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What Is Proof-of-Liquidity (PoL)?
Proof-of-liquidity (PoL) is an economic mechanism used by layer one (L1) blockchain Berachain to incentivize users to provide liquidity to its ecosystem.
PoL is achieved by incentivizing network validators to send their block reward tokens to “reward pools” created by decentralized applications (dApps) that pass on the benefit to users who supply liquidity to the Dapp. At the heart of Berachain’s PoL mechanism is its governance and incentive token called $BGT.
Key Takeaways
- Proof-of-liquidity is an economic mechanism used by the L1 blockchain Berachain.
- Berachain’s governance token BGT is at the heart of PoL.
- PoL aligns incentives between users, validators, and decentralized applications to maximize network participation and liquidity.
- PoL is an innovative staking model but remains unproven under real world conditions.
- The distribution of BGT across the PoL ecosystem encourages higher governance participation.
Proof-of-Liquidity Key Components
We first need to learn about the key components of the proof-of-liquidity mechanism to understand how it works.
They are as follows:
How Proof-of-Liquidity Works
PoL is all about the rotation and re-distribution of incentives between users, decentralized applications, and validators.
Here is how it works:
- On Berachain’s proof of liquidity system, validators earn the network’s governance token called $BGT whenever they propose a new block. Note that $BGT is only emitted through validator activity.
- Decentralized applications (e.g., XYZ Protocol) on Berachain incentivize validators to send $BGT to their reward vaults by offering them dApp tokens (Eg. $XYZ token).
- Rewards vaults can be created by anyone. However, not all reward vaults on Berachain are eligible to receive $BGT tokens from validators. Rewards vaults must be whitelisted by community governance to start receiving $BGT tokens.
- Users are then incentivized to deposit specific token pairs in liquidity pools created by decentralized applications. When they stake eligible LP tokens on whitelisted-reward vault, they start earning $BGT tokens.
- $BGT holders are further incentivized to delegate their tokens to validators to maximize their returns.
- From the perspective of validators, it is advantageous for them to increase their delegated $BGT stake as it enables them to earn more $BGT block rewards (as explained earlier in the validator boost).
- To encourage token delegation, validators distribute protocol tokens received from dApps to their delegators. The validator may choose to take a commission before distributing the remaining protocol tokens to delegators.
PoL Lifecycle From a User’s Perspective
The PoL can be difficult to understand because of various moving parts and interconnected incentive schemes. Therefore, in this section, we will explain the proof-of-liquidity lifecycle from a user’s perspective.
For Berachain users, they participate in PoL activities in the following ways:
- Providing liquidity: The first step for Berachain users to earn $BGT tokens is by providing liquidity to certain liquidity pools. In return, they will receive a receipt token, commonly known as LP tokens within the crypto world. When they deposit receipt tokens in reward vaults, they will earn $BGT tokens.
- Delegation: Once a user holds $BGT tokens, they can maximize their returns by delegating their $BGT tokens to validators. In return, delegators receive token rewards for their contributions. When selecting a validator to delegate to, users have to consider the factors such as the validator’s reward vault allocations for $BGT emissions, commission rates, incentive distribution strategies, validator uptime, and performance.
Proof-of-Liquidity Risks
Here are some risks that the proof-of-liquidity mechanism faces:
Proof-of-liquidity Pros & Cons
Pros
- Ensures that all network participants are aligned to maximize participation and liquidity on the network
- Users can earn DeFi yield by delegating $BGT tokens and providing liquidity, making it easy for beginners and intermediate users
- dApps on PoL systems can leverage incentives schemes to bootstrap liquidity
- PoL natively allows staked assets to be used for yield farming
- The distribution of BGT across the PoL ecosystem encourages higher governance participation
Cons
- PoL mechanism is a novel concept that has not been tried and tested under real world conditions
- Liquidity providers and $BGT delegators are exposed to impermanent loss risks
- Berachain’s PoL allows BGT to be burned for BERA at a 1:1 rate, potentially affecting BERA token in weak markets. Note that BERA cannot be burned for BGT
- Complexity of the PoL system and its various moving parts introduces new unknowns for users
- Distribution of BGT tokens to dApps and users via PoL incentive schemes exposes them to validator risks
The Bottom Line
Blockchain technology is evolving rapidly, and the introduction of the novel PoL mechanism following the launch of Berachain in February 2025 is a perfect example.
To summarize the definition of proof-of-liquidity, PoL is not a consensus mechanism. It is an incentive mechanism used by Berachain to align users, applications, and validators to maximize participation and liquidity on the network.
