Everyone and their grandmother wants to get into DeFi, but these platforms get more complex by the day. Here's how to explain THORchain to your nana.
Updated Mar 29, 2022
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The exchange of tokenized assets is the lifeblood of cryptocurrency. First, it was centralized exchanges like Coinbase and Kraken that enabled crypto holders to trade Bitcoin and fiat with other blockchain assets, but with one fundamental flaw: centralization.
While most of us have grown to trust these platforms as they've proven themselves worthy over the years, less capable companies (looking at you, Mt. Gox and Bitconnect) have demonstrated the need for decentralized permission-less ways to exchange assets.
Uniswap gave us that on Ethereum, but RUNE crypto and the THORchain might just change the game entirely.
Thorchain is a permission-less cross-chain liquidity platform that uses Cosmos' Tendermint consensus protocol. Put simply, THORchain is similar to other decentralized exchanges (DEX) like Uniswap and Bancor, except while those can only serve one blockchain at a time, THORchain is able to exchange crypto assets across multiple blockchains.
For instance, Uniswap only allows users to exchange ETH and other ERC-20 assets that are native to the Ethereum blockchain, which means in order to trade Bitcon (BTC) for Ether (ETH), you must first create 'wrapped' BTC (wBTC)—a token that represents BTC on the Ethereum Blockchain. THORchain eliminates the need for wrapping by providing cross-chain liquidity between assets on their native blockchain, so, during an exchange, ETH can stay on Ethereum and BTC never has to leave the Bitcoin ecosystem.
The main innovation of the THORchain liquidity protocol is that it's secured using its own blockchain. Before THORchain, most DEXs relied on smart contracts which stored complex mathematical algorithms to determine exchange rates between crypto assets. These DEXs only required two parties: a liquidity provider who deposits two assets and earns yield on that pair in the form of exchange fees, and a trader who pays fees to exchange one asset for another.
The problem with smart contract DEXs is that they're a single point of failure, meaning they have the lingering potential of being exploited—whether they be a DEX like Bancor (which suffered a $23 million dollar breach in 2018) or a cross-chain 'bridge' which is used to wrap assets (such as the Wormhole bridge, which was hacked for $325 million dollars in 2022).
THORchain's solution to this is adding a third party to the DEX equation: Node operators. Colloquially called THORnodes, these nodes are an arrangement of 99 independent validators who operate the THORchain blockchain and are collectively the custodians of the liquidity pool by holding shared DeFi wallet keys to the THORchain vault.
While anyone can operate a node that validates THORchain transactions, only nodes that 'bond' (similar to staking in proof of stake) an amount of the native RUNE crypto that's 1.5 times the liquidity in the vault in order to have authority over the network. At least two-thirds of THORnodes must approve a transaction before funds are released, and this becomes more decentralized and secure as more THORnodes join the network.
RUNE is the native asset of the THORchain ecosystem. First, RUNE is used to underwrite pooled assets and serves as leverage for THORnodes, so if a THORnodes breaches protocol or steals from the pool they can then lose part or all of their RUNE deposit. Second, RUNE is used to pay for transaction fees on the THORchain, similar to how Ethereum 'gas' fees work. Third, the most important function of RUNE is being the settlement asset of the THORswap liquidity protocol.
All assets deposited into the THORchain liquidity protocol must be paired 1:1 with RUNE. This means that liquidity providers must deposit 50% of each asset, whether it be BTC and RUNE or RUNE and ETH. For example, when a trader exchanges BTC with ETH on THORchain, BTC is sent to the protocol and exchanged for RUNE, then that RUNE is exchanged for the ETH that the trader receives.
Although large distributions of RUNE as an incentive for liquidity providers may continue to generate downward price pressure, RUNE is able to maintain its value through the utility it offers beyond just a DEX governance token like UNI or SUSHI. THORchain claims the value of RUNE is deterministic, meaning that it's derived from the value locked in the network's liquidity pools because the value of all RUNE locked into the protocol through bonding and liquidity 'staking' is required to be three times that of other assets.
While RUNE is bursting with potential, it's still held back by its limitations. For one, the THORchain protocol accepts a very limited but growing portfolio of layer-1 crypto coins. More significantly, it was proved that THORchain is far from perfect after two exploits in 2021 left the protocol short millions of dollars of ETH and the discovery of even more bugs by its developers prompted them to voluntarily take the network offline.
However, there is a silver lining since the THORchain is still in the experimental 'stagenet' with a mainnet release on the horizon. Security audits at the end of 2021 determined that THORchain's devs have patched up the major outstanding bugs, and the THORchain wallet app available on the App Store and Google Play makes RUNE more accessible and could increase adoption of the network.
The major limitation of buying RUNE on a central exchange like Coinbase or even a DEX like Shushiswap is that the version of RUNE available on those platforms is not the native RUNE token, but rather an ERC-20 Ethereum compatible version.
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Although holding ERC-20 RUNE long-term isn't recommended because that token will eventually be phased out for THORchain's native RUNE coin, this may not matter to short-term investors. The reason for the emphasis on the RUNE coin as opposed to its counterpart on Ethereum is that it contributes to the ultimate goal of fostering a community governed permission-less crypto asset exchange.