In traditional blockchain ecosystems, the infrastructure layer often functions as an economic black hole, drawing in a disproportionate amount of value. This phenomenon results in a significant portion of the network's economic benefits accruing to validators and token holders whose contributions may not extend beyond basic network security. This concentration of value in passive participants creates a misalignment of incentives, potentially impeding ecosystem growth and innovation. While this infrastructure-centric model has been the status quo, it fails to adequately reward and incentivize value creation at higher levels of the stack. Proof of Liquidity shifts focus from value extraction at the infrastructure layer to value creation at the application layer.

The structure of PoS networks today is that the vast majority of emissions go to stakers and validators, along with some allocated to an ecosystem fund meant to stimulate ecosystem growth. This value distribution model eventually results in a chokehold for innovation for apps, as the majority of value flows to stakers and validators as opposed to builders. With less economic value flowing to applications, there's a diminished incentive for creating new applications that could drive adoption and utility. This system also promotes capital inefficiency– resources can be used within the ecosystem instead of being locked up for staking.

Ghost chains

We see the toxic side effects of parasitic systems that are misaligned to the point of creating "ghost chains"—blockchains with robust security but almost nonexistent activity. A clear example of this misalignment is evident when comparing a chain's Total Value Locked (TVL) to the amount paid for security to stakers. Most ecosystems have no real use for the amount of security they have through validator staking—there simply isn't enough demand for security relative to the usage and value secured by the chain.

This imbalance is illustrated by projects with $1-10 billion FDVs, paying over 10% APY to stakers (over $100 million in security payouts) for ecosystems that have less than $100 million in TVL. This situation where the security supply far exceeds the demand creates a negative feedback loop: applications struggle to thrive in an environment where most of the network's value is locked in security rather than circulating in the ecosystem. Ultimately, this scenario highlights a fundamental issue proof of liquidity aims to solve: A layer 1 generates little value if there's minimal building or usage on the network. 

Reorientation of rewards

Proof of Liquidity addresses these systemic issues by fundamentally redirecting value creation to the application layer– both from users and from validators. Proof of liquidity is a mechanism that systematically drives the flow of rewards toward applications as a part of block production, and it operates on two key principles: PoL directly rewards liquidity provision, and introduces a validator-application collaboration model that doesn’t exist in other ecosystems.

At a high level, PoL directly rewards users for participating in the ecosystem. Each protocol has control to decide how users should interact with them to earn BGT, allowing them to create sort of onchain quests to incentivize their users. This shift incentivizes users to engage more deeply with the ecosystem's applications. This forcing function not only forces users to actively participate in the ecosystem but also stimulates the growth of the protocols on the chain. By tying rewards to actual usage and liquidity provision, PoL creates a virtuous cycle where increased user engagement leads to more robust applications, which in turn attracts more users and liquidity. This model also helps to prevent the formation of "ghost chains" by ensuring that network value is directly correlated with ecosystem activity and utility.

Second, PoL as a system requires that validators and applications work together. As part of the block production process, validators direct BGT emissions to applications' reward vaults. This creates a symbiotic relationship between those who provide infrastructure and application developers, aligning their interests and encouraging validators to actively support the growth of the application ecosystem. By intertwining the success of validators with that of applications, PoL creates a more holistic economic model for networks. This alignment of incentives addresses the capital inefficiency problem present in traditional blockchain models, as it encourages the productive use of capital within the ecosystem rather than locking it up in idle staking. 

Proof of Liquidity is a step change in blockchain economics, fundamentally shifting focus from value extraction at the infrastructure layer to value creation at the application layer. This reorientation addresses the inefficiencies of traditional models, where passive participants reap disproportionate rewards. By directly incentivizing user activity either through the form of LP’ing or otherwise, and fostering collaboration between validators and applications, PoL creates a more productive ecosystem. This model not only stimulates application development and user engagement but also ensures that the network's economic benefits are aligned with utility. As a result, PoL has the potential to break the cycle of "ghost chains" and capital inefficiency, redirecting resources towards innovative applications. By aligning rewards with active participation and ecosystem growth, PoL offers a practical solution to the misaligned incentives that have long plagued blockchain growth.