Author: Florian Strauf

Original Title: 《Tokenomics 101: THORChain》

Compiled by: Hu Tao, Chain Catcher

The Importance of THORChain

THORChain fills the gap in today's exchanges by allowing users to trade assets without intermediaries (in other words, in a decentralized manner). The automated market maker Uniswap on Ethereum does this as well, but Uniswap only provides such trading for ERC20 tokens. THORChain enables users to trade native, non-wrapped assets across chains.

You can swap BTC on the Bitcoin network for ETH on the Ethereum network directly from your BTC wallet. You can also receive ETH back into your ETH wallet without having to move your tokens anywhere else. On the other hand, centralized exchanges typically require you to send tokens to them, meaning they will hold your tokens for trading.

If you want to swap one crypto token for another, why hand over custody to a centralized exchange? If you have already used a DEX, why hold onto a wrapped asset that you are unsure what it is backed by? For example, according to their website, WBTC involves custodians.

THORChain has had some ups and downs recently, with a hype phase in May followed shortly by a hack (read more about the hack here and here). The project is still recovering, but as of this writing, all supported chains (BTC, ETH, BNB, LTC, BCH, and many ERC20 tokens) have resumed trading. Users need time to rebuild trust, increase liquidity, and participate in trading again.

The trading volumes of major centralized exchanges (CEX) and decentralized exchanges (DEX) demonstrate their importance. Exchanges are where users buy tokens and swap tokens for other tokens. Binance is the largest CEX, with a daily trading volume of about $26 billion. Uniswap is the largest DEX (but only for ERC20), with a daily trading volume of $1.7 billion.

THORChain's current trading volume is far below that of such popular exchanges, with a daily trading volume of about $30 million. THORChain has just recently relaunched their beta network "Chaosnet," and I wouldn't be surprised to see its trading volume approach that of other large exchanges once the mainnet launches in Q1 2022.
THORChain is virtually invisible compared to other large exchanges
Looking at Uniswap, I can't imagine there wouldn't be a demand for trading to other chains, such as ETH to BTC or ETH to BNB. Centralized exchanges will continue to play an important role, but DEXs bring a significant amount of trading volume due to benefits like no KYC and allowing users to retain custody and control of their tokens.

Let's take a look at how THORChain and its native token (RUNE) power decentralized cross-chain liquidity pool trading. Tokenomics of Thorchain

For the end user, THORChain doesn't seem much different from any other decentralized exchange. However, if you dig deeper, some novel things happen to enable cross-chain asset trading, namely that THORChain is a proof of bond blockchain.

Thorchain Protocol

• The total supply of RUNE is 500 million. The initial distribution mechanism was approximately: just under 220.5 million allocated to protocol reserves for node operators and liquidity providers; 52.5 million for employee incentives, sales, and other business reserves; 52 million allocated to the community; 50 million allocated to the team and advisors; 26 million allocated to seed investors; with over 99 million in circulation.

• RUNE can be used as a priority signal for listing assets on THORChain. This means that if enough RUNE holders vote in favor of a new chain to be added, it will be prioritized over other chains in the queue.
• The protocol also enables a pendulum function to balance the capital in liquidity pools with the capital bonded by THORNodes. This relates to the control THORNodes have over liquidity pools. A sufficiently large deposit from node operators will ensure the security of the network (for more information, see the "THOR Nodes" section below).

Trading

• Users connect to THORChain through exchanges. THORChain is an L1 solution that provides all the infrastructure needed for the decentralized trading process to function properly. Exchanges can use this infrastructure via API (Midgard) and implement their own solutions (see THORSwap and Shapeshift).
• Trading fees are paid by users in RUNE, and these fees are then distributed to liquidity providers and THORNode operators. Users need to use RUNE to pay for trading fees on THORChain.

