Kyle Reidhead
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If you had 1 $BTC and wanted to trade it for $ETH, how would you go about doing it?
Most people would use a centralized exchange like Binance or Coinbase to make this swap.
That’s just… Embarrassing.
It’s been 15 years since Bitcoin’s inception and we still don’t have a standard alternative of swapping between tokens that live on different blockchains, fully onchain.
The standard is still using centralized entities which not only require KYC – that generally takes hours or even days to complete – but that also makes you give up custody of your assets, something that goes against the promise of blockchain.
Not to mention the billions of dollars that the exchanges (FTX, Mt.Gox, Poloniex etc…) have lost on behalf of their customers over the years.
Here at Web3 Academy, we’re all about bringing more people onchain, so today we’ll talk about perhaps one of the most important protocols in crypto: ThorChain.
ThorChain is a protocol that allows anyone in the world to swap between tokens that live on different blockchains, in a fully decentralized and permissionless way.
With ThorChain, if you had 1 $BTC and wanted to trade it for $ETH, you’d just need:
A Bitcoin wallet where you hold your $BTC
An Ethereum wallet
The ability to sign a couple of transactions
That’s all you need to make swaps across multiple blockchains, in a fully onchain manner, without using a CEX or even a multi-chain bridge like Wormhole or Ronin, which were hacked for billions in the past.
ThorChain makes these swaps in a safer and decentralized way, ensuring you don’t lose your funds on the way.
At a point in November, over $200 million in $BTC was traded (24h) via ThorChain, which became the 3rd largest decentralized exchange by volume, just behind Uniswap and PancakeSwap.
When that happened, ThorChain settled around 2% of the total Spot Bitcoin volume that day. That’s no small feat.
It shows that ThorChain has found a good PMF (product market fit) and it has the potential to compete against other DEXs and disrupt many centralized exchanges.
In addition, ThorChain has also implemented a strong business model along with a strong economic structure for its $RUNE token.
So, in today’s report, I want to unpack the ins and outs of ThorChain to:
Learn how they’ve built a great product that has found product market fit
Asses whether or not $RUNE is a token you should invest in
Let’s get into it friends…
At its core, ThorChain is an exchange, similar to Coinbase or Uniswap, as it facilitates the exchange of one token for another (X for Y).
However, it sets itself apart in two crucial ways.
Firstly, unlike Coinbase but like Uniswap, ThorChain operates on a decentralized and trustless framework.
Secondly, unlike Uniswap but like Coinbase, it enables cross-chain swaps.
This innovation allows for direct swapping between different blockchain assets, such as Bitcoin and Ethereum, without needing an intermediary.
Why is this important?
Because right now, swapping tokens isn't easy or always safe.
You might use bridges, but they can be risky – like when the Wormhole exploit happened.
You could use a centralized exchange, but that's a hassle because you have to KYC, move your funds there, swap them, and then move them back onchain. They can also go bust like FTX.
ThorChain addresses these challenges by enabling direct, onchain token swaps.
Many people confuse ThorChain with a bridge. This isn’t a bridge. It’s an exchange.
In this coming section, you will get a better understanding of how ThorChain actually works.
ThorChain can handle swaps between a variety of chains including Bitcoin, Ethereum, Binance Smart Chain, Avalanche, Dogecoin and more…
For each supported blockchain, ThorChain has special vaults. Think of these as big, secure wallets that hold different assets. These vaults are crucial for managing the swaps.
Here’s how a swap occurs. Let’s imagine you want to trade 1 Bitcoin for 17 Ethereum.
Connect your Bitcoin wallet to ThorChain.
Connect your Ethereum wallet as well.
Tell ThorChain you want to swap 1 Bitcoin for 17 Ethereum.
Network validators, who are stakers of ThorChain's native token, RUNE, confirm your swap.
They take your Bitcoin and first swap it for RUNE.
Then, they swap that RUNE for Ethereum and send the ETH to your Ethereum wallet.
TL;DR: Your 1 Bitcoin is converted into 10,000 RUNE (fictional number), then 10,000 RUNE is swapped for 17 Ethereum.
