PoL V1.1 - Bera in Control

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Original post from SmokeyTheBera: https://forum.berachain.com/t/pol-v1-1-bera-in-control/107

Proposal to Introduce PoL v1.1

May 10, 2025

Context

Authors: Smokey, Jack, Carnation, with assistance from other members of Bera Labs.

Since Proof of Liquidity (PoL) went live just over a month ago, it has processed more than USD$10 million of incentives and allocated over USD$14 million of Bera Governance Token (BGT) rewards to the users of Berachain’s apps (https://dune.com/thj/pol-on-berachain). This proof of concept has shown the power of PoL in allocating application incentives at a chain level.

Despite the achievements, both the core team and the community have noted inefficiencies with the current PoL system, and have worked toward various improvements for the next iteration of PoL.

Most notably, there remains a firm gap between the value accrued to BGT and the chain token (BERA). This proposal aims to create long-term BERA value capture aligned with the interests of the network, while continuing to drive value for the chain and keep the PoL mechanism intact.

Within this framework, there are a few specific end goals:

  • Retain the PoL flywheel, while directly creating value for BERA

  • Create Chain Owned Liquidity (as described further below) that benefits the ecosystem & synergizes with native dApps

  • Allow for a more laissez faire incentive policy, as value will now be programmatically captured by the network, rather than needing to be mandated through governance

  • Create a more efficient incentive market

  • Maintain upside for BGT holders & PoL believers without a complete reworking of the existing system

Rejected Implementations

As the community has sought to contribute to PoL, they’ve suggested a number of potential fixes. These are all design spaces that we’ve explored, but generally set aside for reasons relating to the end goals above. We’ll run through a few of the more popular suggested implementations from the community and internally, as well as the rejection logic for each.

Locking Mechanism / ve3,3

A BERA locking mechanism that allows users to convert BERA to BGT would essentially create a massive growth in BGT supply, compressing the BGT premium and diluting BGT yield aggressively. This would then decrease the attractiveness of holding BGT relative to BERA, thus causing existing BGT holders to redeem to BERA, offsetting a portion of the BERA supply taken offline and shifting the existing flywheel. While this was a solution that we considered and discussed for an extended period of time, the lack of long-term effectiveness of ve3,3 based systems, and the complexity of locking-based models for a chain level protocol were deemed to outweigh simpler & friendlier UX alternatives. Ultimately, Berachain is a chain that goes far beyond DeFi, and these sorts of mechanisms will serve as a meaningful impediment to broader adoption and ease of use.

Variable Burn on BGT redemptions

A variable burn on BGT redemptions would allow for BGT to convert back to BERA at a slight penalty to the original 1:1 peg, with the penalty amount being burned. The variable amount would be determined by tracking metrics such as incentive efficiency, LST premiums, etc.

The main outcome of the burn would be a reduction in LST premiums, and the protocol would reduce the max potential redemptions. However, liquidity providers would factor the burn in their expected yield, and this would lead to fewer liquidity providers being active on Berachain. Also, since the “Burn” is limited to a fraction of newly redeemed BERA, it doesn’t act as a sink or as a source of value accrual for existing BERA tokens.

In short, any benefit from the burn would likely be equally accomplished through lowering inflation or future changes to economic monetary policy of the chain, without introducing additional user and LP complexity.

Combined BERA + BGT staking

This solution involved having BERA staked in validators to direct a portion of the BGT block rewards, rather than having BGT boosted in validators direct 100% (current state). While this would help somewhat with BERA value accrual, there were two fundamental limitations to this framework.

First, the private stake present in validators would lower the fair distribution of BGT, increasing yield for both private and public BERA stakers. Our goal with any modifications was to ensure that the primary focus was on improving the liquid ecosystem revolving around BERA as opposed to favoring private round stakers in any manner. Second, due to the size of nominal stake relative to BGT, the impact of shifting this would likely offset BGT yield and cause BGT redemptions more than it would improve BERA staking yields, making it a lackluster tradeoff.

Enforcing BERA as the only incentive token paid to validators

Given that the majority of incentives currently are already paid in BERA tokens, there is likely little incremental benefit when the protocol enforces the incentives to be in BERA tokens. A variation of this could involve giving a bonus to the Reward Vaults when incentives are voluntarily paid in BERA tokens.

Realistically, based on what historical data has shown from incentive-based models, the majority of distributions are generally sold regardless. In effect, any benefit in the short term from converting application incentives to BERA would likely be offset later when end recipients then liquidated their boost incentives. As a result, at best this is a marginal gain, and likely ends without noticeable effect.

