Berachain — The Bear that Captures Both Liquidity and Security

1. Introduction

Proof of Stake (PoS) has recently been adopted as the most popular network consensus mechanism. It has a specific characteristic: the more tokens staked in the network, the higher the security.

However, the native tokens of PoS networks are not only used for staking. They are also used for paying gas fees and as the base currency within the ecosystem. This leads to a paradoxical structure. As staking volume increases, liquidity and network activity in the network's DeFi (Decentralized Finance) ecosystem decrease.

This lack of liquidity causes high slippage in decentralized exchanges (DEXs). It also hinders the growth of various protocols that operate based on token deposits. This negatively affects the entire ecosystem. Consequently, ecosystem protocols are forced to conduct excessive airdrops to secure liquidity. Alternatively, they build their own Layer 2 or appchains. This leads to liquidity fragmentation and degradation of user experience across the blockchain industry.

Even on the Ethereum mainnet, restaking protocols have recently gained attention. The ETH staking ratio has continued to increase, reaching an all-time high of around 28%. However, the average daily gas cost is around 5 Gwei. This indicates a decreasing trend in network traffic.

In the PoS structure, users face a binary choice. They can stake limited liquidity to the network, or deposit it into protocols. A phenomenon occurs where incentives between validators and protocols are not aligned.

Although many foundations have recognized the seriousness of this problem, they attempt to coordinate interests through grant payments. They also offer technical and marketing support for ecosystem contribution protocols. However, this approach has limitations. It is difficult to reflect the opinions of ecosystem participants, such as network users or validators. Ultimately, this can lead to centralization towards the foundation.

If one of the core ideals of blockchain is to create an environment that is "Can't be evil" rather than "Don't be evil," a new attempt is needed. We need to systematically improve the dilemma of ecosystem liquidity and network security inherent in PoS. Berachain aims to solve these chronic problems of PoS-based networks. It establishes a structure that can simultaneously complement both liquidity and network security through game theory-based tokenomics.

In this article, we will examine Berachain's consensus mechanism and tokenomics model. We will focus on the unique incentive structure and ecosystem formed through them.

2. Berachain, Capturing Both Network Security and Ecosystem Liquidity

Berachain is an EVM-compatible Layer 1 network. It is built through BeaconKit, a framework that enables the construction of customizable EVM execution environments using the Cosmos SDK.

Generally, blockchain projects announce a whitepaper containing the development team's technical vision. They build a community through various campaigns and recruit potential users. In contrast, Berachain originated from an NFT project called 'Bong Bears' and the community formed around it.

Bong Bears was launched in 2021 when the NFT market was gaining significant attention. It received a great response from the community of the popular DeFi project at the time, Olympus DAO. Subsequently, they airdropped derivative NFT collections such as The Bond Bears, The Boo Bears, and The Baby Bears to Bong Bears holders. This provided benefits to existing holders and continuously expanded the community.

At that time, the term Berachain was mentioned like a meme within the Bong Bears community. However, the developer Dev Bear started the actual development of Berachain. Currently, the testnet is in progress, with the mainnet launch approaching.

This case contrasts with recent blockchain projects. These projects invest enormous time and capital in building loyal communities but experience significant user churn after their own token airdrop. This case could attract much attention from crypto users.

However, there is another decisive reason why Berachain could be positioned as a promising Layer 1 for many users. It attempts a new consensus mechanism called Proof of Liquidity (PoL). This aims to overcome the incentive alignment problem of participant entities that existing PoS-based networks have faced. It achieves this through game theory-based tokenomics.

2.1. PoL(Proof of Liquidity)

Berachain's PoL consensus mechanism involves the following stakeholders:

Validators : Entities that run Berachain nodes and participate in network validation
Liquidity Providers : Entities that provide liquidity to protocols within the ecosystem
Protocols : Entities that wish to provide specific services on the Berachain network and require network liquidity

In Berachain's PoL, liquidity providers who supply liquidity to a specific protocol's liquidity pool receive Berachain's network tokens. These tokens are issued as rewards for each block. Liquidity providers can indirectly participate in the network validation process. They do this by delegating the tokens they receive to validators. In this process, liquidity providers can receive both interest for providing liquidity and the profits generated by network validators.

This structure may seem at first glance to have a similar effect to depositing assets in a liquid staking protocol on a PoS chain. One receives liquid tokens and deposits them in another protocol to gain profits. The order is simply different.

However, in the PoS method, various liquid staking protocols compete. The types of tokenized tokens diversify. This results in liquidity fragmentation. On the other hand, Berachain has this function built into the chain. This has the advantage of preventing liquidity fragmentation.

