Interview with Berachain co-founder: How to develop from an NFT community to L1 and create a positive flywheel effect

Jul 29, 2024

In this episode, we talk with Smokey, the co-founder of Berachain, about the unique aspects and transformative potential of Berachain within the blockchain ecosystem. Smokey provides insights into how Berachain’s proof of liquidity model enhances security and incentivizes liquidity. He discusses the EVM-identical nature of Berachain, the use of Comet BFT consensus for single slot finality, and the two-token system of $BGT and $BERA. Smokey also highlights Berachain’s evolution from an NFT community, the challenges and innovations in airdrop design, and the role of native dApps in setting a quality baseline for the ecosystem. The conversation concludes with a discussion on the positive flywheel effect and the future of Berachain.

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Introduction and Background of Berachain

Berachain is an EVM-identical Layer 1 blockchain built on proof of liquidity, which enables users to convert their liquidity into security and supports the network’s applications. Unlike many recent copy-paste L1s, Berachain stands out with its unique technology stack. It is the first L1 besides Ethereum to be truly EVM-identical. This means it maintains full EVM compatibility end-to-end and can run on various clients such as Reth, Nethermind, and Aragon. Consequently, anything built on Ethereum mainnet can be seamlessly integrated with Berachain.

Berachain utilizes Comet BFT consensus for single slot finality, combining the best features of different modular systems for chain-building. A key aspect of Berachain is its proof of liquidity mechanism, which ties block rewards to the liquidity brought into the system. This approach aligns liquidity incentives with network security at the chain level, providing meaningful economic reasons for applications to build on Berachain. Block rewards flow from validators to applications, and ultimately to users, fostering an ecosystem where applications are directly incentivized to attract liquidity and increase capital efficiency.

Proof of Liquidity and Incentive Marketplace

Berachain follows the ETH 2.0 specification, allowing the spin-up of an infinite number of validators over time. It starts with a relatively permissioned set and can expand over time. There are two tokens: $BGT, the non-transferable, soul-bound rewards or emissions token used in governance, and $BERA, the basic gas token used for transactions and fees on the network. Validators post a bond in staked $BERA to activate and come online.

The proportion of block rewards or $BGT a validator earns when it wins a block is based on the amount of $BGT delegated to it. $BGT is provided by users who have contributed liquidity in the past. So, while it’s not directly one-to-one, the size of a validator’s block reward is larger if it has more $BGT delegated to it. Validators act as allocators, choosing which pools and applications to direct block rewards or emissions towards, creating a flow of value from validators to applications and ultimately to users.

Validators can collaborate directly with protocols to bootstrap liquidity, allowing a free market approach to decrease capital costs for protocols. Instead of just paying out more emissions in their own token, protocols can distribute their token to a validator and its delegates in exchange for rewards in $BGT. Validators might choose to support early-stage protocols with higher risk but potentially higher returns or focus on categories they believe will bring new interest to the chain.

The design can also accommodate different types of applications, such as GameFi or NFTs, which may not require large TVL but have higher risks. Over time, the system can evolve to support microtransaction formats, where emissions are proportioned to the volume or fees generated by an application. This adaptability ensures that a variety of applications can benefit from the incentive structures in place.

Evolution from NFT Community to Blockchain

The best technology often becomes very memeable. Memetics serve as a means to distribution, and after a product meets a minimum threshold, distribution matters the most. Projects like Eigenlayer or Celestia, which are technically complex, also have memetic elements that make them accessible and simple enough for people to understand and engage with.

In the early days, Berachain started with NFTs for fun, creating 100 NFTs of bears smoking weed, which were distributed in DeFi-focused communities. This self-selected a group of technically competent and meme-savvy individuals. As the community grew, they added mechanisms to the NFTs, like rebasing, to reward initial holders and distribute more broadly. This kept the community engaged and provided a base to explore the potential for a real blockchain project.

Berachain identified a market gap by talking to community members and builders. Many users were deciding between running an ETH validator or providing liquidity in DeFi protocols. Berachain proposed integrating liquidity and security, making them complementary rather than opposing forces. They aimed to support applications built on the chain through proof of liquidity, allowing those who contributed the most value to direct incentives across the network.

For crypto to scale to millions of users, there must be applications that can only exist in a crypto environment. Berachain acts as an accelerant for the application layer, reducing activation energy for protocols and helping them bootstrap liquidity to attract meaningful consumer adoption. The goal is to enable the next breakout app to be built in the Berachain ecosystem.

The community rallied around the idea of Berachain because it was both funny and ambitious. The project began as an NFT community and evolved into building a blockchain, driven by the desire to create something unique and valuable. Berachain aims to cultivate a meaningful ecosystem with core primitives and a variety of projects ready to deploy, ensuring the chain is not an empty wasteland at launch.

