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Proof of Liquidity

Summary

Proof-of-Liquidity unlocks staked liquidity by using liquidity pool tokens as staking assets, allowing for deeper liquidity and thereby increasing capital efficiency.
While Proof-of-Stake in itself is very smart, it creates a dilemma: Should users stake native tokens to secure the network or use them in DeFi to generate yield? Do we decide between security and liquidity? Especially on a DeFi appchain, the goal is to have a market that is as liquid as possible. To solve this dilemma, Proof-of-Liquidity makes it possible to stake liquidity to secure the network:
  1. 1.
    In addition to staking just the native token, users also can stake LP tokens
  2. 2.
    All staking assets are paired against the native token
  3. 3.
    Staked LP tokens keep the corresponding pools liquid
This way, LP tokens are staked with nodes and will automatically be used in the corresponding liquidity pool. Instead of being locked capital, the stake will keep working as unlocked liquidity.
Do you want to become a collator? Find more information here: Collator Guide
Watch an introduction here:

Capital Efficiency

Capital Efficiency is the relationship between how much someone is spending to grow revenue and how much they are getting in return.
  • Fewer gas fees to perform a transaction → More capital efficiency.
  • Less slippage when swapping tokens → More capital efficiency.
  • Fewer transactions to achieve what you want → More capital efficiency.
A protocol is said to be capital efficient if it has little friction, little overhead costs, and provides the most value for the capital invested.

Maximizing capital efficiency

In our thinking process, there was an obvious elephant in the room: If we’re making a DEX-chain, liquidity, and security both need to be ensured without cannibalizing each other. A DEX without liquidity can not work. Liquidity providers are to an extent similar to validators as they give the platform legitimacy and provide security by ensuring deep liquidity, thus allowing the DEX to function. That’s why we decided to merge staking and the provision of liquidity.

Implications & Considerations

Because the concept is so new, it will have a lot of implications that we will need to consider. To name a few:
  • Liquidity Base Layer: As the staked LP tokens are incentivized by staking block rewards and these LP tokens are paired to MGA, we expect them to create a base layer of liquidity on which other trading pairs can rely on.
  • Security: To make sure the system is not gamed by staking bogus tokens, only assets whitelisted by governance will be allowed as Proof-of-Liquidity base assets. Stake once, earn twice: Rewards are much more attractive. As users can be stakers and liquidity providers at the same time, they will profit from both block rewards and trading fees.
  • Risks: Proof-of-Liquidity combines the reward and risk potential of Staking and liquidity provision. Risks are slashing risk if staking with a misbehaving node and impermanent loss risk. These risks are in general well understood by now and steps can be taken to mitigate them.

Conclusion

Proof-of-Liquidity is an evolution of Proof-of-Stake targeted at DEX-specific chains that unlocks liquidity, increases capital efficiency, and adds additional revenue streams to stakers and liquidity providers.
In the end, we think the DEXes that are the most capital efficient will be the most successful. They will attract investors seeking to optimize their trades and income. We invite you to become part of the journey!

Further Reading