Furthermore, validators in Berachain have the authority to determine the liquidity pool where block rewards are distributed through voting. This means network validators have the authority to directly increase the incentives for a particular liquidity pool. Due to this feature, liquidity providers and protocols can be more closely involved in the consensus mechanism in the PoL method than in the PoS method.

2.1.1. Ecosystem Flywheel

Protocols launching on the Berachain network will provide incentives to validators. They will use invested capital, issued tokens, and protocol fees. They do this to receive many votes from validators and bootstrap liquidity for their liquidity pools.

This setup encourages validators to distribute the assets received as incentives from protocols to network token delegators. Their goal is to secure more voting rights. When validators distribute these protocol incentives, liquidity providers are encouraged to delegate their network tokens to validators instead of selling them on the market. This action further strengthens network security.

Through this Proof of Liquidity mechanism, Berachain has built a structure that brings in projects and liquidity providers. These entities were unable to directly participate in the network consensus mechanism in the traditional Proof of Stake structure. Now they act as key participants. These three entities are closely connected by exchanging liquidity and incentives. An ecosystem flywheel is implemented where value circulates: from liquidity providers to projects, from projects to validators, and again from validators to liquidity providers.

2.2. Tri-Token Model

To better leverage the flywheel characteristics of PoL, Berachain adopts a tri-token model. This model utilizes the following three types of network tokens:

** $BERA**: This token functions as Berachain's network usage fee, and gas fees are burned. Validators must stake 69,420$ BERA to activate their node.
** $BGT**: This is the inflation reward distributed to liquidity pools voted by validators. It is a token that cannot be transferred or traded as it is attributed to accounts. Liquidity providers can take the following actions with the$ BGT they receive after providing liquidity:
Burn $BGT and receive$ BERA at a 1:1 ratio
Delegate to validators
** $HONEY**: A stablecoin pegged to the value of$ 1. It serves as the base currency within the Berachain ecosystem. On the testnet, it is implemented by wrapping USDC, and there is potential for it to be converted to an over-collateralized form in the future. A 0.5% fee is charged upon issuance, which is distributed to $BGT holders.

If we apply the tri-token model described above to the relationship diagram of Berachain's participants, it can be represented as follows:

In Berachain, $BGT determines the distribution of inflation rewards. It is non-tradable and can only be received through liquidity provision. Therefore, the structure prevents specific whales from quickly securing a large amount of$ BGT and exerting influence on governance. This setup encourages protocols that want $BGT distribution allocation. To secure ecosystem liquidity, they must allocate incentives to validators with many voting rights and undergo a persuasion process.

The act of Berachain's network participants reaching a social consensus for their own interests leads to the enhancement of network security and liquidity. The secured security and liquidity contribute to attracting more users to the Berachain ecosystem.

As more users flow into the network ecosystem and network usage increases, the amount of $BERA burned as gas fees will increase. Additionally, demand for$ HONEY will rise, as it is widely adopted as collateral and trading assets in ecosystem protocols. This directly translates to profits for $BGT holders.

3. bArtio Testnet

With its loyal community and unique PoL mechanism, Berachain has garnered much attention. It achieved good results, such as reaching one million active wallets within eight days of starting its first testnet, 'Artio Testnet,' in January 2024.

However, due to infrastructure limitations where Berachain uses the Cosmos-based consensus mechanism CometBFT to execute the EVM, issues arose in EVM compatibility and scalability during the testnet operation. In June 2024, Berachain launched a new second testnet called 'bArtio Testnet' to address these issues and the shortcomings revealed during the process of testing the operation of the PoL mechanism.

3.1. Perfect EVM Compatibility

In the process of developing the chain, the Berachain team created and utilized an EVM-compatible framework called Polaris. The purpose was to connect the Cosmos-based consensus mechanism CometBFT with the EVM execution environment.

Polaris is a framework that enables compatibility between CometBFT and EVM through a technology called precompile. This converts and stores the same operations commonly used in two different program execution environments. The Berachain team built and tested the Artio Testnet using this Polaris framework.

However, during the testing process, the following limitations of Polaris were identified:

The consensus engine of the Cosmos SDK waits for the EVM to complete transaction processing before generating blocks. This causes bottlenecks when a large number of transactions are received at once.
Operations not implemented as precompiles do not function properly in Polaris, leading to EVM compatibility issues.

To address these limitations of Polaris, bArtio Testnet newly introduced a new EVM-compatible framework called BeaconKit. This was designed taking inspiration from the Beacon Chain of Ethereum 2.0.

