Ethereum began as an experiment in whether or not a permissionless and decentralized financial system could be built from the ground up, with little to no intermediation from centralizing third parties. Raising over $18 million in its ICO, Ethereum has grown to become the definitive smart contract network, with the most active DeFi community and most on-chain activity relative to its peers. In recent years Ethereum’s dominance has been challenged and questioned by the growing introduction of modular technology and the rapid adoption of alternative L1s. 

The most popular consensus mechanism for modern blockchains is Proof-of-Stake, with Ethereum being a strong example of how PoS functions at a high level. While Bitcoin has been able to achieve great success with its Proof-of-Work model, the debate isn’t relevant for today’s report. PoW is more dependent on physical hardware, while PoS is more geared towards a token-first model centered around staking which makes it easier for those without expensive hardware to participate.

Managing the balance of tradeoffs between security, speed and decentralization, PoS is able to align validators but falls short in rewarding its users - the backbone of any successful blockchain - and its developers, the ones responsible for creating vibrant ecosystems. Validators of Ethereum stake their ETH to participate in the act of approving transactions or creating new blocks, a feature that’s only accessible to those with 32 ETH. 

Ethereum has done well to grow the largest validator set in all of crypto, with almost 30 million staked at the time of writing, this sum possessing a market value of over $75 billion. Validators maintain the security of the network, putting their staked assets on the line to ensure transactions can be properly validated and included in future blocks. 

Because of the inherent risk presented to validators, they earn a bulk of the rewards that come from being selected to validate blocks. Users, on the other hand, are entirely separate from this chain of command, unable to receive proper reward distribution from the protocol level. Even further, protocols and validators within PoS Ethereum are far from aligned, with protocols unable to improve security and validators separated from the benefits provided by protocols. 

Within Ethereum’s PoS model, there is no collaboration between protocols and the validator set, as there simply isn’t a need to align towards a central goal when incentives for validators and protocols are entirely different and detached from each other. Protocols are probably less concerned with the economic security of the chain they’re deployed on than validators are, just as validators are less concerned with the protocols driving activity as long as it proves valuable to them - this is a growing issue that needs to be addressed. There can't be significant collaboration amongst a decentralized set of individuals without communication, something needs to change.

The utilization of incentives isn’t a new concept, as we first saw this occur in the heat of the Curve Wars, with Convex and Hidden Hand being the two biggest proponents of this system. Berachain would be the first L1 to implement an enshrined bribe system designed to align all parties, taking a variety of lessons learned and folding it into a first-of-its-kind approach in GTM strategy. For the first time ever, validators can diversify their revenue streams and form direct collaborations with the protocols making their work valuable - what good is an ecosystem if there isn’t a sense of teamwork or unity?

PoS is able to help blockchains achieve heightened security, but there’s a small issue not often discussed. In the case of Ethereum, the network exists with a single token model, as ETH is used for both staking and paying for transactions on-chain. If you think about it logically, using the same token for security and transactions does not make sense, given how crucial liquidity is to any financial environment. There’s a reason you can’t use fractionalized Starbucks shares to buy a cup of coffee - no one wants to trade in a share of ownership when fiat money is more accessible and offers zero downsides for the same transaction. 

In the case of Ethereum, users are forced to decide between spending their ETH in order to transact on-chain or staking their ETH to participate in validating the Ethereum network - there’s no option for those that might wish to do both with the same set of funds.

It would make the most sense to offer multiple tokens within a network, mainly to help eliminate any opportunity costs users feel are imposed upon them. While this makes sense in hindsight, this isn’t something the Ethereum team would consider with much significance. Instead, we can build off these inefficiencies and design an economically viable way of managing incentives. 

Introducing PoL as a novel economic model 

Building off the shortcomings of PoS, Berachain’s Proof-of-Liquidity presents itself as a novel consensus mechanism built to incentivize all parties, allowing for Berachain’s security and liquidity to scale linearly. When it comes to growing the security of a decentralized network, there shouldn’t need to be any trade-offs made that affect the user experience for marginal security improvements. 

