Playing longterm games

Liquidity is the lifeblood of onchain activity. Over the past cycle, we’ve seen several short-term approaches to acquiring liquidity, many of which have revolved around points and grants. Sometimes this liquidity is put to use productively in the ecosystem, but most of the time, it’s just used to hit some CEX listing metric or spur a short wave of onchain activity in hopes of ultimately affecting token price. The industry is fundamentally ruled by mercenary actors and correlated incentive design. Berachain believes that to build an ecosystem that stands the test of time, we must optimize for long-term games from the start.

Recent TGEs highlight the one-sided relationship between those who provide liquidity and those who reward them, perhaps most readily seen in recent LRT launches. The protocol locks liquidity, benefits from it, and decides how LPs are rewarded. Some teams may brush frustrations off as entitled airdrop farmers, but others recognize that protocols use these deposit stats to demonstrate traction for private fundraising and forming partnerships without actually finding a way to make those users whole.

Aside from pissing off users and destroying public sentiment (which tends to snowball into price action), one of the biggest issues with the current meta is that, after launch, mercenary users simply withdraw their funds and move their liquidity to the next farm. As a new protocol pops up, liquidity gets sucked from existing ecosystems as users rush to extract fresh value - sometimes aptly described as “New Coin Good, Old Coin Bad.” Few can capture liquidity and users long-term, as the opportunity cost of keeping mercenary capital locked without receiving rewards is high. Obviously, this is a great strategy for quick user acquisition but a really poor one for user retention.

So, how does one ultimately tackle this problem?

Berachain sees this as a two-part equation. First, give users and providers of liquidity as much flexibility and influence as possible, reducing the need to leave the protocol. Second, ensure that the stack of users, applications, and validators is aligned and that each party can benefit from the effort and/or capital expended on the chain. This is where Proof of Liquidity enters the equation—Berachain’s PoL makes liquidity liquid and realigns value flows across the network to reward the parties contributing the most to the ecosystem in a systemic way.

Proof of Liquidity 101

Proof of Liquidity is a mechanism for incentivizing and rewarding productive capital with BGT, Berachain’s governance/emissions token. Here’s a brief overview of how the three stakeholder groups participate in PoL:

Validators: Earn block rewards based on the amount of BGT delegated to them and can earn applications’ tokens in exchange for directing BGT emissions to applications’ rewards vaults via “incentives.”

Applications: Can set bounties on the validator marketplace for BGT rewards to incentivize validators to direct BGT emissions to them in exchange for a reward, usually in the form of the protocol’s native token. Applications and validators work together to bootstrap liquidity for an application’s token or the application itself.

Users: Supply liquidity to eligible liquidity venues (pools, vaults, etc.) to accumulate BGT rewards and earn applicable LP fees. Users may also delegate BGT to a validator to earn a portion of the incentives received from applications receiving emissions from that validator.

As a user in proof of liquidity, instead of locking capital for the sole purpose of network security, capital is provided to the ecosystem to earn block rewards (BGT), which in turn may be delegated to a validator contributing to network security. Validators are incentivized to maximize BGT delegated, as their rewards for block-building (and commissions) scale with BGT. As a result, different strategies will emerge to optimize the attractiveness of delegation- this can be social (offering value through community and/or incubation) or economic (incentivizing delegators through a revenue share).

Via a larger BGT delegation, validators can also work with more protocols through the aforementioned bounty marketplace. This allows them to access new revenue streams while helping new dApps on the chain bootstrap liquidity and user bases. Users will look for a validator that is incentive-aligned with them. For example, if a user is invested in protocol X, they’d probably prefer to delegate to a validator directing a portion of their emissions to a vault or LP corresponding to that protocol.

Game theory for stakeholders:

1. Validators: Win by maximizing BGT delegations and servicing protocol liquidity bounties, creating profitability through efficient collaboration with applications.
2. Applications: Win by working with validators to bootstrap liquidity and directly incentivizing users with BGT emissions, enhancing capital efficiency compared to standard liquidity mining programs.
3. Users: Win by providing liquidity to applications they use and delegating BGT emissions to aligned validators, earning incentives and maximizing returns on their stake.

Berachain has been described as a “playground for infinite economic games”.

The alignment above is meant to allow Berachain to also serve as “an infinite playground for economic games” - same, same, but different.

PoL is points, but better

Tokens having cash flows from the fees earned by their respective protocols will be one of the biggest unlocks for the crypto ecosystem. The only reason most don’t is for fear of being incorrectly labeled as a security.

— Viktor Bunin 🛡️ (@ViktorBunin) May 20, 2024

Why do points kind of work (on a short term time horizon)?

1. They offer an additional form of speculation prior to a token (the primary form)
2. They’re generally non-transferable and illiquid, making it harder for people to price them properly
3. Protocols retroactively determine what those points will “cost” them- in terms of token allocation in “post” - once the value has already mostly been extracted from them (through metric boosting, via points farming)

On the other hand,

1. Users have no control over how points are distributed
2. Points lack any form of intrinsic floor value or ability to proxy for the potential value of their corresponding tokens
3. Points often have unknown or highly variable distribution periods, preventing anyone from effectively knowing ownership of “the pie” at any point

What if there was a way to systemically reward those contributing the most protocol value? 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 real opportunity cost of capital. Berachain’s proof of liquidity is points, but better.

Proof of liquidity is a mechanism that incentivizes sticky liquidity through systemic rewards for users who provide productive capital to the ecosystem. There’s no more free lunch for value extraction on either side. Any capital provided to the ecosystem is put to work, creating deeper liquidity and, as a result, better execution prices and outcomes for users and dApps. Proof of liquidity is a dance where validators, applications, and users interact to align financial and social interests through BGT- the governance token emission from the Berachain network. To earn BGT, users provide liquidity to ecosystem applications. As a user, BGT gives holders rights to a percentage of the fees generated from native dapp use, influences which reward vaults are incentivized through governance, and can be delegated to a validator to earn a portion of the validator’s incentives. BGT allows users who contributed value to the system to determine who should be rewarded the most.

PoL is a more efficient way of allocating emissions/liquidity because it’s recursive to the onchain activity of actual users and product growth instead of being the result of sybil usage. BGT is also adjustable in real-time and controlled by users, dApps, and validators, all seeking to align their game-theoretic optimal outcomes. New projects can be added via governance for eligibility to receive BGT emissions, creating a constant cycle with fluctuating incentives.

Berachain: Protocol-level incentive alignment

Crypto is inherently 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 makes it easier for applications to acquire users and liquidity and provides validators with differentiated revenue streams from collaborating with those protocols.

Points are the most popular method of bootstrapping onchain activity and growth, serving to value some future token that may exist in exchange for providing some action or liquidity to a network. However, the distribution and value of points are entirely determined by a single centralized entity and are inherently short-term, leaving a sudden liquidity vacuum and an imbalance between protocol security and economic activity. This leads to a snowball effect that ends with no new users, no new apps, 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 those who contribute, players are incentivized to play long-term games.

Disclaimer：

1. This article is reprinted from [blog], Forward the Original Title‘Proof of Liquidity: Points, but better’, All copyrights belong to the original author [Camila Ramos]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.

2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.

3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.