To pull this off, ThorChain is built on its own blockchain, which is part of the Cosmos network.
This setup is key to how ThorChain operates, for 3 reasons.
ThorChain uses the Cosmos SDK, a toolkit for building blockchains that can talk to each other.
This makes it possible for ThorChain to let users swap crypto directly without needing middlemen or special versions of coins (like wrapped $BTC / $ETH).
The Cosmos ecosystem uses a consensus mechanism called Tendermint.
This ensures that as long as more than two-thirds of the nodes are honest, the network can reach consensus and continue to operate securely and efficiently.
This mechanism allows for quick finality, meaning once a block is added, it's almost instantly considered confirmed, reducing the risk of reversals or forks in the blockchain.
For ThorChain to operate successfully, it needs the $RUNE token.
Firstly, network operators – stakers – must bond $RUNE as collateral in order to secure the ThorChain blockchain.
Secondly, liquidity providers – who make sure there’s enough liquidity to trade on ThorChain – need to lock up $RUNE, as well as the asset they want to provide as liquidity.
For example, if you add $1,000 worth of Bitcoin, you must also add $1,000 worth of RUNE.
This keeps the value balanced in every pool and makes $RUNE a key part of the system – but more on this in the tokenomics section below. 👇
However, it’s worth noting that by operating this way, liquidity providers are heavily exposed to impermanent loss risks, which occurs when the price of the deposited assets changes compared to when they were deposited.
Luckily, ThorChain puts up $RUNE to reimburse LPs for any impermanent losses. That’s however a big expense for ThorChain.
To fix this, ThorChain also operates via ‘Savers’.
‘Savers' are participants who deposit a single type of asset into the network to earn yields.
Unlike liquidity providers in liquidity pools who supply two types of assets (e.g. $BTC and $RUNE), Savers contribute only one asset, such as Bitcoin or Ethereum.
This simpler, single-asset approach allows Savers to earn returns without the risk of 'impermanent loss' associated with providing liquidity in dual-asset pools.
Their deposits indirectly support the network's liquidity, enhancing the overall functioning of ThorChain.
Right now, 7300 wallets have locked up over $83 million in assets like $BTC, $ETH and stablecoins.
This mechanism allows ThorChain to operate in a safe and decentralized manner while rewarding those who contribute to the network's liquidity and security.
ThorChain generates revenue and covers its operational costs through fees charged to users who swap tokens on its platform.
These fees are divided into three main categories:
Network Inbound Fee: This is the gas fee for the blockchain from which you're sending your tokens.
If you're swapping from Bitcoin (BTC), you'll pay the gas fee required by the Bitcoin network.
Network Outbound Fee:
This is the gas fee for the blockchain where you're receiving your tokens.
For example, if you're swapping to Ethereum (ETH), you'll pay a gas fee applicable to the Ethereum network.
Exchange Fee: ThorChain charges an exchange fee for each swap. This fee is used to reward liquidity providers (LPs) and stakers on the ThorChain network, incentivizing them to supply liquidity and secure the network.
Below is a screenshot breaking down the fees when swapping 1 $BTC for ~18 $ETH.
In this example, ThorChain charged $119 for a $40,000 swap, which is equivalent to ~0.3%.
A rate that’s very competitive with most centralized exchange rates. Coinbase for example, charges 0.5% to 4.5% on each swap made on their platform.
Note that the overall % paid in fees by the user might be higher than a CEX because the user needs to cover blockchain fees as well as ThorChain’s fees.
But that’s not ThorChain’s only business model – it also aims to supply infrastructure for other wallets and exchanges.
Platforms like Uniswap and wallets such as MetaMask, Phantom, and Coinbase could connect to ThorChain to enable cross-chain swaps within their applications.
This integration would extend ThorChain's capabilities across various web3 interfaces and make them more money.
Now… What are ThorChain’s expenses?
First of all, ThorChain is far from being a profitable protocol. But as you can see below, it’s had a few good months recently in terms of revenue.
The primary reason for ThorChain's significant expenditure is its focus on network security.
