The Liquidity Proof paradigm of Berachain creates an environment that allocates value to contributors, incentivizing participants to engage in long-term gameplay.
Author: Camila Ramos
Translation: DeepTechFlow
Long-term Gameplay
Liquidity is the lifeblood of on-chain activities. In past cycles, we have witnessed many short-term methods of obtaining liquidity, many of which revolve around points and subsidies. Sometimes, this liquidity is effectively used for the ecosystem, but most of the time, it is merely to meet the listing criteria of certain centralized exchanges (CEX) or to stimulate a short-term on-chain activity, hoping to eventually impact token prices. This industry is essentially dominated by mercenary-like actors and related incentive designs. Berachain believes that to build an ecosystem that stands the test of time, we must optimize for long-term gameplay from the start.
Recent Token Generation Events (TGEs) have highlighted the asymmetric relationship between the protocol locking liquidity, benefiting from it, and deciding how to reward liquidity providers (LPs), especially evident in the recent LRT release. Some teams may view user frustration as a given for airdrop farmers, but other teams recognize that the protocol leverages this deposit data to demonstrate the attractiveness for private fundraising and forming partnerships, without truly finding a way to reward these users.
In addition to angering users and disrupting public sentiment (which often affects price trends), one of the biggest problems with the current model is that after release, mercenary users simply withdraw funds and move liquidity to the next farm. When a new protocol emerges, liquidity is drawn away from the existing ecosystem as users are eager to extract new value, sometimes aptly described as "new coins good, old coins bad." Few protocols can sustainably capture liquidity and users in the long term because the opportunity cost of locking mercenary capital without receiving rewards is high. Clearly, this is a good strategy for rapid user acquisition, but it is very detrimental for user retention.
So, how can this problem be ultimately solved?
Berachain believes this is a two-part equation. First, give users and liquidity providers as much flexibility and influence as possible to reduce their need to leave the protocol. Second, ensure that the stack of users, applications, and validators is aligned, with each party benefiting from the effort and/or capital invested on-chain. This is where Liquidity Proof (PoL) comes in—Berachain's PoL makes liquidity fluid and systematically rewards the parties contributing the most to the ecosystem, realigning the flow of value in the network.
Liquidity Proof 101
Liquidity Proof is a mechanism that incentivizes and rewards productive capital through BGT (Berachain's governance/issuance token). Here is a brief overview of the three major stakeholders participating in PoL:
Validators: Earn block rewards based on the amount of BGT delegated to them and can guide BGT issuance to the application's reward pool through "incentives," earning the application's tokens as a reward.
Applications: Can set BGT reward bounties on the validator market to incentivize validators to guide BGT issuance to their reward pool, usually in the form of the protocol's native tokens. Applications and validators work together to guide liquidity to the application's tokens 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 a portion of the validator's incentives from receiving the application's issuance.
As users in Liquidity Proof, they are no longer simply locking capital for network security but are providing capital to the ecosystem to earn block rewards (BGT), which can be further delegated to validators contributing to network security. Validators are incentivized to maximize the BGT delegated to them, as their block-building rewards (and commissions) are proportional to the BGT. Therefore, different strategies will emerge to optimize the attractiveness of delegation—this can be social (by providing value through community and/or incubation) or economic (by incentivizing delegators through revenue sharing).
With larger BGT delegations, validators can also collaborate with more protocols through the aforementioned bounty market. This allows them to gain new sources of income while helping new dApps on-chain guide liquidity and user base. Users will seek validators aligned with their incentives. For example, if a user invests in protocol X, they may be more willing to delegate to validators guiding a portion of the issuance to the corresponding protocol's treasury or LP.
Game Theory of Stakeholders
Validators: Win by maximizing BGT delegation and servicing protocol liquidity bounties, creating profits through efficient collaboration with applications.
Applications: Win by collaborating with validators to guide liquidity and directly incentivize users with BGT issuance, improving capital efficiency compared to standard liquidity mining programs.
Users: Win by providing liquidity to the applications they use and delegating BGT issuance to aligned validators, earning incentives and maximizing their investment returns.
Berachain is described as a "playground for an infinite economic game." The alignment above aims to make Berachain also a "playground for an infinite economic game," similar yet different.
PoL is a Better Scoring Mechanism
Viktor Bunin stated on May 20, 2024, "The cash flow 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 the fear of being incorrectly labeled as securities."
Why are points effective in the short term?
They provide an additional speculative form before tokens (primarily) exist.
They are typically non-transferable and illiquid, making it difficult to accurately price.
The "cost" of these points is decided by the protocol post-facto—in the form of token allocations—once value has been extracted through metrics and point mining.
On the other hand,
Users have no control over how points are allocated.
Points lack any intrinsic underlying value or the ability to proxy for the potential value of their corresponding tokens.
The distribution period of points is often unknown or highly variable, making it impossible to effectively know ownership of the "cake" at any given time.
If there was a way to systematically reward those who contribute the most to the protocol? Instead of engaging in a one-sided game where one party holds all the cards in a protocol, users participate in a transparent system where they can balance the true opportunity cost of capital. Berachain's Liquidity Proof is a better scoring mechanism.
Liquidity Proof is a mechanism that incentivizes sticky liquidity by systematically rewarding users who provide productive capital to the ecosystem. No party can extract value for free. Any capital provided to the ecosystem is put to work, creating deeper liquidity, thus bringing better execution prices and outcomes for users and dApps. Liquidity Proof is a dance, where validators, applications, and users interact through BGT (Berachain network's governance token issuance) to align financial and social interests. To earn BGT, users provide liquidity to the ecosystem's applications. As users, BGT grants holders a proportional right to fees generated from native dApp usage, influence which reward pools are incentivized through governance, and can be delegated to validators to earn a portion of the validator's incentives. BGT allows users who contribute value to the system to determine who should receive the most rewards.
PoL is a more effective method of distributing issuance/liquidity because it is a recursive result of actual user and product growth on-chain, rather than a result of Sybil attacks. BGT is also real-time adjustable, controlled by users, dApps, and validators, all seeking the optimal outcome for their game theory. New projects can be added as eligible recipients of BGT issuance through governance, creating a continuously cycling wave of incentives.
Berachain: Protocol-Level Incentive Alignment
Cryptocurrency is fundamentally a game of aligning incentives and finding ways to maximize capital. In other ecosystems, the relationship between users, validators, and applications is at best fragmented. The core of Liquidity Proof is to make it easier for applications to acquire users and liquidity and provide validators with differentiated income sources through collaboration with these protocols.
Points are the most popular method for guiding on-chain activities and growth, aimed at valuing tokens that may exist in the future in exchange for providing certain behaviors or liquidity to the network. However, the distribution and value of points are entirely decided by a single centralized entity and are essentially short-term, leading to sudden liquidity vacuums and imbalances between protocol security and economic activity. This leads to a snowball effect, ultimately resulting in no new users, no new applications, and reduced validator participation. Ultimately, Berachain's Liquidity Proof paradigm will shift the focus from short-term gains to sustainable long-term growth. By creating an environment that allocates value to contributors, it incentivizes participants to engage in long-term gameplay.
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