3.1.1. BeaconKit

Unlike Polaris, BeaconKit operates with a clear separation between the execution layer (EVM) and the consensus layer (CometBFT). The two layers are connected and compatible through the EngineAPI. Thanks to this architecture, BeaconKit can use standard Ethereum execution clients (Geth, Erigon, Nethermind, etc.) as is.

In bArtio Testnet, since Ethereum execution clients are used as is, it can provide an EVM execution environment 100% identical to Ethereum. Even when the Ethereum execution environment is updated, Berachain can apply the same effect of the EVM execution environment update on the Ethereum mainnet. This requires no special measures, as validators simply install and run the clients provided by Ethereum.

Moreover, unlike Polaris, BeaconKit operates the execution layer and consensus layer independently. This creates an environment where a bottleneck in one layer does not affect the other layer. Additionally, by introducing the 'Immediate Execution' feature, validators propagate the post-execution state values of all transactions included in a block to other validators when generating blocks. This feature has significantly improved transaction processing speed, resolving the scalability issues that Polaris previously had.

3.2. Strengthening the PoL Mechanism

We have updated the EVM-compatible framework to BeaconKit. Furthermore, we applied several changes to the bArtio Testnet to strengthen the Proof of Liquidity (PoL) mechanism:

Change in validator participation conditions: Previously, a small amount of $BGT staking was required to activate a node. In the bArtio Testnet, this changed to staking 69,420$ BERA. This increases the stake deposited in the network and enhances network security.
Change in slashing conditions: Previously, if a validator acted incorrectly, the $BGT of liquidity providers who delegated to that validator was also slashed. Now, slashing only occurs on the$ BERA staked by the validator. This completely separates the roles of $BGT and$ BERA in the PoL ecosystem and places more responsibility on validators.
Change in block creation authority criteria: Previously, the authority to create new blocks increased according to the amount of $BGT delegated to a validator. We changed this to give validators equal opportunities to create new blocks, regardless of the amount delegated. However, block rewards still increase according to the amount of$ BGT delegated.
Increase in validator limit: We removed the previous cap of 100 validators to enhance network decentralization and security. As of July 16, a total of 150 entities are participating in Berachain network validation.

We can summarize the changes made during the transition from Artio Testnet to bArtio Testnet in the following table. Note that the team or governance may modify these changes at any time before the mainnet launch:

The Artio Testnet verified that the PoL mechanism operates properly. The currently ongoing bArtio Testnet adjusts the details and parameters of PoL and prepares for the actual mainnet launch.

The daily transaction count of the bArtio Testnet has gradually increased since launch to about 3.2 million. There are about 860,000 active wallets. More than 150 projects are preparing to utilize the high EVM compatibility, scalability, and PoL mechanism that Berachain has built.

4. Exploring the Berachain Ecosystem

In typical Layer 1 networks, the foundation issues tokens and allocates a portion to the ecosystem. They operate grant and hackathon programs to build the ecosystem. This is common practice.

Although the Berachain team operates an incubation program called Build-a-Bera, the approach is different. Build-a-Bera conducts seed investments in incubating projects using the team's capital and provides support such as mentoring. However, there are no plans to directly distribute Berachain's tokens to the ecosystem through grants or hackathons.

Smokey The Bera, one of Berachain's founders, has expressed a critical view of the grant systems operated by other networks. The reason the Berachain team can take this stance is that the consensus mechanism, PoL, fundamentally supports ecosystem projects. It allocates $BGT to users who provide liquidity to liquidity pools.

We can view this as a much healthier form than the ecosystem bootstrapping programs of other networks. It relies on 'consensus' among network participants and bootstraps the liquidity of the relevant protocol. It does not simply provide assets to the protocol development team.

Due to the structure of PoL, network participants are involved in each other's incentives. Therefore, communication and consensus among validators, protocols, and liquidity providers are even more important in the Berachain ecosystem. As a result, despite still being in the testnet stage, many partnerships and collaborations are taking place. Some protocols are attempting to perform multiple roles simultaneously, such as directly running nodes.

Next, let us examine the representative protocols in the Berachain ecosystem.

4.1. Native dApps

Berachain has native dApps that serve as infrastructure for the basic functions of the ecosystem. The team has directly built these. Currently, three types of native dApps are operating on the testnet: BEX, Bend, and Berps.

BEX: A decentralized exchange where users can trade without intermediaries or directly create trading pools.
Bend: A decentralized lending protocol where users can borrow $HONEY using various assets as collateral. Users can also provide$ HONEY liquidity and receive interest.
Berps: A decentralized perpetual futures exchange where users can create leveraged positions using $HONEY as collateral. Users can also deposit$ HONEY to provide liquidity for position holders' trading profits and receive trading fees.

