THORChain (RUNE) Review: Interoperable Liquidity Protocol

There are a growing number of decentralized cryptocurrency exchanges, and one of the better known is THORChain, which is powered by the RUNE token.

If you’re looking into a decentralized solution that allows you to easily swap tokens across chains without wrapped or pegged tokens, then THORChain might be what you’ve been searching for. You can also earn by providing liquidity to the exchange, or run a node to help secure the network.

You’re probably already comparing THORChain to Uniswap in your head, so keep reading on to find out how THORChain is different, what it is, how it works, and many other aspects of this blockchain-based decentralized exchange.

What is THORChain?

THORChain doesn’t have a particularly long history, it wasn’t even conceived of until 2018. It does offer a full range of exchange services however, and its continuous liquidity pools are unique in the industry. Because THORChain is built as a cross-chain solution it’s possible to swap any asset using THORChain, which is superior to other decentralized exchange offerings.

The core concept behind THORChain is clearly explained in their whitepaper

“THORChain is a liquidity protocol designed to connect all blockchain assets in a marketplace of liquidity through cross-chain bridges and continuous liquidity pools secured by economically incentivised validators.”

Built on Tendermint, the Byzantine Fault Tolerant engine that powers Cosmos, THORChain is a Proof-of-Stake blockchain that includes network validators who are required to bond RUNE tokens. Validators can be punished for bad behavior through slashing the bonded tokens, which acts as a disincentive toward misbehavior. Network nodes are also used to create vaults and to validate transactions.

Who uses THORChain?

Essentially there are two groups in the THORChain ecosystem. The first are the users, and the others are the liquidity providers.

Users are the primary participants in the network who use the cross chain services of THORChain to exchange tokens easily. Such exchanges are made between liquidity pools, with the user paying a slip fee to cover gas fees and for the execution of the exchange. The swapping done by users are non-custodial and unrestricted.

The second group using THORChain are the liquidity providers who add liquidity to the various pools to power the exchange. This liquidity is bound using RUNE tokens and is then kept in separate vaults powered by the network nodes. By using a continuous liquidity pool in this way THORChain avoids the need for external price feeds or for oracles. Liquidity providers earn rewards through the slip fees charged to users. As explained on the THORChain website:

“Liquidity is provided by stakers who earn fees on swaps, turning their unproductive assets into productive assets in a non-custodial manner. Market prices are maintained through the ratio of assets in pools which can be arbitraged by traders to restore correct market prices.”

Nodes Explained

Nodes underpin all of THORChain’s services and they have three primary functions for the network:

1. Bonding RUNE
2. Create vaults
3. Produce blocks

Each node is run by a node administrator and they receive bond rewards for helping to maintain the network. The total they earn is two-thirds of all system income. Nodes are created every three days and have to compete with one another using bonded capital. In order to ensure the network remains fresh the older nodes are occasionally churned out of the system and replaced. Nodes benefit from being anonymous with plausible deniability on all transactions.

ThorChain and Asset Liquidity

It’s clear to anyone who is familiar with the cryptocurrency markets that all of the coins and tokens, even Bitcoin and Ethereum, are seriously lacking in liquidity. In an effort to better understand how liquid markets function, economists Tonny Lybek and Abdourahmane Sarr sub-divided liquidity into 5 factors:

As you can see, most of these five factors are hardly present in the cryptocurrency markets today. Prices often have little to do with the actual utility or fundamentals of a project, but instead are driven purely by speculation. And in many cases the low cap altcoins are lacking in both breadth and depth, which not only slows execution speed, but also leads to excessive bid-ask spreads.

Consequences of illiquid markets

The excess volatility often seen in cryptocurrency markets is primarily a function of the illiquidity in the markets. While this volatility is attractive to those retail investors who have a high tolerance for risk, since it can deliver incredible returns in a short period of time, in essence the cryptocurrency markets of today are more like casinos for gambling than markets for investing. This high volatility also shows how immature the crypto markets are and in many cases keeps institutional investors and large funds from entering the cryptocurrency markets.

We can also speculate that the volatility caused by illiquidity in the markets is a major factor in the lack of adoption seen for cryptocurrencies. Because economic stability requires higher levels of liquidity it isn’t likely that any of the illiquid cryptocurrencies, even Bitcoin, will become a global transactional currency at any point in the near future.

