THORSwap: A DEX to rule them all

Authors: 0xNappyCaps, Jimbobkos

What is THORSwap

THORSwap is the first Multichain Decentralized exchange (DEX) that utilizes the THORChain network to provide a front-end user interface to perform cross-chain swaps. In addition to being a first-mover in the THORChain ecosystem and building an institutional-grade trading platform, THORSwap is developing a robust value-add community that will benefit from a roadmap that includes the creation of the THORChad DAO, $THOR token, and an incubator for THORChain dApps.

CEX versus DEX

Centralized exchanges (CEXs), are dead. Long live Decentralized exchanges (DEXs). For many crypto veterans these terms are thrown around as nonchalantly as the term noob; but for newcomers to the crypto space these are like a foreign language. So what is a CEX and a DEX?

A CEX is an exchange that has a central entity that facilitates cryptocurrencies trading, swapping, or exchange on behalf of the users on the blockchain by being the custodian of users’ funds. Popular examples of CEXs are Coinbase and Binance. Investors can tell if an exchange they are trading with is centralized by simply recognizing that they do not own the private keys to their wallet. This is the most concerning issue that traders, old and new alike, should be aware of. We can talk about the downside that CEXs inherently contain like potentially crippling regulations, KYC requirements and potential downtime during market stress, but the inability for the investor to control the private keys to their CEX wallets dwarfs these other concerns. The inability for the investor to have full ownership to their tokens or fiat on a CEX exposes the investor to loss of their holdings if that CEX goes dark.

This is why DEXs are considered by theorists (and canonized by users) to be the future of cryptocurrency trading. Unlike a CEX where the trader needs a centralized entity to facilitate a trade, a DEX allows its users to buy, sell and swap their tokens without the need of a middle man. DEXs employ smart contracts to bridge two traders on either side of a transaction without ever taking control of the tokens being traded. However, what makes DEXs superior to CEXs is simply the fact that DEXs allow the user to connect via their browser-based wallet (e.g. MetaMask or XDEFI) without KYC requirements or losing custodial possession of their tokens.

There also is a significant decrease in operational risk as CEXs have recently shown their growing pains in terms of their less than acceptable ability in handling high volatility markets while DEX infrastructure thrived in similar environments.

Over the past 18 months, usage rate for DEXs has increased, evident by the increasing portion of trading volume attributable to DEXs relative to all crypto trading volume, albeit it is still quite small as an absolute portion (7.6% at August 2021).

The Multi-Chain

Many tokens exist on many blockchains. These blockchains, Bitcoin, Ethereum, Terra, and Solana to name a few, all support dozens, if not hundreds, of tokens on their blockchains. Up until recently, DEXs only allowed for native swapping of tokens for a specific blockchain, such as SushiSwap for Ethereum and Symmetry.fi for Solana. If you wanted to swap Bitcoin for Ethereum on SushiSwap you would need to wrap your Bitcoin for use on the Ethereum blockchain and then swap for Ethereum. But what if there was a way to trade native Layer 1 (L1) assets without storing your tokens on a smart contract just to wrap and use them on another blockchain? This problem has been solved by THORChain.

THORChain is a protocol that allows for native L1 token swaps without the need for wrapping assets. This decentralized, cross-blockchain liquidity protocol, built on Tendermint and Cosmos-SDK, is revolutionary and, although it has had its recent hiccups, is poised to dominate as the go to protocol for all future DEXs and DeFi protocols. Key reasons that support a native, multichain future, which Thorchain is leading the movement towards, includes:

1. Cryptocurrencies represented on foreign blockchains (e.g. wBTC) are not ‘native’ and carry centralized risks such as custodian and regulatory risk. At time of this article, there is ~US$350m of wBTC liquidity locked within Sushiswap and Uniswap.
2. An indicator of DEX performance is the amount of trading volume that it processes. More trading volume can infer greater adoption. By THORChain targeting the trading of native assets, it is targeting a market that has magnitudes greater trading volume than non-native equivalent markets. For example, per Chart 1, native has significantly greater trading volume than wBTC:

Chart 1: wBTC vs BTC — 30d average trading volume

3. The success of a DEX is dependent on the amount of liquidity it stores within its protocol. Larger amounts of liquidity can infer deeper trading pools and attract a larger market of traders/swappers due to lower slippage. Single chain DEXs are attracting capital on their respective chain, which can be highly competitive in situations where multiple DEXs exist (e.g. Uniswap vs Sushiswap). THORChain targets native assets across the major blockchains, a significant source of liquidity for its users. Table 1 highlights some native assets that can be held within THORChain along with the amount of liquidity stored within popular CEXs, demonstrating the size of the liquidity THORChain is attempting to attract:

Table 1: Estimated BTC, ETH, BUSD liquidity (US$b) on prominent CEXs

In addition to the above, specific advantages THORChain provides users with over DEX incumbents include the below, which is consistent with their statements regarding liquidity providers being “first-class citizens”:

1. The ability to provide symmetric and asymmetric liquidity provision;
2. 100% impermanent loss protection for liquidity provision held for +100 days;
3. Provides ability to earn yield on native assets (e.g. BTC, DOGE, etc.); and
4. Block rewards to liquidity providers to begin the ‘liquidity black hole effect’ (detailed below).

THORChain currently has a cap on the level of liquidity that can be provided into the platform, this is to manage risk during its ‘chaosnet’ phase. Once liquidity caps are removed, THORChain is likely to experience a ‘liquidity blackhole effect’, likened to a positive virtuous cycle where increased liquidity provided > deeper pools > lower slippage > attracts more traders > increased liquidity provider fees > increased liquidity provided.

But THORChain is just some lines of code. How can users access it to its full potential? In steps THORSwap.

The One DEX to Rule Them All

Built on top of THORChain, THORSwap is the first multichain DEX that utilizes the THORChain network to provide a front-end user interface to perform cross-chain swaps. The swaps are permissionless, trustless, and non-custodial as, similar to the above mentioned DEXs, the user connects via their browser-based wallet.

THORSwap has extremely strong competitive advantages over other front-end THORChain UIs (i.e. DefiSpot, Rango, etc.) as detailed below:

1. Proof of Concept (BEPSwap) executed with very positive results. It was decommissioned due to the implementation of the successor platform — THORSwap (Further details below)
2. THORSwap is the first UI to undergo a public raise, effectively releasing their native token ($THOR) and beginning community incentive programs (which comprise of a large portion of the token allocation), this bootstrapping mechanism could further distance the platform as the market leader ahead of upcoming THORChain platforms (Further details below)
3. DEX aggregation will increase liquidity sources and diversify protocol concentration risk away from the THORChain network
4. Multi-wallet management across Ledger, Keystore, XDEFI, MetaMask (other ETH wallets such Gnosis), Coinbase and Trezor.
5. Fully functional desktop application providing all that the web version has to offer
6. Best position to capture ThorFi adoption (Further details below)
7. An interface for node operators to effectively manage the THORChain network
8. THORNames (Further details below)

THORSwap also has a thorough tutorial that interested new users can access.

Why 0xVentures Invested in THORSwap

THORSwap has tremendous first mover advantage in utilizing THORChain’s revolutionary protocol in its backend. Along with this advantage and the close working relationship between the THORSwap and THORChain developers, 0xVentures recognized the following +EV in investing in THORSwap:

• The Team is well resourced, demonstrates alignment to the protocol and has experience in developing successful, DEX-based user interfaces (e.g. BEPSwap). Their flagship product (THORSwap) is fully functional and has seen significant usage, which cements a strong first-mover advantage. They also harness the power of community feedback and short feedback loops by providing a 24/7, 1:1 ticketing system.
• Robust methods to attract and retain traders, such as institutional-grade user experience and trading incentives. Thus, expecting the protocol to create significant value.
• Tokenomics embedded within $THOR are sound in its ability to accrue value from the protocol, mostly driven by capturing a large portion of trading fee revenue.
• Community is vibrant and engaged which is expected to accelerate THORSwap’s network effect
• Roadmap is ambitious and consists of numerous, value-add opportunities such as; ThorFi integrations and API composability
• A strong solution to capture the tailwind of a THORChain-based ‘multi chain’ future

The Team

THORSwap maintains a robust team that operate under pseudo-anonymity.
Majority of core developers have direct experience with THORChain.
These developers have shown their resilience and dedication by
building non-stop during the THORChain halt and what they have delivered is truly next level.