Berachain has pioneered a new model, one that doesn’t sacrifice on security and works to scale liquidity with the network’s stake - a delicate balance that pleases all actors within a blockchain ecosystem. Utilizing a tri-token model, Berachain is able to support the needs of LPs, standard users, validators and protocols. To better understand the balance of trade-offs achieved, we will briefly explain Berachain’s tokens and their respective functions:

- BGT: The Berachain Governance Token is non-transferable and only earned through liquidity provision on Berachain’s native decentralized exchange, BEX.

- BERA: Berachain’s network token can be used for the payment of transactions, allowing users to spend freely without reducing their capacity to help in network validation thanks to BGT. 

- HONEY: Berachain’s USD-backed native stablecoin, purchasable through a variety of applications or the BEX.

While incentivizing all parties is one of the main draws of Berachain and ideals present within its architecture, it’s important to recognize the priority placed on ensuring validators are treated fairly and properly rewarded. Within the PoL model, value flows directly from the validator set powering Berachain, passing its way through the protocols within the network and ultimately springing from the decisions made by the Berachain user base.

These users vote with their wallets - they provide liquidity and use the applications they want to, which in turn rewards them with BGT, which is sent to validators who reward these protocols in a positive feedback loop. Instead of PoS systems that close out validators from the user base they spend their time and funds securing, Berachain opens the loop up to all ecosystem actors and ensures the delicate balance of incentives continue moving through this loop.

In traditional crypto systems, LPs are incentivized to provide two-sided liquidity to earn a share of a given pool’s volume, though this doesn’t often work out well in practice due to issues like LVR (loss-versus-rebalancing) or the general volatility of nascent crypto markets on-chain, resulting in difficulty for consistent LP profitability. 

In Berachain’s PoL system, it doesn’t have to be that complicated. 

LPs would receive the benefit of BGT distributions, general LP rewards, any applicable rewards from blocks produced and any available validator incentives. By enabling further LP incentivization and providing a backstop in the form of BGT, Berachain is looking to solve problems at the application and protocol layer. If there’s enough of an incentive to delegate BGT and participate in a growing network, it’s natural to assume that liquidity will follow. 

The introduction of an enshrined Berachain ecosystem makes this model more feasible, given the general alignment between protocols that would exist within this collective group. Traditionally, alternative L1s and Ethereum L2s have prioritized ecosystem funds to incentive builders to create applications. All too often, these follow the same trend of reskinned Uniswap and Aave forks. Further into an L1 or L2’s life cycle, more established protocols deploy, bringing a slight liquidity boost and offering more of a marketing kick than anything else. Enshrined ecosystems are a way of aligning a community from day one, rather than having to wait until nine months later after a failed ecosystem fund has made your chain indistinguishable from any of its competitors. 

Users that delegate their BGT to validators earn a portion of distributed block rewards, along with any potential incentives proposed by validators. In an ideal world, validators and protocols would team up to increase the incentive kickback to users, enabling a further increase in LP participation amongst a larger number of users. While the PoL model is mostly novel in its approach to scaling liquidity and security without compromise, the separation between BERA and BGT is additionally useful in making the act of liquidity provision more appealing. While LPs in traditional DeFi protocols are doing it in a purely profit-driven manner, Berachain makes it beneficial as you’re indirectly gaining governance power. 

Learning from the past to build a better future

USV was one of the first to discuss the now infamous fat protocol thesis and its presence within the crypto industry. The basic ideas of this fundamental thesis revolved around the failure of web2 protocols to capture the bulk of the value, letting applications take over and become the largest beneficiaries of the system. Crypto has narrowed the gap between protocol and application layer value consumption, but it still isn’t perfect. If you look even further into the distribution of value present within applications and protocols, the user is often not rewarded proportionally to the immense value they create. 