This lack has caused many to claim that Bitcoin is not a transactional currency at all, but instead should be considered a store of value, similar to the role played by gold in financial markets. However, with gold we do not see the massive fluctuations in price that are seen in cryptocurrencies and serve to deter established investors from utilizing Bitcoin as a store of value. Experienced investors are more interested in finding a store of value that has price stability and a steady appreciation over time.

Some might argue that you can find a more stable trading environment at the major cryptocurrency exchanges like Binance and Coinbase, but these pose their own problems, chief of which is the centralized nature of these exchanges. Because of their centralization they also come with the typical trust and security issues common with centralized exchanges.

In addition to that it is impossible to say that these exchanges actually have liquidity, or if what looks like liquidity is simply wash trading. A decentralized exchange gets around all the issues presented by centralized exchanges, however the one thing they do lack is liquidity, which makes using a DEX an often tortuous challenge.

Thorchain's Decentralized Liquidity Network

THORChain is a protocol, but it provides far more than just a protocol, it is also a complete ecosystem that’s designed to solve all of the problems we’ve already mentioned regarding cryptocurrency exchanges in their current state.

The creators of THORChain know that by making the entire ecosystem chain-agnostic it will easily support all existing digital assets, even those that haven’t yet been created. That’s important because it means THORChain is not in competition with other exchanges and protocols, but is rather working to create one underlying liquid decentralized network.

Because of its decentralized nature THORChain is capable of solving these issues in a trustless manner. That could eventually do away with third-party involvement in the exchange ecosystem.

The network was created around incentivizing the provision of liquidity and safety through staking and bonding. The notion of liquidity pools is certainly nothing innovative by itself, yet there are currently only a small number of underutilized liquidity pools.

And the current solutions like Uniswap and Bancor support only single chains, which makes them less useful. The chain-agnostic approach being taken by THORChain is something unque and new, and eventually it could lead to the solution of the liquidity problem in cryptocurrency markets by supporting the exchange of any one cryptocurrency with any other cryptocurrency in a trustless manner.

If the THORChain solution can reach mass adoption and become a primary exchange solution it can eventually remove a good portion of the volatility present in the cryptocurrency markets. That would lead to more price stability, which in turn would lead to increased adoption from institutional investors.

Another offshoot of price stability and adequate liquidity would be the increased use of digital currencies as a transactional payment method. With this in mind THORChain also has a long-term goal of deploying a payment network to enable trustless digital payments between any parties.

Incentivized On-Chain Liquidity

The core of the entire ecosystem being created by THORChain is its protocol, and the goal of the project is to solve the liquidity issues currently present in cryptocurrency markets. With that in mind, the protocol is designed to handle three functions:

1. Trustless and secure, bi-directional bridging across all chains;
2. Incentivizing asset holders for staking in order to ensure liquidity;
3. Allowing for instant asset swaps and trans-currency payments, any digital asset with each other.

It’s probably not surprising that the technology and mathematics behind THORChain is extremely complex, but the basic concept for the project is quite simple: incentivize the creation of liquidity and then connect all liquidity and blockchains together for complete interoperability, improved liquidity, and eventually create mass adoption of cryptocurrencies that allows anyone to pay for anything, anywhere, with any currency.

In principle is works through several functions. First it incentivizes users to hold their assets on-chain and to place them in continuous liquidity pools to increase overall market liquidity. In return for doing so they are rewarded with staking rewards that come from the network fees.

THORChain can achieve this goal, but to do so it will need to connect as many chains as possible, particularly the chains that are already considered somewhat liquid and economically active such as Bitcoin and Ethereum, along with others like Binance Chain. As the token distribution grows, so too does the decentralization and incentivization of THORChain.

The BiFrost Protocol

The thing that holds the entire THORChain ecosystem together is the BiFrost Protocol. That’s because it is this protocol that enable interoperability between chains. That interoperability is one of the most important basics of the ecosystem because without interoperability the entire ecosystem will fail to deliver.