Team experience

The degree of execution risk is low given the +12 months of proven track record, demonstrated through the development of:

1. BEPSwap (Launched in September 2020 and decommissioned in August 2021) was a single chain DEX used as a proof of concept of the current THORSwap platform, focusing on BEP20 assets only. Over this time, the platform demonstrated strong usage with trading volume of $5b and 750,000 swaps across 70 liquidity pools.
2. THORSwap (Launched in April 2021) is a fully functional ‘beta’ version of the platform. $800m trading volume, 500,000 swaps even with Thorchain liquidity caps and averaging 300–400 daily active swappers in the months prior to the THORChain exploits. The platform also handled the May 2021 market crash well with no downtime experienced.

The below analysis provides some insight into the performance of THORChain to date (of which THORSwap is aiming to capture a significant portion of this performance) against existing incumbents — Uniswap and SushiSwap. Comments/assumptions regarding the analysis are:

• Data for Uniswap/Sushiswap is obtained from Token Terminal and Flipslide Crypto for THORChain, supporting calculations for the analysis can be viewed here.
• THORChain is very early in its activity, as such data presented and comments relating to this data is only for observation purposes only and not intended to arrive at any meaningful conclusions (yet). As the protocol gains a longer track record, then the data will be more indicative of performance. The vertical red line on each chart indicates the date the network was halted due to exploits, the network then formally restarted in mid-September 2021.
• Block/staking rewards have been intentionally excluded from calculations relating to APY to identify the organic return to liquidity providers.
• Average rolling 30d outputs smooth the data to more clearly depict metric trends.

‘Aggregate APY of liquidity providers’ — The organic APY of a DEX is indicative of the return to a liquidity provider. This can act as a positive flywheel effect by attracting more liquidity to the protocol, which can create deeper pools, resulting in less fees charged to traders/swappers, which then attracts a larger number of traders/swappers and so on.

Per Chart 2, key takeaways are:

• Uniswap’s position as the market leading AMM is evident by the amount of trading on the exchange leading to liquidity providers earning the largest APY
• Prior to the THORChain network being halted (before the red line), the fees being generated on the amount of liquidity provided was broadly in line with Uniswap

Chart 2: Rolling 30d average APY (%) to liquidity providers

Note: This calculation is annualized total revenue/TVL, therefore individual pool APYs may differ from outputs in the above chart.

‘Fully-diluted valuation/trading volume’ — This metric attempts to infer the valuation of the protocol performance, which in this case, protocol performance being the amount of trading volume. Larger trading volume infers greater adoption of a DEX, relative to competitors. Applying fully-diluted market cap standardizes the trading volume from a value perspective, similar to Price/Earnings ratio in traditional finance.

Per Chart 3, key takeaways are:

1. Uniswap is trading at a premium relative to the other platforms presented. This could be driven by investor expectation that Uniswap will continue to maintain their positioning as being the market-leading DEX.
2. The fully diluted valuation of THORSwap at IDO will be US$37.5m. Prior to the network being halted and if THORSwap was to capture majority portion of THORChain trading volume, the platform could be considered undervalued relative to incumbents. This is based on the FDV/trading volume metric trending lower over time (the output after network halting is not indicative of being “cheap or undervalued” because there was no trading volume until network restarted in mid-September 2021).

Chart 3: Daily FDV/Trading volume — Rolling 30d average

Note: Fully diluted market cap is used (as opposed to circulating market cap) as it abstracts away supply expected to enter circulation by way of: Staking rewards, treasury payments, team vesting unlocks, etc.

Tokenomics

Creating User-Based Value

THORSwap creates unique user-based value through providing a top-tier user experience, aided by the below features, which aims to capture increased user retention:

1. Institutional-grade trading UI and tools:

• Cross-wallet management
• Mobile access
• Desktop application (removing browser risk)
• Portfolio manager and analytics (Traders, Liquidity providers — THORYield)

2. Integrating ThorFi (first-mover advantage relative to other THORChain-based platforms) results in capturing the market for new THORChain-based, financial primitives

3. 24/7, 1:1 support to maintain customer (trader) engagement, currently being executed to a high standard. The average response time to a discord ticket is ~10 minutes. Appreciating there is a material difference in quantity of clients, however for reference Google’s highest severity issues have a ‘Service Level Agreement’ set at 2 hours

4. Trade mining — Similar concept to ‘staking rewards’, however $THOR is earned by traders to incentivize trading volume

5. Fee discounts — Received in $THOR and is tiered based on $THOR tokens owned:

• 2.5k to 10k $THOR — 25% fees refunded
• 10k to 25k $THOR — 50% fees refunded
• +25k $THOR — 75% fees refunded

Protocol Revenue Generation

THORSwap’s primary revenue driver stems from trading fees for its native swaps. However, in addition to these trading fees THORSwap collects an ‘Affiliate fee’ which is paid by the THORChain network for each trade routed through THORChain by affiliates (e.g. THORSwap).