Incentives and closed-loop incentive systems in DeFi were beneficial to those that participated in the ecosystem - it was never going to serve as an extendable process beyond niche subsectors of DeFi. Curve governance and the demand for veCRV was never a pertinent issue to the value capture of Ethereum as a base layer, let alone the success of Cosmos or Solana and their respective ecosystems. In the increasingly modular world of blockchains, the concept of open-loop incentive mechanisms is more valuable than ever before. The traditional financial system is immensely difficult to govern over, largely because of how interconnected it is and how every cog plays an important role in the great machine. PoL serves as a potential step improvement towards the first open-loop, extendable incentive system at the protocol level. 

It’s difficult to compare Berachain the L1 to Curve the application, but the concept of closed versus open loops make sense with a little context. Concerning Curve (and veCRV specifically), the ability to gain meaningful or significant governance power was useful if you had skin in the game that pertained to Curve, but it wasn’t relevant if your application wasn’t dependent on the success or failure of Curve. 

Curve’s approach hasn’t remained within the walled gardens of Ethereum - it’s alive and well in Berachain’s architecture. Instead of a single protocol’s emissions being directed to a single pool, an entire blockchain has been built with all of its protocols in mind, where users and validators come together to determine where the value flows to next. This can extend to any smart contract within the network, with these same contracts obligated to return some of this back to BGT stakers in order to preserve the loop.  

While Curve was heavily integrated across the DeFi ecosystem and was an extremely core piece of the system as we know it, extending veCRV incentives across the entire crypto ecosystem was never a feasible reality. There’s nothing wrong with a closed-loop incentive system, but it is our belief that crypto can benefit largely from prioritizing collaborative open-loop systems that leave the door open to innovation.

As highlighted earlier, modular blockchains are increasingly a core topic of contention and leading the way for blockchain design at all levels of the tech stack. Interoperable VM environments, evolving consensus mechanisms and shared modular building blocks (see: data availability or shared sequencing) are enabling a world where inter-blockchain communication will quickly become the norm. Now is the time to develop open-loop incentive systems and take advantage of this new paradigm of communication. 

While it isn’t entirely clear where value should accrue in this hypothetical (but increasingly likely) multichain world, it’s undeniable that L1s and L2s will need to collaborate more than ever before to accommodate for the increasingly debated issue of fragmented liquidity. Even though a modular blockchain might be technically superior to its monolithic counterparts, there isn’t a standardized way of solving the fragmentation problem and L2s are quickly becoming more competitive towards each other, the exact opposite system of what modularity was supposed to carry the industry towards.

When protocol ownership is distributed to users from the beginning, alignment isn’t something that needs to be worked on extensively or slotted in a roadmap for future integration - it’s a core feature, one that’s just as immutable as the blockchain it’s built into. 

Some examples of incentive mechanisms across PoS blockchains and how PoL can fill in the gaps

The blockchain trilemma has said that tradeoffs must be made between security, decentralization and speed. This was the consensus prior to the growth of modular blockchain configurations, which have made it possible for blockchains to accommodate for all three without needing to overengineer complex design choices or limit the behaviors of its core user base. Now that developers are able to integrate functionality like shared sequencing layers, data availability laters or even the offloading of proving to dedicated zk proving markets, the game has changed dramatically. 

We mentioned how it’s difficult for L1s and L2s to differentiate on community and product offerings alone, and while this is still the case for some aspects of blockchain architecture, it’s my belief that innovation on this front will open the door for further experimentation around economic incentives. 

There’s another type of trilemma that’s less discussed, but arguably far more relevant than ever before - a practical trilemma of sorts between users, developers and capital. With so many L1s and L2s now competing for very similar user bases and use cases, there needs to be a discussion around not only the incentives required to please all three of these parties, but the methodology used to achieve this.

