a two-part equation. First, giving users and liquidity providers as much flexibility and influence as possible, reducing the need for them to leave the protocol. Second, ensuring that the stack of users, applications, and validators is consistent and each party benefits from the effort and/or capital invested on the chain. This is where Proof of Liquidity comes in - Berachain's PoL makes liquidity liquid and realigns the flow of value in the network by rewarding the parties that contribute the most to the ecosystem in a systematic way.
Proof of Liquidity 101
Proof of Liquidity is a mechanism to incentivize and reward productive capital through BGT (Berachain’s governance/issuance token). Here is a brief overview of the three major stakeholder groups involved in PoL:
Validators: Earn block rewards based on the amount of BGT delegated to them, and can earn the application’s tokens by directing BGT issuance into the application’s reward treasury through “incentives”.
Applications: BGT reward bounties can be set up on the validator market to incentivize validators to direct BGT issuance into their reward treasury, usually in return for the protocol’s native token. Applications and validators work together to direct liquidity for the application’s token or the application itself.
Users: Provide liquidity to eligible liquidity venues (pools, vaults, etc.) to accumulate BGT rewards and earn applicable LP fees. Users can also delegate BGT to validators to earn part of the incentives from applications issued by the validator.
As a user in Proof of Liquidity, you no longer lock up capital for network security, but provide capital to the ecosystem to earn block rewards (BGT), which can be further delegated to validators who contribute to network security. Validators are incentivized to maximize the BGT delegated to them, as their block construction rewards (and commissions) are proportional to BGT. Therefore, different strategies will emerge to optimize the attractiveness of delegation - this can be social (providing value through community and/or incubation) or economic (incentivizing delegators through revenue sharing).
With larger BGT delegations, validators can also work with more protocols through the bounty market mentioned above. This allows them to gain new sources of income while helping new dApps on the chain bootstrap liquidity and user base. Users will look for validators whose incentives are aligned with theirs. For example, if a user invests in protocol X, they may prefer to delegate to a validator that directs part of the issuance to the corresponding protocol's treasury or LP.
Game theory of stakeholders
Validator: Win by maximizing BGT delegation and service protocol liquidity rewards, and create profits through efficient cooperation with applications.
Application: Improve capital efficiency compared to standard liquidity mining programs by working with validators to bootstrap liquidity and directly incentivizing users to win with BGT issuance.
Users: Win, earn incentives and maximize their return on investment by providing liquidity to the applications they use and delegating BGT issuance to consistent validators.
Berachain is described as a “playground for infinite economic games”. The above alignment is intended to enable Berachain to also serve as a “playground for infinite economic games”, the same but different.
PoL is a better points system
Viktor Bunin said on May 20, 2024 that “The cash flow from fees earned by tokens through their respective protocols will be one of the biggest unlocks for the crypto ecosystem. The only reason most tokens don’t do this is because of the fear of being mislabeled as securities.”
Why are points valid in the short term?
They provide an additional form of speculation before tokens (the primary form).
They are often non-transferable and illiquid, making them difficult to price correctly.
The protocol will determine the “cost” of these points ex post — in the form of token distribution — once value has been extracted from them through metric improvement and point mining.
on the other hand,
Users have no control over how points are distributed.
Points lack any form of intrinsic underlying value or ability to represent the underlying value of their corresponding tokens.
The distribution cycle of points is often unknown or highly variable, making it impossible to effectively know the ownership of the "cake" at any time.
What if there was a way to systematically reward those who contribute the most to the protocol? Instead of participating in a one-sided game where the protocol holds all the cards, users participate in a transparent system where they can weigh the true opportunity cost of capital. Berachain’s proof of liquidity is a better points mechanism.
Proof of Liquidity is a mechanism that incentivizes sticky liquidity by systematically rewarding users who provide productive capital to the ecosystem. No single party can extract value for free. Any capital provided to the ecosystem is put to work, creating deeper liquidity, which results in better execution prices and outcomes for users and dApps. Proof of Liquidity is a dance where validators, applications, and users interact through BGT (the governance token issuance of the Berachain network) to align financial and social interests. To earn BGT, users provide liquidity to ecosystem applications. As a user, BGT entitles holders to receive a percentage of fees generated from native dapp usage, influence which reward vaults are incentivized through governance, and can delegate to validators to earn a portion of validator incentives. BGT allows users who contribute value to the system to decide who should receive the most rewards.
PoL is a more efficient way to distribute issuance/liquidity because it is a recursive result of on-chain activity of actual user and product growth, not the result of a Sybil attack. BGT is also adjustable in real time, controlled by users, dApps, and validators, all seeking to align their game theory optimal outcomes. New projects can be added as eligible to receive BGT issuance through governance, creating a cycle of fluctuating incentives that continues to cycle.
Berachain: Incentive alignment at the protocol level
Crypto is essentially a game of aligning incentives and finding ways to maximize capital. In other ecosystems, the relationship between users, validators, and applications is fragmented at best. At its core, Proof of Liquidity is about making it easier for applications to acquire users and liquidity, and providing validators with a differentiated revenue stream for working with these protocols.
Points are the most popular method for bootstrapping on-chain activity and growth, designed to assign value to certain future tokens in exchange for providing certain actions or liquidity to the network. However, the distribution and value of points are entirely determined by a single centralized entity and are short-term in nature, leading to sudden liquidity vacuums and an imbalance between protocol security and economic activity. This leads to a snowball effect, and ultimately no new users, no new applications, and shrinking validator participation. Ultimately, Berachain's proof-of-liquidity paradigm shifts the focus from short-term gains to sustainable, long-term growth. By creating an environment where value is distributed to contributors, participants are incentivized to play the long game.