The THORSwap team is also currently working on additional streams of revenue generation (i.e. THORNames, third-party APIs, etc.)

$THOR Token

THORSwap will also be introducing its own governance token, $THOR, through a series of private and public sales beginning in October 2021.

The $THOR token has a number of explicit value accrual features that a token holder is entitled to when they stake $THOR for governance and receive vTHOR. This approach incentivizes participation in the platform and aligns token holders and their governance decisions with the success of the platform.

Summarized below are key value accrual features of vTHOR:

Primary value accrual

1. Trading fee revenue — 75% of the trading fees generated by THORSwap will accrue to vTHOR holders. This will be in the form of ‘Buy-back & distribute’, where fees will be used to buy THOR on-market, create buy pressure on the token and distribute (pro-rata) to vTHOR holders. This could create a scenario where vTHOR receiving this yield could sell THOR on market, creating sell pressure and offset the initially created buy pressure. However, given the presence of incentivized ‘time-locking’ on staking rewards (discussed further below), this will likely create a net-hold mentality of yield and limit potential sell pressure.

Secondary value accrual

1. Trading fee discounts — Incentivizing vTHOR holders to be users of the platform; and
2. Entitled to ecosystem/community rewards.

A staking reward program will be used to bootstrap participation within the network. All community incentives (including staking rewards) will be fully distributed 4 years after the token generation event. Staking rewards contract includes a ‘multiplier’, which incentivizes stakers to lock their holdings for up to 4 years, with longer locking resulting in higher multiplier effect. There is added flexibility for stakers to choose a level of illiquidity (e.g. 1 week, 1 month, 6 months etc.).

The above token accrual features are expected to incentivize a large number of $THOR tokens to be ‘staked’ for governance purposes, thus taken temporarily out of circulation. This will likely lead to a supply-side shortage and result in a strong positive catalyst on price.

This ‘supply-side shortage’ will provide indirect value accrual to $THOR token holders (those that do not wish to participate in governance) given anticipated capital appreciation of the token.

Protocol longevity

The protocol has two levers which contribute to funding opex/capex:

1. Treasury (10% of token allocation) — A lump sum capital pool; and
2. Ongoing revenue — 20% of all fees generated by the protocol will be allocated to the Treasury

The above two components highlight the ability for the protocol to use internal capital for protocol funding, the latter providing an annuity which builds confidence that the protocol will be well funded to take advantage of future growth opportunities.

Token vesting

The core team’s tokens are locked for a substantial duration which creates strong alignment with the long-term success of the protocol (initial 6 month lock-up after which tokens are vested linearly over 36 months).

‘Private investor’ tokens unlock over a 24 month period (linearly) with a 6 month lock-up, as such a large token dump is unlikely, however if a majority of private investors sell down their holdings (post lock-up) then this could create a consistent degree of sell pressure on price over this period.

Trading blackhole effect

Similar to THORChain’s ‘liquidity blackhole effect’, THORSwap could experience a ‘Trading blackhole effect’ in that, trading rewards and fee discounts > more trading through THORSwap > more trading fees > more trading fee revenue to $THOR holders > increased value of $THOR > more trading rewards and fee discounts > more trading through THORSwap. This is currently being conceptualized given the platform hasn’t experienced this yet, however we look forward to seeing this potential positive virtuous cycle play out when trading rewards and fee discounts are activated.

Key takeaways regarding tokenomics

1. THORSwap platform features are likely to create user-based value and strongly contribute to attracting and retaining traders;
2. Above value accrual methods as standalone features are strong, they are further enhanced should a large number of token holders lock up vTHOR for a considerable amount of time;
3. Requiring governance to be entitled to the value accrual methods is a valuable method to incentivizing decision-making of the protocol; and
4. Incentivizing greater staking rewards for multi-year lockups is also a valuable method to aligning time horizons of governance participants with long term protocol success.