Forcing BERA Pairing

An alternative option for driving on-chain demand for BERA revolved around the idea of mandating that protocols utilize or pair against BERA in some manner. While that may generate some value from a purely fundamental point of view, it would also become meaningfully exclusionary for the dozens of teams in the ecosystem who wish to create a wider variety of pairs (stables, LSTs, etc). This goes without mentioning the many variants or more complex types of staking tokens which may partially use BERA (ie. IVLP type products), or imbalanced DEX positions which may be composed of a small amount of BERA.

From community discourse and internal discussions, this option felt like it would be more likely to alienate teams in the ecosystem as opposed to helping to scale Berachain over time.

Proposed Solution: PoL v1.1

After extensive consideration toward PoL v1.1, we would like to present some of the ideas that have resonated the most with applications, users, and liquid investors.

In short, PoL v1.1 would implement a variable rate fee to the redistribution of incentives given by applications (not on the BGT distributed to a rewards vault). This ensures that more of the value of PoL for applications remains intact, at the expense of a small haircut to BGT yield. If done correctly, this haircut in yield can be offset by increased demand for BERA through mechanisms described below, as well as through higher incentive revenue for the chain (higher BERA/BGT value = more total value in incentives that the chain can support while maintaining some constant incentive efficiency for applications). A major focus for the incentives collected through incentive redistribution is the permanent removal of BERA from supply, primarily through the creation and maintenance of ‘Chain Owned Liquidity’, which will also drive utility for the ecosystem and ongoing fee generation levers for growth.

In the early phases, the revenue generated from incentive redistribution will be primarily focused on Chain Owned Liquidity in major pairs on BEX (e.g. BERA-HONEY, BERA-wBTC), but can easily be extended over time into supply for other native dApps. In tandem with other PoL projects like auto-incentives (recycling fees from LP on BEX into more PoL incentives), it creates a long-term aligned and sustainable lever for both practical liquidity growth and decreasing circulating supply of BERA. This implementation would likely also allow the protocol to reduce existing PoL governance oversight in certain areas, including (but not limited to) caps on the amount of PoL usable within a Reward Vault. Notably, this liquidity would fundamentally be owned by the chain itself; not Labs, nor the Foundation.

In a future where a high enough density of Chain Owned Liquidity has been reached, and the marginal benefit of more major liquidity is small, then other mechanisms to take BERA supply permanently offline may be considered as a replacement. This is including, but not limited to, beginning to take pairs in other major ecosystem tokens or other incentive tokens from protocols.

Implementation

Change Overview:

  • A dynamic rate fee is taken from Reward Vault incentives picked up by the validators and given to BGT boosters. This does not impact the amount of BGT going towards the Reward Vaults.

  • The rate is proposed to begin at a fixed rate of 20%, before transitioning to a dynamic model.

  • Incentives collected in BERA tokens will remain in BERA (no selling of BERA), while non-BERA tokens are eligible to be converted to other major assets.

  • Periodically, the collected BERA and Majors will be paired in a LP on BEX.

  • The initial focus / pair of interest would be BERA-HONEY LP, as one of the most actively traded and fee-generating pairs.

  • Any excess BERA will have a few options for being deployed, in example, but not limited to:

    • Staked into Foundation-operated validators to direct rewards to Reward Vaults of the native dApps of Berachain (i.e. BEX to start with, potentially others in future)

    • Delegated to application validators that create novel use-cases for validators within their PoL mechanism design

    • Deployed into future native applications like BEND single-sided as a borrowable asset

    • Remain in a smart contract to be paired into a BERA-Major LP down the line

  • The fees (i.e. swap fees, staking rewards, etc.) produced by the Chain Owned Liquidity will be periodically collected and used to collect more BERA-Major LP.

  • Restrictions around Protocol Owned Liquidity within PoL would be reduced, as this change would further disable negative impacts.

Suggested implementation will involve a two step process:

  1. First, begin with a flat incentive redistribution of 20%, to begin value capture

  2. As an option to smooth transition, begin week one with a 5% fixed rate, and ramp up to 20%, increasing 5% each week.

  3. Second, concurrently discuss and finalize implementation on a more comprehensive framework for incentive redistribution to ensure a more nuanced approach

Dynamic Incentive Rate Model:

The proposed framework here to be discussed by the community would involve a variable rate incentive redistribution framework based on the efficiency of spend in PoL. When applications are achieving high return on incentive spend, the incentive redistribution captured by the protocol will be higher. As incentive efficiency improves over time, the variable rate for redistribution will trend downward. Additionally, this incentive redistribution would be effected on the incentive distributed by the application, rather than on the BGT output. This maintains the expected spend efficiency for the application incentivizing, at the expense of slightly lowering BGT yields (more on this later).