The largest portion of its spending goes towards block rewards, which are payments made to stakers for their role in securing the network.
Following this, the next major expense is impermanent loss protection.
As mentioned, ThorChain compensates liquidity providers for some of the losses they incur due to impermanent loss.
These expenses are necessary in order to ensure maximum protocol security, so to become profitable, ThorChain needs to attract more users to its platform.
Let’s look at some stats to see where they currently stand. 👀⏬
P.S- ThorChain also has a lending/borrow service that burns $RUNE – I’ll talk about later in this report so keep reading.
ThorChain recently surpassed the threshold of 20 million all-time swaps.
These swaps have collectively settled over $33 billion.
The 3 most popular tokens traded via ThorChain are
$BUSD – I presume this is the case because $BUSD is shutting down, so people have swapped their stables to other tokens.
$BTC – Of course.
$ETH – Obviously.
This top 10 makes up 70% of all swap volume on ThorChain.
Pool names follow the format "blockchain"."asset".
Bitcoin in particular stands out as one of the top traded tokens, and that’s to be expected.
ThorChain is one of the only protocols that people can use to swap from Bitcoin to other tokens without going through centralized exchanges.
As for liquidity providers and stakers, we can see that $364 million of liquidity is currently sitting in the pools.
For this, LPs have made a total of $75 million…
As for stakers, they secure the network with over 105 million $RUNE…
For their efforts, they’ve made over $59 million dollars.
Now that we know the activity of this app, which has clearly found PMF, let’s see if $RUNE, the native asset of ThorChain, is a good investment…
Liquidity providers (LPs) and stakers both require RUNE for participating in ThorChain, with LPs using it to supply liquidity and stakers for securing the blockchain.
Unlike Uniswap, where the UNI token's value isn't directly tied to the platform's transaction volume, $RUNE is integral to ThorChain's operation.
Learn more about Uniswap here.
In ThorChain, any increase in the platform's usage directly boosts demand for $RUNE, making it more than just a governance token.
As ThorChain's activity grows, so does the demand for RUNE, aligning the token's value closely with the platform's success.
The $RUNE supply is hard capped at 500 million tokens.
As of this writing, over 300 million RUNE tokens (60%) are in circulation.
With a $RUNE price of $4.7, the total market cap is almost $1.4 billion, with a ~$2.3 billion fully diluted market capitalization.
To understand the inflation of $RUNE, we need to know how tokens were distributed in the first place.
(100% of the $RUNE was created at genesis and distributed via different mechanisms):
Startup Capital: 21% (5% SEED, 16% IDO) for initial backers.
Development Team: 10% for early developers.
Bootstrap Rewards: 24% to early network users.
Long-term Incentives: 44% for Node (stakers) and LP rewards over 10+ years.
So, because ThorChain needs to reward stakers and LPs, $RUNE is still expected to continue having inflation over years to come, to secure their network.
However, that’s completely fine! As we established before, this is essential for protocol security.
When ThorChain started off, the APY for stakers was 30%.
Today, it’s about 18% and the plan is to lower that APY to 2% after 10 years.
At that point, the majority of the APY will come from fees, which, if achieved, will make ThorChain a very sustainable protocol.
ThorChain’s burning mechanism is tied to their lending service – ThorChain offers interest-free loans with no liquidation risk or time limit.
Users can borrow by using native tokens (like BTC, ETH) as collateral, with $RUNE serving as the medium of exchange.
Burning and Minting $RUNE:
Opening a loan reduces the circulating supply of $RUNE as collateral is locked
Closing a loan increases $RUNE's circulation when the collateral is released
The net amount of $RUNE burned or created depends on the difference in value between the collateral and $RUNE at the time of repayment.
Right now, there’s a lot more $RUNE being burnt than minted.
A higher amount of $RUNE being burnt suggests that
More loans are being closed versus opened
or…
That the value of $RUNE is increasing relative to the collateral, requiring less additional $RUNE to be minted for repayments.
Right now, the increased burning of $RUNE is led by favorable market conditions.