The THORChain team has created the BiFrost protocol from scratch, and it does just one thing – connects all the existing blockchains with one another. Eventually the team hopes that this protocol will be the ecosystem for all digital assets, which will help provide a better trading environment, lower transaction fees, and greater staking rewards. And of course it will allow for ease of exchange for any digital asset.

It ensures the trust and security of the network and avoids double-spending and other malicious behavior. In simple terms it does this through the implementation of a set of 100 staked validators. These staked validators govern the multi-signature accounts on THORChain to create vaults.

Any time an external coin is moved to a THORChain vault it is the responsibility of one of these validators to sign the transaction. Once they do so a new equivalent version of the external coin is created on THORChain. When someone wants to withdraw their staked coins the external coin is unlocked by burning the THORChain equivalent coin. This approach makes bridging between chains far safer and it gives far greater liquidity than the current implementation of atomic swaps.

Bifrost is initially supporting Bitcoin and Binance Chain in the testnet that was launched in November 2020. The next coins to be supported are Ethereum and Litecoin, following which it is thought that Monero will be added to the mix. The mainet should launch sometime in the first half of 2021.

Yggdrasil Protocol

THORChain is also working on solving the blockchain scalability issue through the Yggdrasil protocol. If THORChain wants mass adoption at some point it will need to have both a high transaction throughput and low transaction costs. That’s what the Yggdrasil protocol aims to do.

The protocol introduces a new vertical sharding approach meant to solve all three parts of the scalability problem. With the Yggdrasil protocol THORChain will be able to achieve maximum scalability while also remaining decentralized and as trustless as possible.

Aesir Protocol

The Aesir protocol is aimed at the governance of THORChain. It hopes to provide a fair and economically effective on-chain governance mechanism that will remain fork-free.

In addition the maintaining the network and receiving rewards, staking also conveys voting rights on THORChain. These rights extend to governance changes, on-chain commands, token structure changes, state changes, architecture changes, and changes to consensus rules.

Asgardex

Currently THORChain’s exchange functionality works through the online BEPSwap tool. Eventually the project plans on switching to Asgardex, which will be the exchange user interface sitting on top of THORChain. Asgardex seeks to solve all of today’s issues with both centralized and decentralized exchanges. It is also meant to showcase the capability of THORChain and will be community-run and fee-free.

Solving Security

• Incentives ensure bonded RUNE is always double pooled RUNE
• Malicious nodes are slashed to protect pooled capital
• The liquidity and security of the system is tightly coupled
• A Threshold Signature Scheme with no trusted dealer protects assets
• The system is always Byzantine fault tolerant

Solving Scalabilty

• Liquidity is sharded into realms to reduce signing committee sizes
• Liquidity is delegated into smaller vaults for faster signing
• Base infrastructure is Tendermint (100+ Nodes possible)
• Chains and Assets added via economic weight
• High performance CosmosSDK replicated state machine

Solving Cross Chain

• THORChain observes transactions on external networks
• State is highly-validated: incorrect transactions are ignored or refunded
• Logic is applied to state changes, generating outgoing transactions
• Transactions are signed via a chain agnostic TSS protocol
• Outgoing transactions are broadcast back to the external network

What is BEPSwap?

BEPSwap is the very first user interface for THORChain. It allows for swapping and staking BEP2 tokens, and users can also earn staking rewards by providing liquidity to the ecosystem. Traders are also able to monitor changing prices and act as arbitrageurs, profiting by exchanging tokens to correct pricing.

Launched in beta in September 2020 BEPSwap has grown to several thousand users and roughly $10 million in daily trade volume. Small still, but it is a beta project and also warns users not to stake or add large amounts of liquidity. Still, with a bonding APY of almost 30% it is an attractive alternative to lending, yield farming, or traditional bank accounts.

The RUNE Token

The RUNE token is THORChain’s native token and it too is a crucial part of the system. It is a BEP2 token that is used in all the liquidity pools and is bonded by the nodes. Because RUNE tokens remain at a 1:1 ratio to asset value all the liquidity pools can be linked. RUNE also serves as the reward token for the ecosystem.