It’s easy to look at established blockchains like Ethereum and Solana as examples of mature blockchains representing the best of what we can build, but they’ve grown into this position only through the deliberate effort to make it this far. In terms of their architectures and daily usage, these two chains should be recognized as the pillars of excellence for modular and monolithic blockchains. In terms of culture, Ethereum is quickly becoming viewed as a more established, institutional type of chain that’s experienced its respective waves of degeneracy like DeFi Summer. Solana is fresh into its own phase of degeneracy, viewed almost unanimously as the best chain for memecoins and recognized as a casino of sorts, evident through its growth in daily volumes and impressive cultural rebound. Ethereum’s validator set is the largest in crypto, but Solana has built an enviable and decentralized validator set of its own - both are doing quite well across all of these metrics.

The other side of the coin is less easily quantifiable. While Solana’s low transaction costs led it to become more popular for memecoins relative to Ethereum, there’s no evidence to support the idea that this was crafted meticulously by the core developer team - this type of activity can only form naturally, and it’s probably the best form of PR you can receive in crypto. Looking at Ethereum and DeFi Summer, there also isn’t any evidence that the Ethereum Foundation actively sought out to attract hundreds of food farms with ridiculous APYs - once again, this occurred quite spontaneously. 

Berachain stands out as one of - if not the first - blockchains to build with all of this in mind from the beginning. There’s been a collaborative effort between the broader Berachain community and a swarm of passionate developers to align themselves around a central goal, with PoL serving as the overarching north star in this equation. Berachain’s approach isn’t entirely novel or revolutionary on its own, but its deliberate effort to align everyone from the beginning and build out an infrastructure to accommodate for this is what’s so exciting. 

PoL as the potential first properly aligned consensus mechanism with longevity in mind

PoL navigates these difficulties, utilizing BGT as its main reward function, separating the emissions and creating a sustainable revenue stream through traditional dynamics of block validation, with incentives used to enable a secondary market atop core PoS functionality. Beyond all of this, one of the most important questions to answer is whether or not Berachain validators and BGT stakers can maintain a properly aligned relationship far into the future - a blockchain’s block space is only as valuable as its demand for it at any given time. 

While this report won’t get into the dynamics of Berachain’s ecosystem, cross-protocol interactions and other topics related to adoption and usage, we can make an argument that Berachain blockspace will be highly in-demand, especially given the recurring issue of Ethereum transaction costs and a lack of originality present across existing blockchains. If you’d like to explore the Berachain ecosystem in greater detail, here’s a link to an excellent report covering the current state of BeraFi. 

There are a handful of applications that have persisted throughout all of DeFi’s life cycle, but this pales in comparison to the number that have faded away after liquidity mining incentives or have simply seen usage drop off a cliff due to lack of product-market fit. Blockchains offer everything from a secure validator set, ecosystem of applications and obvious utility that’s inherent in blockchain design - this is where Berachain can succeed. 

It’s been difficult for crypto to fulfill the fat protocol thesis, but what if the answer was in front of us the whole time? From my perspective, enshrined ecosystems work in favor of a blockchain, developing an aligned set of applications and loyal users that feel comfortable participating in actions like LPing and delegating, knowing the rewards available. The larger number of users you draw into your ecosystem, the more likely it is they’re converted as well.

The phenomenon can be examined through the most widespread example of an enshrined ecosystem, this being Apple and MacOS. Those that purchase an iPhone or MacBook are almost immediately sucked into the Apple ecosystem, becoming so dependent on it for everything from cloud storage to iMessage functionality that there isn’t much incentive to leave. Apple’s hardware and software design are not technically superior to its competitors, which doesn’t align with the traditional belief that faster and cheaper blockchains will win out, but it does confirm that there’s real value in offering a superior user experience. Users of Apple products enjoy the UI, ease of access and a variety of other ancillary features available to them. 