VCs are increasingly interested in projects with strong meme cultures and solid fundamentals. Berachain’s approach is to avoid generic forks and instead focus on developing unique primitives that attract retail interest and drive ecosystem growth.

Airdrop Design Challenges and Innovation

I think that airdrop design is very difficult and is one of the areas that probably requires a little bit of innovation. And I think it’s something that’s increasingly turning closer to liquidity mining or developer acquisition efforts than it is anything else. I don’t know if I’d agree with the first part though, right? Because if you look at the last cycle, like, you know, Optimism, Arbitrum, there were a lot of L2s that are still at massive market caps right now that did pretty meaningful or non-trivial airdrop campaigns, right?

Because in any case, you need some manner of distributing and getting that initial float out there such that you don’t have like a super high FTV low flow project, right? But I think that what has happened is like we’ve seen a lot more money come into the private markets and that’s caused a lot more projects to launch at like pretty inflated valuations, which means that like, you know, that effect has felt that much harder when there aren’t as many marginal buyers, right? And there’s a lot more marginal sellers.

Decreasing Utility and Retention of Airdrops

I do think the average utility of an airdrop has decreased. And I think that they are retaining many fewer users than they were in the past. I also think that institutional airdrop farmers and these effectively farming operations have increased in complexity and nuance and are much more talented than they were in the past, which adds another burden there.

In the future, we will probably see airdrops turn more into something that ends up being a more tangible source of value accrual to the project. Right now, people think of airdrops as a means of getting distribution, but many don’t actually end up getting the distribution they want. Beyond that, people also think of airdrops as a way of improving sentiment or how the market feels about a project. It has somehow become an industry standard to give free money to folks, which I find pretty weird logically.

The way we approach it is that we care a lot about a few different groups. One is the original community that’s helped us get here, which has been with us for two and a half, almost three years. The project wouldn’t exist without them, so we care about them a lot. Two, we care a lot about developers and those who are actually building in the ecosystem. We’re fortunate to have many folks who want to build on Berachain and have already taken the time and effort to deploy and do a lot of work on the test net. They’ve helped us improve our software and build a better ecosystem, and they demonstrate that people want to use this thing.

We also care about the folks who help test different products and participate in the network at its earliest stages. There’s a lot of work that goes into that process, and it’s never the easiest or nicest thing. Additionally, we care about new liquidity and new entrants entering the ecosystem.

It’s possible to design an airdrop that is elegant and rewards the parties that have contributed the most. There will always be people who complain about not getting free money, but you can’t make everyone happy. When looking at projects that have had successful airdrops, think about Celestia, Gitcoin and Ethena. In many cases, they have not set incredibly high expectations for their airdrops and have built products that have significant use. All those things are critical solutions for different parts of the stack.

Airdrops can be pretty bad, but if you build a good product, it becomes easier to have a good airdrop.

I don’t know if it’s necessarily in the context of airdrops, but I think it’s more of a long-term perspective. What the two-token system for Berachain actually does is it effectively allows people to choose what they care about most. It embeds choice into the protocol itself. To be clear, it’s not two tokens for the sake of having two tokens. It’s because if we want to maintain the ethos of the structure of proof of liquidity, it’s important for $BGT to be non-transferable and soulbound. Otherwise, people could just buy it, which would defeat the purpose of having to provide liquidity to earn block rewards.

The Two-Token System on Berachain

I wanted to highlight this because we’ve had people ask us why we have two tokens. The point of POL (Proof of Liquidity) necessitates it. The two-token system allows users to choose their risk profile or what they care about. On one hand, you can hold $BERA, speculate on the liquid price action, and use it to pay gas. On the other hand, you can hold $BGT. By holding $BGT, you can compound your rewards in pools you’re depositing in. For example, if you LP a stable pool and earn some $BGT, you can choose to delegate that $BGT to the validator that puts the majority of its emissions towards the same stable pool, potentially earning more than if you just held or sold liquid $BERA.

There’s an element of game theory. You can also use $BGT to stake with a different validator or delegate to a validator receiving incentives from a protocol you want exposure to, effectively getting a call option on something without having to buy or pay for it. It’s a “have your cake and eat it too” scenario. The whole time, you’re earning fees from the various applications powered by $BGT across the chain.

This system allows for a more long-term, compounding viewpoint versus a short-term price action perspective, which is probably healthier in a market. It lets users figure out their style of play.

Creating a Positive Flywheel Effect on Berachain

I think what we’ll probably see is a few different things happening. Initially, a number of protocols will launch, and we’ll likely see a lot of capital piling into the native applications. These participants will earn a bunch of $BGT and will probably do exactly what I mentioned earlier — LPing on certain pools that are not super high risk, such as stable pools and major pools. They will compound those LPs by directing more $BGT towards the pools they are LPed in.