Liquidity

• Liquidity pools are a common concept among other automated market makers (AMM) like Uniswap and Sushiswap. The main difference with these AMMs is that THORChain matches each pool with RUNE. Therefore, the ETH pool on THORChain will have an equivalent amount of RUNE, rather than being matched with whatever currency it might be traded against. In contrast, Uniswap has pools for every possible trading pair (e.g., USDT:ETH, USDT:SUSHI, USDT:UNI, etc.).
• Fewer pools mean that the pools will be deeper. All ETH can be in one pool, regardless of what currency it is trading against. It only needs to be matched with RUNE.
• Liquidity providers (LP) can deposit an equivalent amount of RUNE or automatically convert their deposit tokens to RUNE. The protocol will sell half of the LP's deposit (e.g., ETH) for RUNE to ensure a proper balance is maintained.
• Technically, liquidity pools are just wallets of different chains controlled by THORNodes.

THOR Nodes

• To control the wallets of liquidity pools, THORNodes must run a node for each blockchain they support, as well as an additional THORChain node.
• To execute trades between ETH and BTC, a THORNode will observe the Ethereum network to lock funds, and then release the funds to the Bitcoin wallet once the Ethereum lock is complete.
• Once completed, THORNodes use a threshold signature scheme (TSS) to sign outgoing transactions, which is used alongside cryptography rather than smart contract logic. This allows THORNode to interact with chains like Bitcoin (which does not support smart contracts). In principle, TSS acts like a multi-signature wallet, requiring a majority of THORNodes to sign a transaction.
• Similar to staking, THORNodes must deposit RUNE bonds to become active validators. The amount of bonds required depends on the total amount of RUNE in the liquidity pool. The total amount of RUNE bonds across all THORNodes needs to be twice the amount of RUNE held in the liquidity pool. Keep in mind that the amount in the pool is matched with RUNE at a 1:1 ratio.
• In summary, for every $1 of assets, there are $3 of RUNE backing it.
• This feature creates protection against witch attacks, where attackers attempt to take over a large portion of the network to gain access to pool assets. The RUNE bonds and the amount in the pool help prevent such attacks, as RUNE would depreciate accordingly during such an attack, making it unprofitable.
• Pendulumincentives encourage liquidity providers to pool more assets when bonds are over-supplied and incentivize node operators to bond more assets when bonds are under-supplied to maintain the balance of bonds and liquidity pools. As of this writing, the yield on bonding is about 15%, while the yield on liquidity pools is about 20%.

The pendulum incentives have three different states as described below (optimal, unsafe, and inefficient):

• This is what the protocol considers a safe distribution:

• When more assets are added to the pool, the protocol attempts to intervene by increasing rewards for node operators:

• The opposite is over-supplied bonds (as shown below), which is considered inefficient because a large amount of capital is bonded to ensure a small amount of capital provides liquidity. Therefore, to offset this, rewards for liquidity providers (referred to as "stakers" by THORChain) will be increased.

• These three states are an interesting way to achieve the desired behavior using tokenomics.
• These fees are currently supported by protocol inflation (issuance), but plans are in place to be fully covered by transaction-related fees.

Final Thoughts

As an alternative to Binance or Coinbase, decentralized exchanges are what crypto users truly need. Decentralized exchanges provide custody for your tokens throughout the process and reduce the risk of having to trust centralized entities to manage your funds. THORChain may not offer all the tokens people might want to trade, but it is a significant step in the right direction. As demand grows, more people will follow suit, potentially turning THORChain into a place for trading tokens.

With the audit and subsequent relaunch of its beta Chaosnet, THORChain is refocusing on delivering new features and developing its ecosystem. Adding new and upcoming tokens, as well as THORChain exchanges to support a wider range of wallets, is crucial in competing with Binance and Coinbase. The easier it is to swap one token for another, the more users will want to use the protocol, which will also help attract more liquidity.

Honestly, THORChain has a series of obstacles to overcome, and controlling security, increasing user adoption, and increasing the number of supported tokens will be a challenge.

However, with cross-chain communication (IBC) and Wormhole, cross-chain collaboration is increasing, and transferring tokens between chains is becoming easier. Let's see what the future holds. Perhaps it will involve token availability similar to Binance, but with the characteristics of decentralization, no KYC, and self-custody.