Besides providing liquidity on-chain and staking rewards, RUNE also provides the network with security. This is accomplished through its incentive system, which offers potential malicious actors more incentive to provide liquidity than to corrupt the system, since nodes earn two-thirds of the system income. That means all transactions carried out with RUNE receive larger rewards compared with liquidity providers. In addition, the nodes automatically close down whenever any malicious behavior is detected.

The RUNE token serves four purposes within the THORChain ecosystem: Security, Liquidity, Governance, and Rewards.

Security – Validators stake RUNE tokens in order to secure the network. Nodes are required to bond RUNE tokens to have a chance at becoming one of the 100 validators. That bonding creates Sybil resistance within the network. Running a validator node requires 1 million RUNE as a bond.

Liquidity – In the liquidity pools every token is bonded to RUNE. This creates the necessary liquidity to perform swaps. By using RUNE to bond assets there are fewer connections needed between tokens.

Governance – Voting rights come from staked RUNE tokens, providing decentralized governance to the network.

Rewards – Validators and liquidity providers receive their rewards in the form of RUNE tokens.

There is a total supply of 500 million RUNE, with a circulating supply of just over 158 million. Those are primarily the 150 million tokens that were sold in July 2019 during the RUNE IEO. Those investors have done very well as the price was just $0.032 for the 20 million RUNE sold in the public sale, and just $0.0245 for the 130 million RUNE sold in private sales. As of early January 2021 the price of RUNE is at $1.58, which is just off the all-time high of $1.66.

In addition to the 150 million tokens sold both publicly and privately there are 150 million tokens allocated to the development team and for operational and community reserves. The remaining 220 million tokens are saved for the emissions reserve.

Governance on THORChain

THORChain was created with minimal governance by design. The development team was interested in creating a system where the validators are responsible for creating their own cross-chain bridges as needed. New chains can also be added to the ecosystem through community or node participation in the governance. Larger amounts of staked capital mean new assets get added to the ecosystem.

Basically users create new liquidity pools on their own on an as needed basis. New assets are easily listed by creating a staking transaction with the new asset in the THORChain transaction memo. Once the new pool is created it is bootstrapped and swapping is disabled. Then, every few days the assets that have the deepest liquidity are enabled for swapping. The protocol will list new assets based on the amount of liquidity, with the greatest liquidity getting preference.

Thorchain in 2021 and Beyond

THORChain planned on releasing their mainet in 2020, but were unable to reach that goal. They were able to launch the beta for BEPSwap, retiring the prior RUNEVault app. Obviously launching the mainet is a major goal for 2021. The team is also interested in adding more chains to BEPSwap, as well as creating developer tools that allow for validators to build bridges to other chains when demanded to do so by the community.

Other plans for 2021 and beyond include creating a layer-2 scaling network called the Flash Network, which will then be connected to other lightening networks. The purpose of the Flash Network is to resolve the issue that currently exists where there is no way to prove a recipient has received funds in a lightening to lightening swap. THORChain plans to use the price feeds from its own liquidity pools to power this Flash Network.

In Conclusion

As you can see THORChain is an extensive project, with some huge potential once it is fully launched and ready to capture more market share from the current centralized exchanges and DEX. As mentioned above, the more assets it can add, the greater the liquidity it will be able to provide, and the more adoption we could expect. Overall it has the potential to grow huge over time.

We also believe the tokenomics of the project are quite good, and that demand for RUNE will inevitably grow as adoption increases. That should obviously lead to higher pricing for the token. RUNE tokens are required by validators for bonding, and that’s a limited amount since there are only 100 validators.

However they are also needed for staking in liquidity pools, and there the demand is unlimited. Plus transaction fees are burned, making this a deflationary token. With the current bonding APY around 30% RUNE is an excellent staking token right now. Best of all, the good tokenomics will also help attract more users to the platform.

RUNE has seen massive price growth, although it hasn’t been without volatility. That’s somewhat ironic considering the project is looking to counter volatility and bring stability to cryptocurrencies, but there you have it. Because THORChain is blockchain agnostic it has the ability to expand dramatically by adding hundreds, if not thousands of chains. It’s all up to what the community wants.

With a market capitalization of $240 million RUNE tokens are currently the 82nd largest cryptocurrency by market cap, and they have been rapidly moving up the ladder after adding more than 100% in December 2020.