These native dApps provide basic DeFi functions to users in the early Berachain ecosystem. They operate before other protocols launch. They also serve as the pools where $BGT is distributed to liquidity providers. This is the starting point of the PoL mechanism. In the currently ongoing bArtio Testnet, the liquidity pools (gauges) that can receive$ BGT distributions are also composed of native dApp liquidity pools.

Native dApps expand the usage of $HONEY by utilizing it as the main collateral asset. They further strengthen Berachain's tri-token model. They use a structure that distributes the profits generated from the protocols to$ BGT holders.

Furthermore, they serve as a catalyst for diversifying the ecosystem. They encourage developers who want to launch protocols on Berachain. They push them to develop creative protocols that utilize the PoL mechanism in various ways, rather than basic infrastructure protocols.

4.2. How DeFi Protocols Utilize PoL

DeFi protocols on other networks typically attract liquidity by providing additional incentives to liquidity providers. They then use the secured liquidity to attract user traffic and generate protocol revenue from fees.

However, Berachain's DeFi protocols do not provide additional incentives to liquidity providers. Instead, they provide additional incentives to validators and strive to build the following flywheel:

Provide incentives to validators who voted for $BGT distribution to their protocol. This encourages more$ BGT to be delegated to those validators.
As more $BGT is delegated to those validators to receive incentives, more$ BGT emissions occur in their protocol's liquidity pool.
Additional liquidity flows in from the outside to receive the $BGT emissions distributed to the liquidity pool. This increases protocol traffic and revenue.
Repeat steps 1-3.

Furthermore, in the process of building this flywheel, protocols are emerging. They aim to provide user convenience and create added value. Negotiations constantly take place to exchange protocol revenue and future added value. Other protocols aim to gather users' fragmented liquidity. This exercises more authority in the negotiation process and generates profits.

4.2.1. Kodiak

Kodiak is a DEX that provides concentrated liquidity provision (CLAMM, Concentrated Liquidity AMM) to trading pools. It is similar to Uniswap v3. It helps users supply liquidity intensively to specific ranges. It offers higher-efficiency $BGT farming compared to BEX.

Kodiak has two types of tokens, $KDK and$ xKDK. Users can exchange the two tokens within the protocol.

$KDK: An incentive token paid to liquidity providers and traders.
$xKDK: Kodiak's governance token and a non-tradable token. Holders are provided with a portion of the revenue generated within Kodiak. This includes fees incurred during swaps and incentives submitted by other protocols.

With concentrated liquidity provision, users can farm $BGT with high capital efficiency. However, if the liquidity provided falls outside the range due to price fluctuations, the liquidity is not utilized for trading at all. Therefore, liquidity providers cannot receive$ BGT farming and trading fees. This requires continuous range management by liquidity providers.

In response, Kodiak additionally provides a vault feature called Kodiak Islands. It automatically adjusts the liquidity provision range according to market conditions. This solves the cumbersome problem of liquidity providers managing the range. It simultaneously resolves the issue of idle liquidity arising from the concentrated liquidity provision range being exceeded. This ensures that abundant trading liquidity is maintained on Berachain. Furthermore, by using the native dApp BEX in the process of automatically adjusting the liquidity provision range, it establishes a mutually complementary relationship with native dApps.

Currently, Kodiak operates a validator node on bArtio Testnet. There is a possibility that validator activities will be synchronized with the protocol mechanism in the future. It is necessary to pay attention to the future development of the protocol.

4.2.2. Infrared

Infrared is a liquid staking protocol in the Berachain ecosystem. It operates vaults that provide liquidity to liquidity pools where $BGT emissions occur on behalf of users. It delegates the$ BGT generated by utilizing the liquidity deposited by users in those vaults to its own validator nodes. It then provides users with $iBGT, a liquidity token for$ BGT, and $IRED, a governance token.

** $iBGT**: A token that liquefies$ BGT. Users can utilize $iBGT in other DeFi protocols to generate additional revenue.
** $IRED**: Infrared's governance token. It has the authority to determine the$ BGT voting rights of Infrared validators. It can receive fees generated in Infrared.

In this way, by providing users with the benefit of simultaneously guaranteeing the two functions of $BGT, exchange for$ BERA and voting rights, it can acquire a large amount of $BGT. Moreover, as Infrared gathers more$ BGT within the Berachain ecosystem, the role of $IRED, the token that can exercise the voting rights of that$ BGT amount, also becomes more important. Therefore, it is expected that many protocols will appear that design a structure utilizing $IRED as a substitute role for$ BGT.

