Exploring Berachain and Proof of Liquidity

Introduction

Berachain is an Ethereum Virtual Machine (EVM) compatible Layer-1 blockchain that uses a novel consensus mechanism called "Proof of Liquidity." In 2023, it raised $42 million in a private funding round led by Polychain Capital. In March of this year, Bloomberg reported that Berachain raised $69 million in its latest funding round led by Brevan Howard Digital and Framework Ventures. Upon completing this funding round, it expects to reach a $1.5 billion valuation.

This article will explore the Berachain ecosystem, including its three tokens and Proof of Liquidity consensus mechanism. First, we'll examine the Berachain EVM.

EVM Equivalent vs EVM Compatible

The Ethereum Virtual Machine (EVM) is Ethereum's runtime environment for executing smart contracts. It provides an isolated, secure space for running smart contracts on its blockchain. Furthermore, the EVM has a set of supported operations (opcodes), smart contract languages (like Solidity and Vyper), and tooling (Hardhat, Remix, and Foundry).

So, an EVM-equivalent blockchain seeks to replicate the entire environment and functionality of the EVM and support the same operations, smart contract languages, and tools. The goal is to create a seamless experience for users and developers transitioning from Ethereum to the new chain.

EVM Compatible

An EVM-compatible blockchain supports a degree of interoperability with Ethereum without replicating the entire environment. It could support smart contract languages and tools to a certain extent while maintaining differences in security, functionality, or performance.

Berachain EVM

As mentioned, Berachain is an EVM-compatible Layer-1 blockchain. Thus, it supports the same operations and tooling as the EVM while bringing additional functionality that optimizes for its Proof of Liquidity consensus mechanism. Therefore, the team considers Berachain an "EVM-equivalent-plus" blockchain.

Polaris EVM

Berachain's technology is built on Polaris, a high-performance blockchain framework for building chains on top of the CometBFT consensus engine. The Polaris EVM provides the execution environment for Berachain smart contracts and is where Berachain's EVM compatibility emanates. Berachain developed the Polaris EVM to build a modular stack to separate the EVM runtime layer and provide an improved EVM experience.

CometBFT Consensus

The concept of Byzantine Fault Tolerance (BFT) has been around for decades but recently gained popularity due to the success of blockchain technology. Blockchain technology is a modernization of BFT. It provides a way for chains to handle machine failures even if the machine becomes malicious.

CometBFT is a BFT middleware that securely replicates a state transition machine on many machines. It is a fork of Tendermint Core, and security is guaranteed so long as less than one-third of the machines on the network fail in any way. CometBFT consists of two primary components:

1. Its user-friendly and highly performant application interface.

2. The consensus engine is based on the Tendermint consensus algorithm. Tendermint ensures that all the machines record the same transactions and that they're in the correct order.

BERA, BGT, and HONEY

Berachain has a tri-token system with BERA, BGT, and HONEY. BERA is sometimes called the "gas token" because it sends transactions on the blockchain. In other words, it pays for the transaction's gas. BERA tokens are available through various Berachain Testnet Faucets.

BGT stands for "Bera Governance Token." In PoS networks, blockchains use a governance token to secure the network through staking. Likewise, Berachain uses BGT for delegating in its Proof of Liquidity model. To acquire BGT, a user must first deposit liquidity in the BEX. On the BEX, users can swap tokens, provide liquidity to the BEX, and earn BGT rewards.

Berachain uses HONEY to stabilize the protocol. It's a stablecoin that pegs approximately 1-to-1 with USDC. Users must first get BERA from a Berachain Testnet Faucet, then swap BERA for HONEY on Berachain's Native BEX.

Berachain Liquidity Pools

Berachain offers flexible pool types to support various swap paradigms, weighted pools, and more. All of the pools adhere to a standard pool interface for user interaction.

Creating pools is permissionless; thus, anyone can create a new pool on the BEX. First, the pool creator must determine the type of pool they want. Next, creators in the BEX must provide the liquidity to start the initial pool.

Current pool types in the BEX include the Balanced Pool Type, which features a weighted asset pool. To create a Balanced Pool Type, the creator must configure and provide for the following:

1. The token set.

2. Between 2 to 8 tokens in the pool.

3. Initial liquidity.

4. Token weights in the pool.

5. The fee paid to Liquidity Providers during swaps.

Here is an example: We have $100 worth of HONEY and want to pair it against BERA separately. In a traditional pool, the breakdown would look like this:

$50 of $HONEY paired with $50 of $BERA

$50 of $HONEY paired with $50 of $stgUSDC

Initially, Berachain will launch a set of House Pools. The goal is to have these pools flush with deep liquidity so they can create MetaPools. A MetaPool contains at least one Liquidity Provider token. A Liquidity Provider token represents shares in a liquidity pool.

Proof of Stake Downsides

Next, we'll look at Berachain's consensus mechanism. But to better understand Berachain's Proof of Liquidity consensus mechanism, let's first examine some of the disadvantages of Proof of Stake (PoS), a widespread consensus mechanism used in blockchain technology. In PoS consensus, token holders can validate transactions and create new blocks based on their stake, which the protocol holds as collateral.

One of the disadvantages of PoS is that improved security can lead to a reduction in liquidity. Participants stake tokens to become validators and delegators who receive rewards and secure the network. However, the stake can become centralized if newly minted tokens continuously go to the same participants. Below is a more complete list of the disadvantages:

1. Liquidity Issues: Securing the chain can lead to a reduction in liquidity.

2. Stake Centralization: The stake can become centralized.

3. Insufficient Validator Incentives: Validators can receive minimal rewards for their work securing the network.

Thus, Proof of Liquidity is a novel consensus mechanism developed to address some of the PoS model's shortcomings. It seeks to overcome the challenges faced by networks striving to remain decentralized and align network incentives between validators and the project ecosystem.