The goal with this model would be to ensure that applications are still achieving positive return on investment spend, gently encouraging more efficient incentive spend over time, and capping the incentive redistribution as a factor of the value that applications capture (rather than a fixed rate that could exceed value captured through Proof of Liquidity).

A sample formula for this below:

Incentive Redistribution Rate = K*[1-(R/BERA)]

with a floor of 10% and a cap of 30%

Where:

  • K is some constant fixed rate, suggested 40% (e.g. the incentive recapture is 40% of the value created by PoL)

  • R is the rate an application is incentivizing per BGT in the PoL orderbook

  • BERA is the price of BERA at the time that the application is filled by a validator

This rate is charged on a per-fill basis, meaning that two bids at different rates in the order book will each be priced and incentives will be redistributed independently and accordingly. Additionally, this model intentionally does not account for the impacts of the BGT premium, as this value capture for LPs should remain intact as long as it exists.

Based on our sample modelling and historical backtesting, generally we’d expect this rate to average at around 15% of posted incentives. In the current incentive environment, this would result in low eight-figures of revenue for the protocol, which would be utilized to permanently take BERA supply offline through productive creation of Chain Owned Liquidity that can create compounding growth over time. Combined with fee generation from major pairs like BERA-HONEY, and BEND upon launch, this can quickly evolve into mid 8 to low 9 figures of productive liquidity and value capture around BERA.

Drawbacks of Incentive Redistribution

The primary drawback of Incentive Redistribution would be an effective reduction of BGT yield and short term compression of the BGT premium. That said, there were a few reasons this route was considered as the primary option:

  1. Over time, the BGT yield and premium would naturally compress as new BGT inflation comes online. Eventually, users would start to burn some BGT for BERA, which would reduce the claims on incentive yield and naturally reach a steady-state equilibrium.

  2. The impact of lack of BERA accrual in the current system likely hurts BGT yields more than the proposed changes. The maximal amount of incentive intake that the system can support is effectively a function of: [Bribe Efficiency]*[BGT emitted], where the value of BGT emitted is correlated to BERA. As a result, improving BERA fundamentals increases the effective capacity of the system to support incentives at scale.

  3. Through thoughtful implementation of a PoL v1.1 mechanism, the impact on BGT can be minimized, especially relative to the improvements in the core PoL loop.

  4. Based on our research, we’d expect the average incentive redistribution rate of 12-15% to result in a reduction of the BGT premium from ~1.45 to ~1.25, which is variable based on the rate of inflation over the period of the implementation and the future yields from PoL / BGT burns. Ideally a portion/all of this delta would be offset through more direct value capture for BERA as a result of implementation.

4a. Additionally, given a meaningful portion and the majority of current BGT holders are using leverage to magnify yield exposure, the expected rate of return relative to other major staking assets should remain meaningful.
4b. A lower BGT premium that results from an increase in BERA value also leads to reduced downside risk to BGT holders.

  1. The plan would require liquidation of non-BERA incentive tokens. Realistically, this isn’t a major change, as based on on-chain data from both PoL (and basically every other incentive program in history) the majority of incentives are already currently liquidated into HONEY/BERA or autocompounded.

5a. At the very least, the new model would reduce the amount of liquidation pressure from BERA-denominated incentives, thus helping bolster any correlated assets.

Timelines

We’re seeking feedback, questions, and critiques on this proposal for one week. If significant flaws or alternatives are not raised, the proposal would move to a vote by the BGT Foundation.

Addendum - Other Potential Changes for PoL v1.1

While not being strictly required to implement Incentive Redistribution, the authors also wanted community feedback on other improvements that could complement and enhance the effectiveness of the Incentive Redistribution strategy.

  1. 10-20% fixed BGT emissions towards BEX major pairings, ensuring that major BERA denominated and stable pairs will have sufficient liquidity on Berachain. This will also reduce the need for other protocols to incentivize this liquidity.

  2. Enabling BEX’s auto-incentives, where the protocol fees collected by BEX are automatically forwarded as incentives for BEX’s own reward vaults. This is expected to increase the revenue going back into PoL and enhancing returns for BGT and validators. Beyond BEX, other native Apps could also adopt auto-incentives to incentivize their users and offer competitive yields.

The Incentive Redistribution in PoL v1.1 will continuously help increase the permanent liquidity for BERA-Major pairings, which will act as supply sinks for BERA. The permanent liquidity will generate an increasing amount of fees over time, some of which will continue to deepen the liquidity for BERA/Majors and the auto-incentive portion will increase the overall returns towards BGT. The positive flywheel here is that Incentive Redistribution leads to more Chain Owned Liquidity, which leads to more fees produced over time, which leads to more incentives passed back to PoL, which leads to more redistribution earnings.

Berachain.