A representative protocol designing such a structure is Kodiak, introduced above. Kodiak plans to collaborate with Infrared to open a Kodiak vault within Infrared. This provides Kodiak's liquidity providers with the opportunity to farm $IRED instead of$ BGT.

Moreover, derivative DeFi protocols such as Gummi and BeraBorrow are continuously emerging. They state that they will enable $iBGT to be used as collateral. This forms an ecosystem centered around Infrared.

Furthermore, Infrared recently unveiled a liquid staking feature for $BERA. This is in addition to liquid staking for$ BGT. It aims to establish itself as a protocol providing comprehensive liquid staking solutions within the Berachain ecosystem.

4.3. How Communities Utilize PoL

Berachain's DeFi protocols are attempting to resolve the liquidity war that will unfold within PoL. They are based on quantitative incentives expressed in numbers. They are further striving to provide users with convenience and capital efficiency.

In addition to this approach, there are also movements in the PoL ecosystem. They form communities through NFTs and memes. They establish a presence through various community activities. Subsequently, they generate and distribute profits through that presence.

This method inevitably involves more qualitative aspects. This can lead to inefficiencies in incentive distribution compared to the approach of DeFi protocols. However, as the complexity that arises when derivative protocols emerge and combine in the DeFi ecosystem can hinder new users from entering Berachain, there may be an increasing demand for intuitive and qualitative approaches to the liquidity war.

Moreover, given that Berachain originated from an NFT project and has the most cult-like community, this approach may be a much more 'Berachain-like' strategy than the one being taken by DeFi protocols.

4.3.1. The Honey Jar

The Honey Jar is a community gathered around the core philosophy of building a community-driven flywheel. It connects each entity and constructs sticky liquidity that does not easily disperse. It evolved around an NFT called 'Honeycomb' in 2022.

Honey Jar has expanded much like Berachain did. The community grew by issuing and distributing derivative NFT series of Honeycomb to holders. This expanded base allowed Honey Jar to solidify its presence. It formed partnerships with various projects building on Berachain. It then passed benefits from those projects on to NFT holders.

Recently, it has provided services useful for users entering the Berachain ecosystem. This includes creating educational materials and operating a testnet faucet. Furthermore, it is incubating projects like S&P (Standard & Paws). This is a community-based service to assess project credibility. It is also incubating Bera Infinity. This platform calculates and rewards ecosystem contributions. Honey Jar functions as a venture studio, not just a community.

Honey Jar also runs a validator node within the ecosystem. Through these activities, it built a strong presence in the Berachain community. As of July 2023, Honey Jar became the validator with the most $BGT delegated.

Recently, it established a DAO. This DAO negotiates incentives and forms liquidity partnerships with protocols launching on Berachain. It distributes the obtained incentives to Honeycomb NFT holders. This prepares for the liquidity war that will start with the Berachain mainnet launch.

5. Conclusion

Berachain started as an NFT project. It built a structure connecting three entities: validators, liquidity providers, and protocols. It introduced the PoL consensus mechanism based on a loyal community. This aligns their interests closely.

Furthermore, various DeFi protocols are building new models. They are preparing to launch to actively use Berachain's consensus mechanism. Community-based projects are also striving to solidify their presence.

An ecosystem flywheel is being built based on Berachain's PoL consensus. However, this flywheel can also act as a vicious cycle. Therefore, for sustainability, Berachain has challenges to solve:

** $BGT inflation** :$ BGT is continuously inflated. There is a limit to creating demand solely through external liquidity inflows. In the long run, the amount of $BERA burned needs to increase. But the PoL structure focuses on securing liquidity. It may be difficult to increase actual network usage.
Possibility of centralization : As the ecosystem matures, a strong cartel could form. This could center around specific validators, protocols, and liquidity whales. If the ecosystem only revolves around this cartel, new protocols will struggle to enter. This ultimately hinders the influx of new users.

To solve this, user-friendly protocols must emerge. They need to attract new users and encourage active transactions. Additionally, consensus among participants is necessary. This ensures protocols that positively impact the ecosystem receive sufficient liquidity support.

The success or failure of Berachain's experiment will impact the blockchain industry. It attempts to integrate liquidity and security through incentives. Since it is currently in the testnet stage, we must observe how Berachain addresses these challenges.

References

Berachain
Berachain Docs
BGT Station
Berachain Blog
Infrared Blog
Kodiak Blog
Berachain — The Convergence of a Strong Community and Experimental Endeavors
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Berachain: Memetic Playground or DeFi Utopia?
Bullish on Berachain Part I: The Future of MemeFi
THE HONEY JAR 101 GUIDE