I’ve been getting into different crypto projects and I’m excited to talk about THORChain, one of the most interesting in the space. Here’s a brief overview.
What is THORChain?
If you go to the official community website, THORChain describes itself as a decentralized cross-chain liquidity protocol, but what does that mean? It’s a cross-chain liquidity protocol in that it captures the liquidity of cryptocurrencies on different chains (Bitcoin, Ether + ERC-20 tokens, Litecoin, etc), and provides a suite of financial services such as exchanging, lending/borrowing, derivatives trading on top of that liquidity. It’s decentralized in that the protocol is run by a distributed set of anonymous actors. In addition, anyone can use the protocol in a permissionless manner regardless of where they live, and no KYC/AML is conducted on users.
Currently, the most popular decentralized exchanges are Uniswap, Sushiswap, PancakeSwap, etc. These decentralized exchanges facilitate trades with boundaries firmly set by the native layer-1 they are built upon. Users of Uniswap can only exchange between ETH and ERC-20 tokens and not between coins/tokens existing on other blockchains. THORChain is a superset of these walled garden decentralized exchanges, as it allows for true cross-chain trading.
To put it in simple terms, if you have centralized exchanges like Binance, FTX, Coinbase, then THORChain seeks to be the decentralized equivalent.
Why THORChain?
THORChain exists to solve mainly one problem. That problem is that with centralized exchanges, individuals lose custody and transparency of their assets/private keys and turn over that control to a centralized actor or small set of actors. In the short-lived history of cryptocurrency, centralized parties have proven to be untrustworthy whether it because of lack of regulation or human incompetence. Examples include most infamously Mt.Gox (centralized exchange) which at one point handled 70% of all trading volume and was subsequently hacked and user’s funds were lost, BlockFi (centralized crypto interest provider) which lost hundreds/thousands of bitcoin from running erroneous promotion campaigns, and numerous centralized exchanges that have run off with user funds.
- https://www.cnbc.com/2021/04/23/bitcoin-btc-ceo-of-turkish-cryptocurrency-exchange-thodex-missing.html
- https://www.cbc.ca/news/business/osc-quadriga-gerald-cotten-1.5607990
- https://www.coindesk.com/blockfi-botched-promo-payments-april-confusion
In addition to individuals being able to maintain sovereignty over their own, another principle of cryptocurrency is to separate money from the state. Regulatory scrutiny can cause centralized entities to bend to the will of the state. Some examples include stopping capital flows, impeding on user’s privacy, and confiscating an individual’s assets. Centralized exchanges serve as an avenue of attack for nation-states and have low cost of corruption. Decentralized exchanges such as THORChain attempt to solve these problems.
How does THORChain work?
First, it’s important we know the various agents of the THORChain ecosystem.
Liquidity Providers — Deposit assets into liquidity pools. Earn percentage of swap fees and some additional block rewards given by the system for providing liquidity.
Swappers — Trade from native asset to native asset in a decentralized non- custodial manner.
Node Operators — Secure the network and run validators that process transactions (swaps, liquidity deposit/withdrawal, etc) .
Arbitrageurs — Traders recognize price discrepancies that might exist between prices on THORChain and external markets and perform swaps to bring to true equilibrium.
In order to create liquidity in the markets, centralized exchanges use an order book to match buyers and sellers. In order to solve the liquidity availability issue that many decentralized exchanges face, THORChain utilizes an automated market maker model where the native token RUNE serves as the base pair for each native asset in a liquidity pool. A liquidity pool is comprised of in value 50% RUNE and 50% native assets. For example, if 1 RUNE were to equal $10 dollars then, in a RUNE:USDC liquidity pool you might see 100 RUNE and 1000 USDC. The exchange ratio is set by a constant product formula x * y = k (x is the quantity of asset X and y is the quantity of asset Y, and k is a fixed constant).
If a user wants to swap Bitcoin to Ether, a simplified explanation of process would look like this.
- User sends bitcoin from his bitcoin wallet to a THORChain controlled bitcoin wallet.
- THORChain implements swap logic where Bitcoin is exchanged for RUNE in the RUNE:Bitcoin liquidity pool
- THORChain implements swap logic where RUNE is exchanged for Ether in the RUNE:ETH liquidity pool
- Ether is sent out from THORChain controlled ethereum wallet to designated user ethereum wallet
- Technical implementation can be found at https://docs.thorchain.org/technology
The THORChain protocol runs a proof-of-stake consensus mechanism which means the network is operated by validators who have staked capital in the form of RUNE and are able to run nodes to process transactions. Node operators are rewarded block fees in RUNE for processing transactions, and transfers of assets to and from THORChain vaults must be approved by at least 2/3 of all nodes to produce a signature to approve of the transaction (aka threshold signature scheme).
