⚡️A Beginner Introduction to THORchain ⚡️

By AsianOxV — January 29, 2022

⚡️Welcome Thorchads! ⚡️

This article is a beginner high level introduction to the THORchain protocol. If you are new to the THORchain ecosystem, this is the article for you! I will be exploring topics such as liquidity, THORchain’s solution, and how the protocol works.

Disclaimer: None of this content is financial advice. I am simply helping educate others on how the THORchain protocol works and how cross-chain swaps will occur. I encourage you to do more of your own research with the resources I provide at the end of the article to further understand the project.

Before I get to what THORchain aims to solve, you must understand liquidity and how it is one of the largest issues in the blockchain industry.

What is liquidity?

Liquidity is the ability of a crypto to be easily converted into cash or other crypto.

Why is liquidity an issue?

If the coins you have are not liquid you will have a hard time converting/selling these coins at a favorable rate resulting in a potentially large loss due to illiquidity. Also known as slippage.

All of the liquidity is currently scattered across all the different blockchains like Ethereum, Solana, Terra, Polygon, and more. These blockchains are unable to easily interact with each other natively without bridging your assets that are expensive and at times not secure.

Think of each island as a separate blockchain. The liquidity on each of the island can’t be used easily with other blockchains natively without using a cross-chain bridge to “connect” the assets for liquidity and trading.

THORchain aims to solve this issue of fragmented liquidity once and for all.

So what is Thorchain? 🤔

THORchain aims to provide decentralized & native cross-chain liquidity open to any person, centralized exchange, decentralized exchange, crypto project. Anyone would have the ability to tap into the deep, permissionless (anyone can trade), cross-chain, native decentralized liquidity. In addition to accessing the liquidity, you would also be able to access and utilize cross-chain swaps and generating yield on your native assets. There are no wrapped assets and there are no custodians for this protocol.

Thorchain currently supports 6 chains: Bitcoin, Bitcoin Cash, Binance, Ethereum, Doge, and Litecoin

The next integration that is already in the stagenet testing phase is the Terra integration. LUNA and UST (stablecoin) will be availble for trading and swapping once the integration is finished. According to the last weekly Thorchain call, the Terra integration is estimated to finished by end of February.

Possible future chain integrations include: Solana, Fantom, Polygon, Avalanche, and more

Thorchain is aiming to add a new chain every 2 weeks to support swapping and earning yield on your native coins. As a lot of these chains are very similar onboarding more chains will become easier and easier.

Now that you know what THORchain is aiming to solve lets jump into how it works. Lets bring the thunder. ⚡️⚡

How does a Cross-chain swap work at a high level?

• Lets say I want to trade native Ethereum to native Bitcoin.

When a user trades Ethereum to Bitcoin, the validating nodes will first detect and agree that Ethereum has been received in the Ethereum vault. The nodes then collectively sign the outbound Bitcoin transaction to the user from their Bitcoin nodes. 2/3 of the nodes have to approve any outbound transaction in the network.

What are Thornodes aka Node Operators?

• All THORNodes communicate and operate in cooperation to create a cross-chain swapping network. Users will run a anonymous THORChain Node and a node for each supported chain. These nodes operators are responsible for running the network software and signing transactions
• Thornodes uses a security arrangement called threshold signature protocol (TSS) in order to further enhance the security of the protocol. This means that to sign a outbound transaction, 2/3 nodes must validate and sign this for the transaction to go through. In addition, these transactions are signed by random validators so even the nodes themselves don’t know which transactions they are signing
• There are 67 active nodes and 27 standby nodes currently. The more nodes there are the more decentralized the network becomes
• Currently it requires 300k Rune currently to run a node and node operators are rewarded by earning Rune for helping secure the network and sign transactions

Why do THORnodes post Rune bond?