Going back to the topic of finance more broadly, if you are a financial system of any kind, liquidity is more than likely the #1 factor that goes into crafting a superior user experience. If you are a DEX, you need liquidity for new coins. If you are a lending protocol, you need borrowers to provide the yield for lenders. In the traditional financial system, liquidity is the key to ensuring the stock market continues turning and keeps the global economy running smoothly. Berachain’s enshrined ecosystem is a feature that directly serves PoL, creating an entirely unique flywheel never attempted at the protocol layer.

Exploring the near future of PoL and its effects on liquidity

With all of this in mind, you might be asking yourself how PoL will function in reality, and whether or not a system can be self-sufficient in an industry as volatile as crypto. Ignoring the question of incentives at the protocol layer, we’re stuck wondering how Berachain might behave once mainnet is live, when the users start flooding in and breathing life into the network. Where will they choose to provide liquidity? What type of coins will be launched, and which of these will attract the most liquidity? Will meta flywheels emerge amongst Berachain protocols, with alliances forming to further incentivize LPs in the pursuit of more BGT?

While most of these questions can’t be answered without a live environment of Berachain mainnet upon, they’re very important to consider. As highlighted earlier, L2s have been very interesting to examine due to the heterogeneity of communities, despite sharing very similar architectures and value propositions. As far as L1s go, most of the activity since FTX’s fallout has been centered in Ethereum and more recently Solana, with very little innovation at the protocol or application layer. 

User activity in crypto to-date has been nearly entirely driven by financial pursuits, exemplified by a lack of unique product offerings in the application space despite the numerous advancements in blockchain architecture. We’re becoming increasingly modular, performant and superior alternatives to traditional financial systems, but what will it take to make that great leap? PoL on its own is an impressive step forward in blockchain design, but it wouldn’t be significant without the additional steps taken by the Berachain team to build a complementary structure surrounding it. 

There are a variety of promising, unique protocols building atop the primitives offered by Berachain. To give a short list, there’s Gummi, Infrared, Kodiak, Shogun, IVX and many, many more- how might these teams use PoL to their advantage? Are there hidden synchronicities waiting to be unlocked, partnerships or strategic collaborations that can unlock value and create a truly aligned ecosystem? Numerous attempts have been made in recent months to build L1s or L2s with a community-first mindset, though none have succeeded for an extended period of time. It’s disingenuous to market a blockchain as a place of battleground, an arena where your users are forced to compete amongst each other to extract value from a whitelisted group of protocols. 

In a world where Berachain launches and PoL becomes a dominant alternative to PoS, there’s immense value in this unified ecosystem where value creation can exist within its own sovereignty. There’s frequent debate over cross-chain interactions, infrastructure and solutions designed to bridge applications to new ecosystems. Despite this, we as an industry are far from a scenario where users can access cross-chain liquidity, with easy access between chains for traditional on-chain activities like making swaps, purchasing an NFT or depositing into a new protocol. What if everything you needed to do was situated on one blockchain, situated within an ecosystem where protocols complement each other and share the pie?

With all of this in mind, there’s a question to be asked: what might Berachain resemble at the launch of mainnet? How about three months after that, or even three years? It’s difficult to apply traditional forms of fundamental analysis to crypto, but it’s just as difficult to perform any sort of long term analysis due to its unpredictability. There are zero examples out there to gauge Berachain’s success on - what’s been built over the past two years has never been attempted and PoL is a novel concept that’s yet to be tested in the wild. 

This would maybe give traditional financial analysts cause for concern or confuse them, but to crypto natives it’s the opposite. It’s an exciting time to be a user interested in Berachain, a developer exploring a new idea or a supporter of crypto who likes when novel ideas get released into the wild. Simply put, Berachain is fresh, new and ready to surprise the industry. Berachain’s collaborative approach has been highlighted and it’s evident the chain and its community are extremely competitive in the culture category; combining these two ideals prior to the launch of a blockchain has not been done, and hopefully that’s enough of a reason to let go of traditional mental models and explore what everyone is so passionate about.