The security of THORChain is built into it’s protocol. Say for example, a shady group of node operatiors mine a transaction that would steal funds from THORChain controlled wallets. Well, node operators must put up 2x the amount of RUNE that exists in the system, which is equivalent to the total value of all native assets as bond/collateral. If node operators conspire to steal funds from THORChain, the system would be proven to be insecure and naturally users would withdraw funds. The value of RUNE would subsequently to 0, since within the constant product formula the amount in the native asset would reach near 0 and the amount in RUNE would reach near infinity. The node operators would have effectively lost twice the value of what they were trying to steal.
To ensure that the network is in a secure state, THORChain uses a mechanism called the incentive pendulum to ensure that the amount of rune bonded is twice that of the the rune in liquidity pools. This pendulum effect ensures economic incentives are in place to keep the network secure and growing. If there is too much RUNE bonded, then the network is inefficient and block rewards in RUNE are allocated to liquidity providers. If there is too much rune that is in the liquidity pools, then more block rewards in RUNE are allocated to node operators.
Tokenomics of THORChain
The tokenomics of THORChain are truly fascinating and not found in any other token in the crypto space. Remember that THORChain liquidity pools contain 50% RUNE and 50% native asset in value, and that node operators must put up 2x the amount of RUNE that is contained within all the liquidity pools. This gives RUNE a base deterministic price that is set at 3x the total value of native assets. The free market assigns a speculative premium on top of that usually to accommodate for the expected increase in total value locked up.
THORChain has the potential to continuously suck in the liquidity of the entire crypto ecosystem and exponentially increase its total value locked up. Liquidity providers are incentivized to deposit assets, as they have the potential to earn 10%+ yields on their native assets (significantly higher yields than any centralized counterpart). If pools get deep enough, slippage is reduced, and traders get better prices. The better prices, the more trades that occur. The more trades that occur, the more fees incurred for liquidity providers, who are enticed by high yields. And the cycle continues..
Currently, liquidity caps are put into place to ensure that liquidity is kept low while the system is tested and and while the development team fixes production bugs that are not able to be produced in a test environment. Liquidity caps will be removed once the system is stable. Once liquidity caps are removed and additional node operators enter into the system and put up additional bond, THORChain liquidity can grow very quickly.
Potential Risks
Despite all its benefits, THORChain has a number of risks that the reader should be aware of.
- Bugs in code cause vaults to be exploited and funds drained from THORChain or network to be halted. There have been small instances of this.
- Not enough trading volume to incentivize liquidity providers. Liquidity providers withdraw, seeking higher yields elsewhere.
- Non profit seeking, irrational actor go against the game theory of the system.
- Not enough node operators to allow for increase in total value locked up.
- Goldfinger attack
Ecosystem + Community
The THORChain community is one of the strongest in the crypto ecosystem. This has proven to be a beneficial moat in the space as people vastly underrate the network effects of community. In addition, the ecosystem of THORChain continues to grow everyday as members of the community contribute with front-end interfaces, dashboards, guides, technical supports, etc.
- Treasury worth $200 million to fund projects.
- Xdefi wallet, which is the first multichain browser wallet
- More found here https://thorchain.org/
Roadmap
THORFi
- Lending/borrowing on native assets
- Given lending/borrowing is the biggest ecosystem in Ethereum DeFi, this has the potential to be the biggest source of total value locked up + fee accrual for liquidity providers
Synths
- Derivatives trading. Solves problem of long settlement times to transfer between different chains. Now THORChain handles natively. Expected volume increase of 5–10x
THORStarter
- Project started by the community, to capture long tail asset liquidity.
Additional Chains
- BSC, Dogecoin, Solana, Dash, Decred, Cardano, etc
Wallet integrations
- Trust wallet/Ledger will implement THORChain swaps
Future Predictions
- Exchange integration. Larger players that need liquidity will use THORChain’s permissionless and eventually deep liquidity pools
- Price prediction — I’ll be setting a reasonable TVL target of $1 billion for now which at current circulating rune supply would set the price of rune at a base deterministic price of $15. If THORChain hits 1 billion safely and the protocol is able to sustain itself in terms of fee generation and trade volume, a TVL target of $5 billion can be set and a price target for rune could be set at $100.
Disclaimer
Not financial advice. Just sharing thoughts! I own a position in RUNE and am a liquidity provider.
