The goal of this article is to explain what THORChain is and why RUNE is a valuable coin. I will first explain what THORChain is and some of its important distinguishing characteristics. Then I will dive into RUNE’s properties and finish up by explaining how the capital structure of the network and its Incentive Pendulum will make the value of RUNE increase as a direct function of liquidity.
What is THORChain?
THORChain is a decentralized liquidity network where crypto assets are able to be traded for one another across different networks/blockchains through the use of continuous liquidity pools, which allow the liquidity providers the ability to earn fees on the assets they are staking, and at the same time providing a safe and low cost marketplace for users to exchange any crypto assets they want. THORChain is secured through Proof of Stake.
What are the distinguishing characteristics of THORChain?
First off, THORChain is a decentralized exchange. Being decentralized provides some advantages that centralized exchanges do not. Users do not have to rely on an intermediary to trade, maintain account balances, or ever give up custody of their assets as it operates on a peer-to-peer basis. Being decentralized also makes users less vulnerable to an attack because there is no central authority for hackers to go after. The Rune token is used as well through staking to ensure that the nodes which secure the network are there to protect the assets on the exchange.
THORChain is a cross-chain solution. Their cross-chain network, called the BiFrost Protocol, allows users to swap any asset for any other in the crypto world. This is a major differentiator from other decentralized exchanges (DEX’s), which mostly operate exclusively on the Ethereum network. THORchain will be the first AMM to allow value transfer between chains like BTC, ETH, DOT, XMR, etc. THORChain is positioned to be the solution to connecting the entire crypto world.
Another differentiator for THORChain is the mitigation of impermanent loss that users typically fear on other exchanges when participating as a liquidity provider. THORChain’s express goal is to maximize the revenue for its liquidity providers. The pool logic that THORChain uses, versus that of Uniswap for example, greatly reduces the amount of impermanent loss that is incurred. Impermanent loss arises because of liquidity pool logic that assumes an even 50/50 split among the value of assets in a pool. For example, on Uniswap a pool contains $1,000 Tether and 10 ETH when ETH was worth $100. If the value of ETH increases to $200, then there are now only 5 ETH in the pool. The liquidity providers have incurred impermanent loss because they would have increased the value of their assets more by holding the assets outside of the pool and letting their value rise with the market. THORChain uses Continuous Liquidity Pools, which incorporates a slip based fee. Traders are penalized for causing larger slippage with fees. This fee model penalizes those looking for faster execution and also mitigates the risk of bad actors because their slip based fee will be greater than the fixed swap fee that an exchange like Uniswap uses, which makes the attack much more expensive to execute.
THORChain is not prone to a liquidity crisis like other exchanges. If a liquidity pool required more of an asset, the incentive pendulum would increase the incentives for providing that asset to the pools. All the assets are also backed by RUNE to the tune of 3X the amount of pooled capital per asset. Increased liquidity also means a decrease in volatility, which currently keeps institutions and other risk averse investors away from the crypto world, so this would help drive adoption as well.
What is Rune?
Rune is the base currency that is used on the exchange and has multiple functionalities according to THORChain’s website:
Liquidity — RUNE is used as the settlement currency so that only one liquidity pool is needed per network added to THORChain in order to settle trades between all other networks. RUNE is bonded to the assets that it is pooled with, so as those assets increase in value, so does RUNE. Once the network is aware of the value of the assets it’s securing it can use incentives to make sure they are safe.
Security — Because RUNE is bonded to the pool by Node users this disincentivizes people from stealing the assets in a pool or from any other behavior not in accordance with network rules. The value of RUNE bonded by a node should always be 2X as much RUNE as is staked into pools. If a node tries to steal assets from the pool then the RUNE they have put up is reduced by 1.5X the value of the assets stolen and the pool is made whole again. Slashing fees are applied to staked funds to various degrees as well based on the degree to which the node acted maliciously on the network.
Governance — RUNE looks after the asset listing process on the exchange. The new asset with the most RUNE committed is at the front of the queue.
Incentives — RUNE is the incentive fee of the network. There are slippage fees and fixed network fees. There is gas consumed in every transaction that is constantly being taken from vaults. The gas is compensated back to the provider by 2X its value in RUNE. There is also a block reward paid out per block to providers of liquidity.
Amplifier — RUNE will be most liquid on its own network, which means that the THORChain exchange will set the price for RUNE. This will help to provide important liquidity to otherwise illiquid assets
Why is the value of RUNE going to increase as a direct function of liquidity?
The Incentive Pendulum of THORChain is what keeps the network both safe and efficient. Below is the optimal state of the network taken from their knowledge base.
The Incentive Pendulum is used to balance the liquidity pools when they inevitably fall out of balance. For example, if the liquidity pools have too much bonded capital then the network is inefficient because there are too many resources dedicated to securing too few assets provided by stakers. The incentive pendulum will decrease incentives for node operators and increase incentives for stakers in the liquidity pool in order to restore balance. The opposite scenario can arise where there is more capital pooled than capital bonded, which makes the network unsafe. The Pendulum will increase incentives for node operators and decrease incentives for stakers, once again restoring balance. As you can see above, 66.7% of RUNE must come from capital bonded by nodes to secure the network while the other 33% of RUNE comes from liquidity providers. At the same time, the value of capital bonded should equal the value of capital pooled, which makes the total value of RUNE per liquidity pool 3X the value of the other asset in the pool.
THORChain is built around the goal to maximize incentives for liquidity providers. This is because the higher the incentives are for the liquidity providers, the more liquidity will be provided to the pools. This means deeper liquidity for traders, which leads to less slip based fees. Smaller fees means more trading in those liquidity pools, which increases the profit for the liquidity providers, and in the end this comes full circle to bring more liquidity to the network. Liquidity begets liquidity. This is perhaps more simply illustrated by the below picture from a tweet from Andrew Kong, which he dubs the Liquidity Black Hole Theory (Link to the full twitter thread is below).
This theory would mean that THORChain would be able to pull liquidity from all different types of exchanges. RUNE operates across all different blockchain networks meaning more and more liquidity will be pulled into THORChain liquidity pools in the form of assets on any of the major chains like BTC, ETH, and XMR as mentioned earlier. Finally, because of the structure of the liquidity pools with RUNE’s value equaling 3X the value of the other asset in the pool, the demand, and therefor price of RUNE, will increase with a direct correlation to the liquidity that is provided to the network. This is the reason that THORChain’s express goal is to maximize incentives and revenue for its liquidity providers, and the reason why I think RUNE’s value should not be overlooked.