Why is the liquidity protocol THORChain worth paying attention to? Understanding the investment logic of the cross-chain version of Uniswap

This article was published on Mars Finance, author: Andrew Kang, a venture capitalist and market analyst in crypto assets.

Last year, I made several large concentrated investments in projects like SNX, FTT, and KNC, achieving success. Now, I firmly believe that RUNE has the potential to deliver similar, if not better, results. This article will explain this investment theme from the perspectives of market opportunities, fundamentals, and a long-term asset structure.

Why is THORChain Worth Paying Attention To?

In simple terms, I refer to this project as "the rising star of cross-chain Uniswap."

THORChain is a cross-chain liquidity protocol designed to connect all blockchain assets into a liquidity market, secured by numerous incentivized nodes. By utilizing Tendermint, Cosmos-SDK, and Threshold signature schemes, THORChain can maintain applicability not just for a single blockchain network, nor favor any specific asset or blockchain, and achieve large-scale scalability without sacrificing security.

THORChain allows users to swap digital assets across almost any blockchain in a trustless and permissionless configuration, with low fees and market price asset swaps. Liquidity is provided by stakers, who earn fees from asset swaps, converting their non-appreciating assets into appreciating ones in a non-custodial manner. Market prices are maintained through the ratio of assets in the pool, and traders engaging in arbitrage can help bring assets back to their correct market prices.

While the first product implementation of Thorchain will be a cross-chain automated market maker (AMM) exchange, Thorchain has the potential to integrate numerous decentralized finance (DeFi) applications, including margin trading, lending/borrowing, and derivatives trading. This is made possible by its scalable cross-chain communication protocol.

The native asset of THORChain is RUNE, which serves as both the base asset in liquidity pools (similar to ETH in Uniswap) and the bonded asset used by validators to ensure network security.

Where is the Opportunity?

At the current level of technology, DeFi has only penetrated the Ethereum and Ethereum token markets. However, the majority of financial activities in the crypto space revolve around Bitcoin trading and Bitcoin lending. The potential for DeFi applications based on BTC is quite astonishing, and the broader crypto community has expressed strong demand for this.

In 2020, the average trading volume of decentralized exchanges saw significant growth, yet it remained below $20 million per day. The trading volume of decentralized exchanges includes trading pairs between ETH and all ERC20 tokens. In contrast, the spot trading volume of the Bitcoin/USD trading pair (excluding other BTC trading pairs) was 100 times that amount in 2020, averaging between $1 billion to $3 billion per day.

From the perspective of lending services, the active non-public debt collateralized by BTC exceeds $1 billion. In comparison, the active debt based on DeFi is only about 10% of that figure.

Fundamental Analysis

Pool Model

1) The Thorchain trading system utilizes a pool model, which is a key concept emerging from the DeFi space.

• In order book-based exchanges, complex orders need to be executed; in contrast, traders prefer the convenience of executing a financial transaction (like a swap) at a known reasonable price immediately.
• Most traders do not optimize for every basis point; they can tolerate a reasonable amount of slippage/spread/fees that occur in pool exchanges.
• Low trading volumes and integration frictions can lead to significant spreads and a lack of depth, preventing market makers from providing strong liquidity on order book-based decentralized exchanges.

2) There is a model that spans multiple DeFi applications for order matching, whereas the pool model has seen considerable adoption in the market.

• Decentralized exchange trading: Kyber/Uniswap vs. DDEX/IDEX
• Trading volume: Pool exchanges (80%) vs. Order book exchanges (20%) [Source: Dex.watch]
• Lending platforms: Compound vs. Dharma
• Dharma had to pivot from a p2p model to one built on Compound
• Currency markets like Aave and LendF.me, which emulate Compound, have attracted over $60 million in liquidity
• Synthetic asset trading: Synthetix vs. UMA
• Synth supply: Synthetix (over $20 million) vs. UMA (less than $100,000)
• Derivatives trading: Futureswap vs. dYdX
• Futureswap achieved a daily trading volume of $7 million within 3 days of launch
• dYdX took over a year to reach the same milestone, currently averaging daily trading volumes of $2 million to $6 million

Liquidity Incentives

1) Thorchain plans to incentivize liquidity absorption through network releases—specifically, paying liquidity providers with newly issued RUNE;

2) Synthetix also employs a release-based mechanism to incentivize the liquidity of its assets.