Community

The THORSwap community is large (Discord: ~14k members, Twitter: ~20k followers) and more importantly, very engaged, demonstrated by:

• The amount of visitors and member engagement within the discord server is broadly increasing, as shown in Figure 1.

• More specifically, the THORSwap ticketing system since May 2021 has registered 2,559 tickets from members providing feedback and suggested enhancements to the THORSwap platform.

THORChad DAO

Recently THORSwap introduced the THORChad DAO. THORChad DAO is the future home of the THORChad Metaverse, where community initiative projects and apps can launch from.

The first of these projects is THORChad score; where users are rewarded by analyzing their on-chain activity on THORSwap with a points system. Users can increase their THORChad score by completing challenges such as providing liquidity, performing swaps and staking $THOR. The score qualifies users for airdrops, NFTs, early access to projects and other incentives. See an example THORChad score below:

Figure 2: ‘THORChad score’ dashboard

This feature unites the THORChain and THORSwap communities in a sort of brotherhood bond that we all made it through the tougher times and will soon be enjoying the pleasures of Valhalla together.

Community bootstrapping

A large portion of the tokens (50%) is earmarked for community initiatives, demonstrating a sizeable level of bootstrapping dedicated to growing the community after the token generation event, Figure 3 summarizes these initiatives, which include — Thor governance (Staking), LPs, Trade mining, Community rewards and ecosystem rewards

Figure 3: Initiatives slated to be implemented using the community incentives pool

The Roadmap

1. Becoming a DEX aggregator begins to position THORSwap as the gateway to trading in a pure, decentralized environment by not only accessing liquidity in THORChain but being the interface to access other liquidity sources. This will be completed in two stages:

• Stage 1 — Integrate 1inch (valuation at time of this article is ~US$506m), the most prominent DEX aggregator within the Ethereum network, handling ~60% of all DEX aggregator volume; and
• Stage 2 — Integrate additional liquidity sources from other chains, including: (a) Other ETH liquidity: 0x, Uni, Sushi, Bancor; (b) Cosmos: Terraswap, Osmosis, Kava Swap; and © Binance Smart Chain: Pancake.

2. THORChain Finance (ThorFi) is the additional financial primitives that are slated for development within the THORChain network (beyond swap/liquidity pools) as summarized in Figure 4. To date, THORSwap has already built features to access the ‘Synthetic asset’ primitive, this positions itself to attract adoption for this primitive ahead of other THORChain UIs.

3. The provision of APIs allows the creation of ‘vertical stacks’ to be built on top of THORSwap in an efficient manner. A big proponent for the success of DeFi more broadly is the presence of composability between protocols. There is an expectation that the use of APIs will foster a vibrant ecosystem of other platforms integrating and building on top of THORSwap.

4. Whilst not explicitly slated by the team, a potential opportunity could be THORSwap partnering with fiat gateway providers to plug directly into the THORSwap platform. CEXs rely on their ‘fiat gatekeeper’ status to maintain market relevance, however a fiat gateway to THORSwap would render CEXs redundant and create a seamless entry from the centralized financial system to the decentralized financial system.

Key risks

Summarized below are key risks that have been considered regarding 0xVentures’ investment in THORSwap:

1. Concentration risk of THORChain — Any adverse impacts that occur to the THORChain network (e.g. halting, bugs, etc.) will directly impact the trading experience of the THORSwap platform. THORChain has been the victim of two highly publicized hacks in the matter of months. There could also be a prolonged adoption of liquidity providers given the hacks may increase hesitancy in providing liquidity. However, this risk will be somewhat reduced through diversifying liquidity sources with the ‘DEX aggregation’ strategies (previously mentioned) and THORChain’s remediation strategies following the hacks.
2. Market participants may not value Layer 1 swaps — wBTC has had strong adoption to date. There is a risk that this adoption continues driving market participants to overvalue wBTC/undervalue native swaps as a service.
3. Threat of current and future THORSwap competitors — There are a number of competitors (e.g. DefiSpot, SKIP, Rango, etc.) that could take market share from THORSwap.

Disclosures

This investment report has not been sponsored by the THORSwap development team. It has been published for informational purposes only and is not investment advice, thus should not be solely relied upon to make investment decisions. Members of 0xVentures have invested in THORSwap. This statement is intended to disclose any conflict of interest and is not a recommendation to purchase the THOR token. The information within this report is current at 7 October 2021.

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