• THORChain’s security model relies on proof-of-bond model and by posting bond, it keeps validating THORChain nodes honest. If any nodes misbehave, their rewards will be harshly slashed as a result. Note there is also what we call nodes that churn in and out every couple of days in order to ensure nodes are behaving honestly.
• THORnodes are strongly incentivized in fees to post an amount of RUNE as bond that approaches 2x the value of all native assets in the liquidity pools.
• If the liquidity pools have $25m of combined Bitcoin, Litecoin, and Doge, for example, the THORnodes are incentivized to collectively post at least $50m of RUNE in their bond.

In order to keep the system in a optimal state, we have what is called a incentive pendulum that will reward node operators with more fees if the system doesn’t have enough Rune bonded.

The opposite of the previous scenario is to provide liquidity providers with more fees if the system has too much Rune bonded but not enough liquidity pooled.

• The reason that Thornodes need to maintain a RUNE bond of 2x the value of all deposited assets in the liquidity pools is to avoid a attack on the network where assets are lost. If nodes collude to steal funds, they will lose $2 for every $1 they could steal resulting in a net loss due to Rune being hacked.

Cross Chain is Hard:

Building cross-chain swaps and liquidity is not easy. Several protocols have tried to build cross chain swaps or even tried to use atomic swaps but haven’t done so successfully and at scale. The reason that cross-chain is hard to build is because by increasing the number of chains that are available to swap between, you inherently take on the risk from each chain increasing the attack vectors of the protocol.

• Do note that there several hacks over the summer of 2020 that have now been resolved. Any lost funds were covered by the huge warchest of Thorchain. On every swap, a certain % of the fees go to the treasury in order to cover these sorts of events. No one lost any money in the end.
• As a result of these hacks, there is now a full time 24/7 team, 9Realms and Thorsec that is constantly monitoring the network in order to ensure there is no malicious attacks occurring.

RUNE Token:

• The RUNE token is at the center of the THORchain ecosystem. It secures the network through bonding of node operators, users can provide liquidity with the token and earn more Rune tokens/other assets, and helps with on-chain governance for voting.
• Total Rune Tokens available: 500,000,000

Note there are 3 different types of RUNE:

• There is Ethereum based Rune, ETH.RUNE
• Binance based Rune, BNB.RUNE
• Native RUNE, THOR.RUNE
• Only Native RUNE can be used to provide liquidity and post bond for nodes. You must upgrade your ETH.Rune/BNB.Rune in order to use the native THOR.rune token productively.

Why must Rune be bonded with each pool?

• By pairing each deposited asset against RUNE (i.e., ETH+RUNE or DOGE+RUNE), THORChain aggregates liquidity into X number of pools. The number of pools is equal to the amount of currently supported chains. This will increase as the chain integrations are finished.
• This is important because this means that the number of pools is limited to the chains that are supported. Uniswap, the largest DEX (decentralized exchange) for example has many pools with varying token pairs.
• This result in pools that have high slippage on Uniswap. If you try to trade this pair, you will lose a lot of tokens simply because there isn’t that much liquidity available for swapping in that pool resulting in unfavorable rates(high slippage).

Thorchain solves this by creating continuous, deeper liquidity pools with less slippage which further incentivizes more trading, fees, better rates, and less fragmented liquidity. Liquidity begets liquidity. This is what Thorchads call the blackhole of liquidity.⚡️

What is a liquidity pool?

A liquidity pool is a crowdsourced pool of cryptocurrencies or tokens locked in a smart contract that is used to facilitate trades between the assets on a decentralized exchange (DEX).

A good guide on how liquidity pools work from Finematics: https://www.youtube.com/watch?v=cizLhxSKrAc

How does pooling work in THORchain?

The difference between symmetrical and asymmetrical is often misunderstood in the Thorchain ecosystem. Essentially, you can pool your native assets asymmetrically or symmetrically into a liquidity pool.

This is a diagram from LPU University showing both scenarios. Note that LPU is not a DEX but just a community of Thorchads helping each other out with questions. Join it and ask some questions!

Add in 50% BTC and 50% Rune Asset

In this above example you provide 50% BTC and 50% rune assets. Now anytime a swap occurs including BTC, 50% of the fees related to the swap will be allocated to the liquidity providers in the BTC pool proportional to their pool size.