• The Synthetix sETH pool became the largest Uniswap pool within months, reaching $24 million, accounting for 25% of Uniswap's total liquidity.
• The Synthetix sUSD pool grew to over $10 million within weeks, becoming the largest pool on Curve.fi.

3) RUNE's price has a positive feedback loop based on liquidity.

• Network effects are closely related to exchanges, especially pool-based exchanges.
• Since RUNE is the core base trading pair in liquidity pools (a RUNE:BTC pool must contain $100 of RUNE and $100 of BTC, and so on), the higher the price of RUNE, the greater the value of the assets that can be staked, thus increasing the "value locked in DeFi"—a crucial metric that everyone pays attention to.
• From the perspective of network utility, an increase in RUNE's price can incentivize the team and investors.
• Thorchain introduces DeFi to various tokens on the Binance Chain, which currently do not provide yield. RUNE has already established dominance on BinanceDex and has received commitments from various token foundations on the Binance Chain.
• The Thorchain team is also collaborating with the Binance Chain team, which is working to bring DeFi to the Binance Chain.
• The current price of RUNE and the supply on the mainnet suggest that liquidity exceeding $10 million will be achieved shortly after launch.
• Assuming RUNE's price reaches $0.65, the corresponding market cap would be about $120 million, with locked assets around $40 million—this is on par with Uniswap.

Continuous Liquidity Pool (CLP) Trading Model

1) For information on the Continuous Liquidity Pool (CLP), refer to my previous tweet interpretation.

2) CLP can be viewed as "an automated market maker model that charges fees based on slippage," similar to Uniswap—Uniswap uses an AMM with a 0.3% fee based on the XYK constant product.

3) This model gives Thorchain a price feedback mechanism resistant to internal manipulation, as slippage-based fees protect it from "sandwich attacks" that other AMM systems are prone to.

4) Most DeFi protocols rely on external price feeds, which are either centralized or still prone to errors.

5) Compared to other AMM models, the CLP model allows liquidity providers to capture more fees, further promoting a positive feedback loop. In contrast, Uniswap XYK leaks value to arbitrageurs.

"If the profit from every arbitrage opportunity is x, Uniswap takes 30 basis points and pays liquidity providers, whereas THORChain does not. It charges a tiered fee from 0 to 10,000 basis points based on the trader's impatience. Even if the fee is 9,999 basis points, the trader still has 1 basis point of profit to earn—there will always be someone to take it.

Now, let's consider why traders become impatient:

There is a significant and rich price difference between two major markets. It is limited, so the first person to get it will take it. In Uniswap, the trader paying the highest gas will complete the transaction and take it. This has already happened!!! However, the beneficiaries are ETH miners, not liquidity providers—their profits are capped at 30 basis points.

In THORChain, traders will compete—whoever is willing to pay the highest liquidity fee will win. How high they can pay is their choice. Secondly, this is not a race to the bottom on rates, but a race to the top in incentives!

The pool serves as a lasting economic reward for restoring the correct market price; any price difference is a profit opportunity. Therefore, the higher the fees, the more returns liquidity providers receive. Thus, it is not about reducing fees, but maximizing incentives as much as possible! The more liquidity providers earn, the deeper the pool becomes, requiring more arbitrage.

CLP becomes a black hole—it starts to吸入流动性，直到拥有 51% 的市场份额才会停止."

6) Compared to other AMM models, the CLP model leads to liquidity providers capturing more fees and experiencing fewer short-term losses, further promoting a positive feedback loop. In contrast, Uniswap XYK leaks value to arbitrageurs.

