Liquidity has been the backbone of DeFi (decentralized finance) since its inception. However, securing liquidity through locked capital is detrimental to DeFi in the long term. This realization acted as a catalyst behind the inception of Berachain’s Proof-of-Liquidity (PoL).
The traditional Proof-of-Stake (PoS) mechanism has certain irreversible drawbacks. It provides an unfair advantage to network participants at the time of TGE (token generation event), laying the ground for mass sell-offs. Also, PoS leads to a reduction in liquidity for LP pools and transactions if the chain’s security were to be improved. Since PoS chains follow a single token economic model, protocols do not have the flexibility of funding growth with their token holdings as it may lead to a slump in the token’s price.
It is to tackle these challenges that Berachain leverages the PoL mechanism.
Enter Proof of Liquidity (PoL)
Just like PoS, PoL uses a gas token to incentivize validators to secure the network. However, PoL introduces an additional token called governance token to incentivize liquidity providers and determine the potential reward for stakers securing the network.
Berachain builds on PoL, introducing two tokens: $BERA – the native gas token, and $BGT – the governance token. Using PoL enables Berachain to attract liquidity by distributing $BGT as an incentive. Liquidity providers can contribute liquidity to BEX pools and earn $BGT (Bera Governance Token). $BGT holders then delegate their tokens to validators.
These validators then produce blocks proportionate to the $BGT delegated to them. Both delegators and validators are rewarded by Berachain for strengthening the network. Validators also have the voting rights to decide on the inflation of $BGT.
What Makes PoL So Effective For Berachain?
Here’s how PoL acts on the shortcomings of PoS:
Separate Tokens: PoL separates the functionalities of the delegation token and the gas token ($BGT and $BERA in the case of Berachain), ensuring enhanced network security and ample liquidity.
Incentivized Liquidity Gathering: The only way to earn $BGT is by providing liquidity to the BEX pools. It ensures ample liquidity for the pool, making trade settlements and on-chain transactions more efficient.
Cross-Exchange Market Making: Fragmented liquidity is a key challenge in DeFi which leads to underutilization of available assets. PoL also enables larger exchanges to serve as the primary market makers for emerging exchanges, facilitating the creation of an interconnected trading ecosystem within Berachain.
But, there are a few challenges…
Users participating in PoL are required to lock their assets. While this ensures liquidity in the beginning, it also means these users will be eager to unlock their assets and sell in the market soon after TGE to book profits.
Here, the liquidity strength depends on the willingness of these users to lock their assets for a longer period. Since $BGT is a non-transferrable token, these users have limited opportunities to generate more profit. Thus the unwillingness to lock assets for a longer period.
With insufficient tokens locked up, a liquidity crisis is never too far, creating a detrimental scenario for the entire Berachain ecosystem. And the solution for this had to come from within the ecosystem.
Enter FTO: The Driving Force Behind Honeypot’s Flywheel Model
Honeypot Finance’s FTO (Fair Token Offering) model’s designs shares follow the same mechanism as Berachain’s PoL. While the end goal of both FTO and PoL is the same: to reduce sell pressure at the time or after TGEs, FTO is hyper-focused on building liquidity through supplier volume instead of locked volume.
The Fair Token Model proposes:
100% Deep Liquidity: The FTO model ensures that all the tokens are in the pool at the time of the launch, which prevents market manipulation.
LP Token Creation: Instead of buying the actual token, investors buy LP (liquidity provider) tokens at the time of launch, creating liquid markets from day 1.
Fair Pricing: Both protocol and participants are treated the same and the allocation of LP tokens is split 50-50 between them, eliminating the chances of an unfair advantage for either party.
LP Sale Without Price Slump: Protocols are allowed to sell the LP tokens to raise funding for operational purposes. However, this sale does not impact the token price in any way.
Built on Berachain, Honeypot’s FTO is primed to accelerate activity and boost liquidity within the ecosystem.
Most importantly, FTO unlocks additional usage for $BGT by integrating it into Honeypot’s Flywheel model. Here’s how:
- $BGT holders delegating to the BeeHive node (Honeypot Finance’s node) receive $HPOT (the governance token of Honeypot) as bribes.
- The bribe mechanism is directly linked to voting rights, boosting incentives for $HPOT and $Honey token pools.
- In return, $HPOT holders can collect $BGT profits by participating in PoL mining.
PoL vs FTO: FTO Acting as an Accelerator for PoL
Users holding $HPOT, $Bera, or $Honey can invest in the $HPOT-$Honey-$Bera liquidity pool to earn $BGT. Most importantly, they need to hold only one of these three tokens to be eligible to earn $BGT.
Together, $BGT and $HPOT power a lucrative income flywheel model, which leads to:
- Significant rise in platform revenue and community node size
- Surge in $HPOT buyback, inflating its market value
- Boost in $HPOT bribes and incentives, further increasing the demand for $HPOT
Every time a user unlocks their tokens to remove liquidity, they lose their ability to generate income through $BGT emissions. Eventually, they can burn their $BGT holdings to acquire $BERA. The FTO model encourages more users to provide liquidity as it minimizes loss probability with users getting 50% of their invested tokens back in the LP form.
Final Verdict
Once Honeypot gains prominence and helps emerging protocols attract liquidity through its Dreampad, the need for staking $BGT could rise substantially to power the network as well as the liquidity pool. Technically, FTO is bound to promote PoL, while tackling the issue of fragmented liquidity with efficient capital utilization.
Proof of Liquidity (PoL) boosts on-chain activity, speeding up the circulation of tokens. This enables PoL networks to reach similar or even better economies of scale with fewer tokens compared to Proof of Stake (PoS) systems, where many tokens are locked up by validators, reducing circulation speed.
Fair Token Offering (FTO) also enhances token circulation by providing immediate liquidity post-launch. This readily available liquidity makes trading the token easier, further strengthening the PoL system’s capacity to achieve substantial economies of scale. Together, these mechanisms complement each other, enhancing the overall functionality and sustainability of the DeFi ecosystem on Berachain.