As more protocols come online and submit governance votes to ensure their protocol vaults or pools in the chain’s DEX receive $BGT emissions, I foresee people starting to rotate into these. Validators will begin to work with protocols to start that incentive flywheel, allowing folks to take riskier bets on mid-cap or small-cap tokens. I’ve even heard plans for POL-powered meme coins, which could pair with a lot of emissions from validators directing resources that way, further boosting the positive flywheel.

In short, the positive flywheel starts when protocols partner with new up-and-coming validators, and users delegate their $BGT to these validators, thereby incentivizing the new protocols. For those one or two out of ten protocols that end up working and increasing massively, we’ll see that effect recycle throughout the ecosystem. A real massive amount of gains or alpha will come from people betting on the right protocols early, with very low risk, by working with validators incentivized by those protocols.

The ideal metagame we want to create rewards people who put in more effort or time. We want a system that forces engagement and ensures that if you do the work, you can achieve outsized returns. This concept has been seen in ecosystems like Blur and Pendle, where people who choose the right strategies can do much better than the norm.

The basic flywheel works like this: you LP in a given pool, the pool pays you $BGT, which generates more fees. You hold that $BGT longer, auto-compound it into your pools, and continue the cycle of deeper fees, more liquidity, and repeat.

This creates a new type of speculation, where you can speculate on the activities and popularity of a project or token without the high risks associated with traditional methods like MEV or direct token purchases. This approach brings the often under-the-table processes into a free market context, allowing for more transparent and engaging speculation.

An additional mental model is thinking of it like Curve at the chain level, without the vote-locking multipliers. It allows you to direct emissions not only to any given pool in the DEX but also to any protocol on the chain. This creates a flexible and modular system at a different level of the stack, correlating liquidity provision with governance and decision-making power.

Exciting Projects on Berachain

1. Puffpaw: A quit-smoking and vape-to-earn DePIN on Berachain. It incentivizes healthier behaviors like reducing nicotine intake, with a strong team that has shipped millions of vapes globally.

2. Exponents: A new layer for speculation in directional trading, akin to a Uniswap moment for derivatives. It combines Uniswap’s spot arbitrage mechanism with a bribing layer for incentivized long or short positions.

3. Gaming Projects: Examples include an Animal Crossing/Stardew Valley farming game and groups like Shogun, which have raised funds from Polychain and Binance Labs to build a solver network for cross-chain asset trading.

4. Gummi: A marketplace that allows borrowing any asset against any other asset, with shared liquidity profiles and isolated risk profiles.

5. Kodiak: Offers concentrated liquidity and automated liquidity management strategies, aiming to be a go-to community and altcoin DEX.

6. Over Under: Uses ML and computer vision algorithms to speculate on outcomes and generate odds on Twitch streams, allowing for real-time betting on in-game actions.

7. Concrete Finance: Building credit default swaps on-chain and liquidations as a service, catering to more complex and nuanced stages of DeFi.

8. Infrared: Provides a liquid form of $BGT as a yield-bearing primitive within different protocols, aiming to become the convex, LIDO, and block-building layer of Berachain.

For more information on the ecosystem and upcoming projects, you can visit the Berachain foundation page and follow related Twitter accounts for the latest updates. The mainnet is expected to launch before the end of the year, with a focus on ensuring it is battle-tested and ready for immediate activity from dozens of companies.

The Role of Native dApps on Berachain

The native dApps on Berachain are designed to serve two main purposes. Firstly, they are meant to initiate the $BGT generation flywheel, ensuring this process is secure and not reliant on third-party dApps. This is crucial for controlling block rewards across the chain safely.

Secondly, these native dApps are intended to start the fee generation flywheel, allowing $BGT to earn fees from these applications. Additionally, they set a quality standard for the ecosystem. At the beginning of a new ecosystem, there’s often a proliferation of low-quality forks of popular dApps like Uniswap and Aave. By having robust chain-enforced primitives, Berachain aims to avoid this issue, ensuring liquidity is concentrated in high-quality applications from the start.

These native applications serve as a stable baseline but are not meant to be the ultimate solution. The goal is for better applications to replace these native dApps over time. However, they need to be strong enough initially to maintain stability and set a high standard for future developments.

Users earn $BGT by providing liquidity and participating in the native dApps, such as LPing in the DEX or borrowing through the lending protocol. This is how most $BGT is expected to be generated initially.

For those interested in Berachain, we plan to expand our presence in the APAC ecosystem, including China, Singapore, Hong Kong, Korea, and Southeast Asia (Vietnam, Thailand, Indonesia, Malaysia, Philippines). We’re excited to grow our presence with boots on the ground, protocols building out these ecosystems, and engaging with various trading and farming groups.

If you’re a builder or interested in getting involved with Berachain, keep an eye on our social channels and feel free to reach out to our team. We aim to be as responsive and helpful as possible, ensuring people know about what we’re building and how it can benefit them.

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