Team

1) Given the interdisciplinary nature of cross-chain technology, this project clearly requires expertise across crypto-economics, cryptography, blockchain security models, cross-chain interoperability, AMM systems, and more to deliver a successful product.

• Through over a year of collaboration, publicly published content, and private communications, the Thorchain team has demonstrated very high proficiency in these disciplines.
• 12 engineers, including 1 PhD in cryptography, consensus experts, and former wallet engineers.
• Very familiar with the latest literature on multi-party computation, automated market making, etc.

(a) AMM Examples

• Projects anchored to BTC, such as tBTC and Ren, have shown expertise in the aforementioned areas, but their core architecture hinders scalability due to capital inefficiencies.
• See the article "A Comprehensive Overview of the Decentralization and Scalability Dilemma of Cross-Chain Anchored BTC Projects."

2) Swish Labs completed early development work. Swish Labs is a world-class development team with major enterprise clients and has established strong blockchain interoperability development partnerships with other mainstream blockchains like Cosmos and Nervos.

• Swish engineers have high praise for the system design and code quality of Thorchain.

3) Top security audit partners

• Code audit—CertiK
• Completed, no major issues found
• Economic model audit—Gauntlet
• The Gauntlet team is also the economic model advisor for projects like Compound Finance, Celo, Nucypher, etc.
• This team has publicly published articles supporting the practice of relying on AMM as price oracles.
• Threshold signature scheme (TSS) audit—Kudelski
• This team has audited Binance's tss-lib and is very knowledgeable in this field.
• Thorchain has implemented Binance's tss-lib.

4) Communication and Interaction

• The Thorchain team has the most transparent and thorough communication strategy I have seen in the crypto space.
• Monthly financial reports, weekly development updates;
• Daily easy-to-understand commits/comments on Gitlab;
• On platforms like Telegram, Discord, Twitter, they can comprehensively and satisfactorily answer all questions related to economic models, development progress, financial status, etc.—many projects suffer from the common problem of not getting satisfactory answers from community managers, while project leaders are often absent from communication.

5) Capital Efficiency

• Thorchain raised only $2 million through a small private placement and IDO, yet its development progress has surpassed that of projects that raised more funds.
• Thorchain has a $5 million treasury ($1.5 million in liquid funds; $3.5 million in RUNE), ensuring over 2 years of development progress.

Risks

1) The Thorchain team is very transparent, self-reflective, and has even listed the risks of the project early on;

2) You can refer to this article.

Market Structure

1) Structured Assets

• RUNE's particularly high staking rewards make it a long-term asset.
• Token holders tend to hold to earn rewards.
• There are no channels for shorting. High yields lead to high borrowing rates, making it unattractive for over-the-counter lenders and platforms wishing to launch futures to borrow RUNE tokens, as they need to borrow RUNE to provide liquidity for these products.
• Low circulation leads to rapid appreciation of asset prices without the need for large purchases.
• Market distortions of staking yields
• SNX is a good example: SNX has the same structural asset properties, with high yield staking introduced to its peak, yielding 3500%.

2) From the perspective of network utility, an increase in RUNE's price can incentivize the team and investors.

3) Other Investors

• Over 4 well-known US funds
• Synthetix team
• Engineering director of Swish Labs
• Several funds providing ecosystem development support
• Validator organizations

Expected Project Development Timeline

1) Public Alpha—Completed

2) Closed testnet and audits—Ongoing [Verifying whether Thorchain's key functions meet expectations]

3) Open testnet—Early to mid-May [Verifying whether functions can continue to work under user-operated nodes]

4) Chaosnet—Late May to early June [Real-time testing with limited assets]

5) Mainnet—July to early August

Pricing Model

As RUNE's "cash flow" is easily quantifiable, we have developed a pricing model to determine a rough range of RUNE's potential value.

The table below includes some variable assumptions determined in collaboration with the Thorchain team and research institution Delphi Digital.