Add in 100% BTC and the pool automatically sells half your BTC to Rune

• Something to be aware of when providing liquidity is what we call “impermanent loss”.

Impermanent loss (IL) is the risk that liquidity providers take in exchange for fees they earn in liquidity pools. If IL exceeds fees earned by a user when they withdraw, it means the user has suffered negative returns compared with simply holding their tokens outside the pool. Essentially this occurs because the prices of the 2 assets you provide are always changing in price relative to one another. The pools will automatically rebalance to ensure the $ amounts are the same at all times.

• Great Resource to Understand Impermanent Loss: https://www.youtube.com/watch?v=8XJ1MSTEuU0
• Do note that you receive impermeant loss protection for any pools you provide liquidity to. You receive 1% protection for every day you are in a pool. In the pools, you are always 1:1 in terms of assets no matter if you deposit asymmetrically/symmetrically your impermanent loss will always be calculated as if you entered the liquidity pool symmetrically.
• Essentially, you will be ensured that you will be protected/compensated 100% as if you simply just held your Rune/other Non-rune assest as the worst case scenario.

RUNE’s 3:1 Ratio and Marketcap Valuation: VALUE ACCRUAL⚡️

Liquidity Providers provide the following in a pool:

● $1 of ETH in the pool
● $1 of RUNE in the pool

This in kept in check by arbitrage between traders.

THORChain Nodes provide

● $2 of RUNE in the bond from validators
● This is kept in check by the incentive pendulum between LP’s and Nodes

RUNE can thus arguably be valued at 3x the total value (TVL) of non-RUNE assets in THORChain’s liquidity pools. This would be the base fundamental value without considering any sort of speculative premium in price.

● $5 billion of non-RUNE assets in the pools = $15 billion baseline (marketcap) value of RUNE.

• This formula assumes every RUNE is productively deployed in THORChain’s system; in reality, a significant portion of RUNE will always be on other exchanges, wallets, etc., meaning an even higher market cap would appear plus the speculative premium.

Conclusion:

• The end product would be for a end user to be able to connect to any exchange such as Uniswap/Sushiswap that has integrated Thorchain as its backend liquidity. Lets say they want to swap from native ETH to native BTC. to the user, they can make this swap IN 1 TRANSACTION without bridging assets.
• It should be noted that currently THORchain is in MCCN (Multichain Chaos Net). MCCN is essentially a slower yet more methodical approach to ensure that the functionality is working before we fully release the caps into Mainnet. There are still artificial soft/hard caps in place in order to prevent huge losses and the mainnet launch with no caps and full control over to the community is almost here. We have checked off more requirements in order to transition into mainnet. Mainnet is expected to finish up with a month or two, then we will see the true potential of THORchain rise!

TLDR: THORchain is the solution for fragmented liquidity across blockchains. It aims to provide decentralized, native, permissionless, continuous and deep cross-chain liquidity. Unifying liquidity to be available across many chains has MASSIVE 3:1 value accrual through THORchain’s design of the RUNE token. Betting on THORchain is essentially betting on multiple chains yet also at the same time the RUNE token. Multichain is the not future, multichain is already here.

Thanks for reading! Please don’t feel disheartened if you didn’t understand everything. It took me months to get to understand even the high level. I did not cover everything as there is simply too much information to cover in 1 article. Cross-chain is more complex than most other protocols. I encourage you to read all the whitepapers and ask questions. I wanted to also credit a lot of the information I found from Erik Vorhee’s article as well as the Thorchain website.

Congrats you are now a Thorchad! 🤝

Resources:

Thorchain Website: https://click.thorchain.link/3eu

AltcoinAsian Twitter: https://twitter.com/altcoinasian

Thorchain Twitter: https://twitter.com/THORChain

9 Realms Twitter: https://twitter.com/ninerealms_cap

Erik Vorhees Introduction to Thorchain Article: https://erikvoorhees.medium.com/an-introduction-to-thorchain-for-bitcoiners-3f621bf0028e

Want to ask questions about Thorchain? Join the LPU discord where many will help you answer any questions you may have! https://discord.gg/deEWQTRE3F