*Migrated from Medium* Original Date - 01/04/21

This weekend, I simultaneously came across THORChain and its native asset RUNE through both a good friend of mine and Twitter chatter. After taking a deeper dive into it, I thought it would be valuable to jot down some thoughts around RUNE and its place in the crypto ecosystem.

Background

What is THORChain? THORChain is an interoperable blockchain that serves to facilitate cross-chain token swaps. Ok, that sounds interesting, but what actually is it? Well, let’s assume that we do move into a crypto-native world. Available to internet users will be a multitude of different ecosystems that reside on different Layer 1 blockchains. DeFi will be blossoming on Ethereum, wealth locked into Bitcoin as digital gold, dApp activity occurring on NEAR, and on the list goes. Users will want to move in between these systems given certain use cases: i.e. using my BTC to get some yield in DeFi. This should be a seamless transaction, especially if the crypto era is to actually work for society, and thus there needs to be a way to move it over logically and efficiently — THORChain is attempting to do this.

Using liquidity pools, incentivized and managed similarly to Uniswap, THORChain allows users to swap assets and therefore access different ecosystems. What is interesting to note is that it swaps assets on a real basis. Unlike Ren (which is a project that I think has made great inroads into this space), there is no wrapped BTC (a.k.a. zBTC) being created here. Rather, we are swapping real BTC for real ETH. There are notable pros to this, the main one being that its great to have real assets on both ends and not a burnable token wrap. On the other hand, there are more risks now with the user moving across assets — there is some neat logic behind using your BTC in DeFi and not switching BTC into ETH. What if you like holding the BTC (even though it is technically wrapped) and earning some safe yield? User preferences might be different here, and this is certainly an area to put some thought into.

Something very interesting about THORChain is that it is built off of the Cosmos SDK (Cosmos being the most well known project building in the interoperability space). This foundation takes advantage of successful and proven code, reducing execution risk. Albeit, given that it is not built on a chain such as Ethereum, certain security risks may preside — although incentives have been set up to theoretically prevent this.

The Effectiveness of THORChain

A neat characteristic of the platform that needs to be mentioned is the relative effectiveness of the THORChain liquidity pools at creating value for liquidity providers and lowering costs for users. Reading into Delphi Digitals’ report on the platform, they present a case study on theoretical performance of a THORChain pool vs. Uniswap’s very popular ETH/ MKR pool. Below are the results:

There are three core areas of better theoretical performance that need to be mentioned:

1. Higher total liquidity fees: On THORChain, liquidity providers earn more fees on an absolute basis. This is great for them as it means they are making more money. But doesn’t this mean that it is more costly for users? No…
2. The median liquidity fee is theoretically much lower Uniswap’s. So, how can providers be making more by charging less? Well, the THORChain pools are designed to be cognizant of cost meeting demand. It flexes down cost-wise for small users who aren’t demanding much liquidity and flexes up cost-wise for large users who demand a lot of liquidity (versus standard UNI 30 bps)
3. Slippage is much lower on THORChain. This is derived from its implementation of CLPs, or continuous liquidity pools, which are designed to reduce impermanent losses

RUNE: What is it?

Now that we know what THORChain does high-level, it is important to discuss RUNE. RUNE is a ‘productivity asset’ that is used on the platform for two primary use cases:

1. It is staked in liquidity pools where it acts as a base pair. Note that THORChain doesn’t allow for direct asset transfer, but rather for moving in and out of RUNE to other assets. Thus, every pool will be RUNE paired with an asset following a 1:1 ratio dollar-wise
2. It is bonded as collateral by nodes for security sake following a 2:1 ratio dollar-wise

I won’t discuss the second use case as this is pretty understandable given the basics of crypto incentives; however, let’s dive into the first. So, RUNE is needed to run the liquidity pools and it is needed eventually to move from one asset into another one. From this pool, 2/3 of the system income (RUNE rewards (new issuance) + trading fees) goes to network nodes and 1/3 of system income goes to liquidity providers.

RUNE is not intended to be a governance token. THORChain will be governed more like Bitcoin, whereas nodes running the software can determine what direction the blockchain takes (need a super majority). Given that the blockchain is based on the Tendermint consensus mechanism (Cosmos), it is a PoS network that has certain security functions to prevent malicious attacks (i.e. grinding to a halt).

RUNE Economics

Bottom line is that: RUNE rises in value as the total asset value staked increases. Why? Well, each pool is made up of RUNE and another asset. Additionally, security nodes are bonding more RUNE on top of this. Combined, we have a ratio of 3:1 dollar-wise with the other asset. So, as THORChain increases in popularity and more assets are added to available liquidity (will be economically incentivized to do so), the required RUNE will go up. To present an example, assume we only have one pool of BTC to RUNE. Let’s say BTC liquidity goes up 5x, well, in order to run this pool, RUNE liquidity must go up 30x and this is a fixed supply asset. Therefore, demand for RUNE grows and supply is fixed leading to price appreciation.

A quick side note here, RUNE also has a Slip Based Fee model whereby they get more fees when transaction size increases relative to the pool. This, in theory, stands to incentivize liquidity providers to actively search for increasing transaction volume — demand begets liquidity supply.

Conclusion

Overall, THORChain is an interesting project that is just hitting the spotlight after a series of difficult years. On a theoretical basis, it is very appealing and is taking a competitive position in the market that is currently not totally occupied by a competitor (partially by Ren and Cosmos). If the big picture crypto adoption thesis does play out, interoperability will be key and maybe THORChain can be a winner. As THORChain wins, liquidity should increase, and therefore RUNE appreciates. Albeit, there are risks to all of this and, hinted at by my repetition of the word “theoretical”, a lot still remains to be proven. I look forward to keeping tabs on THORChain going forward.

Key graph to refer to on incentives and RUNE economics:

Disclosure: This blog series is strictly personal/ educational and is not investment advice nor a solicitation to buy or sell any assets. Please always do your own research.