Proof of Liquidity Consensus Mechanism

With Proof of Liquidity, the goal is to increase security by increasing liquidity.

Berachain's Proof of Liquidity addresses the above four issues with PoS through these various mechanisms:

1. Liquidity Issues: BGT (the delegation token) is separated from BERA (the gas token). Hence, the staking token differs from the one used for other on-chain actions. Users can only earn new BGT by providing liquidity to the BEX, which incentivizes further liquidity.

2. Stake Centralization: To address PoS centralization issues, Berachain distributes new BGT to liquidity providers. Because stake is distributed to separate market participants rather than directly to stakers, token inflation is more fairly and evenly distributed than in traditional PoS chains.

3. Insufficient Validator Incentives: Proof of Liquidity addresses the third issue with PoS by incentivizing protocols and validators to work together. Berachain aligns its goals by having validators incentivize a protocol's Liquidity Provider pool via BGT. Additionally, protocols help those validators accumulate more BGT stakes via bribes (see below).

Berachain's Proof Of Liquidity model focuses on three objectives:

1. Build liquidity.

2. Solve the stake centralization challenge.

3. Align validator incentives with protocols.

With Proof of Liquidity, participants contribute liquidity to pools and receive governance tokens as a reward. These tokens are vital to the delegation process within the Proof of Liquidity system. In the case of Berachain, the governance token is BGT. Users add liquidity to BEX liquidity pools to earn BGT in return. They can then delegate their BGT tokens to validators.

As mentioned, a primary distinction of a Proof of Liquidity consensus is that the network's delegation and gas tokens differ. Berachain seeks to bolster liquidity, improve capital efficiency, and synchronize the project's ecosystem goals with the validators by decoupling these tokens.

Contributing liquidity to the BEX is the exclusive way to obtain new BGT tokens. This requirement motivates users to participate in liquidity pools and makes Proof of Liquidity a more active version of PoS, where delegators lend their tokens to a validator. With Berachain, the protocols receive all of the participants' liquidity. By bootstrapping liquidity, Berachain can accomplish more with fewer resources. That could be an essential distinction given all the new Layer 1s rolling out.

So, we've learned that Proof of Liquidity is an innovative consensus mechanism that addresses some of the issues found in PoS. Next, we'll explore Berachain's validators and their vital role in the network's security and consensus mechanism.

Validators and Delegators

To participate in Proof of Liquidity, users must acquire BGT tokens by providing liquidity to the BEX.

In Proof of Liquidity, validators earn BGT rewards when they propose a new block. These rewards include transaction fees and block rewards, which pay for their role. The network randomly selects validators to propose new blocks or attest to the validity of proposed blocks.

Random selection is weighted by the amount of BGT a validator has. Thus, validators produce blocks proportionally based on the amount of BGT delegated to them. The greater the delegation weight, the higher the validator's chance of block production.

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A validator's stake weight determines two things:

1. How many blocks a validator produces in comparison to the other validators?

2. What percentage of future BGT emissions can their votes set?

The validator determines which Liquidity Provider pools are incentivized for users to deposit their tokens. The amount of BGT delegated to a validator determines the BGT inflation the validator controls. BGT inflation directed towards the native BEX liquidity pools means deeper liquidity for those pools.

Let's assume a validator has 5% of all the staked BGT delegated to them. That validator controls 5% of where future BGT inflation will be directed.

Those who don't want to be a validator can acquire BGT and delegate their tokens to network validators to earn more BGT by providing liquidity to the BEX liquidity pools. Those who don't want to delegate their BGT tokens to earn rewards can burn them for BERA.

BGT tokens delegated to a validator can be used to create and vote on governance proposals. After a validator receives BGT rewards, they are responsible for sharing a percentage of the awards with specific liquidity pools through a precompiled contract called "Berachef." BGT incentivizes validators to behave honestly. Validators also get to vote on future BGT inflation across multiple liquidity pools.

The amount of BGT rewards earned by a user for staking liquidity per pool is based on a few factors like the BGT amount emitted to that pool and the amount of liquidity that the user provided to that pool (out of all liquidity in the pool)

The main takeaway is that delegators and validators receive rewards, creating a symbiotic ecosystem where all parties benefit.

Berachain’s Cutting Boards

Breaking down which Liquidity Provider pools will receive future BGT inflation is called creating a "Cutting Board."

Validators can choose to split up their Berachef weights in different ways. One Liquidity Provider pool could receive 100% of the BGT inflation emissions, or multiple Liquidity Provider pools could receive percentages of the validator's BGT inflation emissions, which total 100%.

For example, 75% of the BGT inflation could go to BERA/HONEY and 25% to the USDT/HONEY pool.

Bribe Mechanics on Berachain

In most contexts, "bribe" is an unsavory term and can even describe an illegal action. However, with Berachain's Proof of Liquidity model, Bribes are a way for validators to incentivize network participants to delegate BGT tokens to them instead of others.

Validators offer Bribes to their BGT delegators, and it's a way for validators to differentiate themselves from the crowd of other validators above and beyond the standard metrics for gauging validator performance.

For validators that have created Bribes, they are distributed to their delegators as follows:

• A Bribe is handed out each time a validator chosen for the Bribe proposes a new block.

• Bribes can be set for a future epoch but must be set before the epoch begins.

Summary

The testnet is live now, and Berachain's mainnet is set to launch in the second quarter of 2024. With its innovative Proof of Liquidity model, Berachain is poised to better align the incentives across its ecosystem and could play an influencer role in how Web3 platforms use liquidity.

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