As always, before investing in a token, we must be aware of their ‘dark side’ and all the risks associated with its mechanism. Let’s address these risks.
ThorChain has experienced several notable hacks in its history, particularly in 2021.
April 2021: ThorChain suffered a DNS hijacking attack where the hacker redirected users to a malicious website, attempting to steal personal information. However, this attack did not directly impact the blockchain or its funds.
July 2021: A more severe incident occurred in July 2021, where a hacker exploited a vulnerability in ThorChain's ETH Router smart contract. This attack led to a loss of approximately $5 million in Ethereum.
July 2021: Shortly after the second hack, ThorChain faced another attack, resulting in a loss of around $8 million. The hacker exploited a vulnerability in the Bifrost protocol used by ThorChain to connect with different blockchains.
August 2021: In a relatively minor attack compared to the previous ones, ThorChain suffered a loss of $800,000 due to a vulnerability in the ETH Router. However, the hacker responsible for this incident suggested a fix for the vulnerability and returned the funds, minus a 10% "bounty."
The concerns around hacks remain present even today.
In ThorChain's lending system, the relationship between collateral value and RUNE's value affects how much RUNE is created or destroyed.
If collateral like $BTC increases more in value than RUNE, the system makes more RUNE when loans are paid back, leading to inflation.
If RUNE’s value goes up more, less new RUNE is made, leading to deflation.
This process can however lead to risks.
For example, if collateral values rise a lot and RUNE’s value doesn’t, it might cause too much RUNE to be made, reducing its worth.
Also, big changes in prices can make it hard to predict how much RUNE will be needed for loan repayments.
If these price changes keep happening, it could make ThorChain less stable, leading to a potential death spiral – someone even compared this mechanism to Terra Luna, which saw a colossal collapse.
This is something that’s even highlighted in ThorChain’s whitepaper, where they say they have “controls in place to address these concerns”.
I think that ThorChain is an application that has found product market fit and that just needs to focus on acquiring users.
I’ve personally used ThorChain a few times and it’s a pleasant experience.
I rather prefer this:
Token A → Token B
Rather than this:
Transfer Token A → CEX (KYC) → Swap for Token B → Transfer Token B to web3 wallet.
I think it’s just a matter of time until more and more users start using ThorChain. However, if you’re considering investing in $RUNE, you should be aware of 2 things.
While ThorChain is a unique protocol, it still competes against centralized exchanges, who dominate the spot market.
The blunt truth is that it’s much easier (and probably cheaper) to just swap tokens on CEXs versus ThorChain, since you must pay outbound and inbound blockchain fees.
So ThorChain relies heavily on more and more people moving onchain, and opting exclusively for onchain tools.
I think we’re heading in that direction, however, you should be aware that ThorChain has onchain competitors as well.
It's not only competing against other cross-chain protocols like Chainflip but also with cross-chain bridges like Wormhole (which are less safe but remain strong nonetheless).
ThorChain is currently a long way from being a profitable protocol.
The reason for this comes down to high expenses like block rewards, impermanent loss protection, reserve security and so on…
To achieve profitability, ThorChain needs to generate more fees (revenue).
To do this, they need to focus on 2 things:
Getting more users to their own interfaces
Integrating their protocol in the back-end of other interfaces like Uniswap, MetaMask etc…
When that happens, they’ll be steps closer to achieving profitability.
And it’s already starting to look decent, as new addresses are coming in:
Lastly, I’m pleasantly surprised as to how they’ve built a very good looking tokenomic structure where $RUNE (the asset) is a vital part of the protocol (ThorChain).
So, as the adoption of ThorChain rises, so will (most likely) the value of $RUNE.
Apart from the risks associated with their lending service, it’s looking very good.
Unless ThorChain experiences additional hacks (like in 2021), I don’t see any reason why it wouldn’t do well over this bull market, especially if they’re able to pull off a deal with a big decentralized exchange or web3 wallet.
Thanks for reading. And remember, you're strong, you’re powerful, you’re alpha! ❤️
Kyle Reidhead
Founder of Web3 Academy and Impact3
Find him on Twitter
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