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Tokenomics 101: THORChain

How To Swap $BTC for $ETH Without a Centralized Exchange

Tokenomics Primer

The term ‘tokenomics’ is a hybrid of token and economics and its meaning is quite similar to economics. Tokenomics studies how people interact with tokens. More specifically, the issuance, distribution, and burning of tokens of a cryptocurrency.

Photo by Manuel Salinas on Unsplash

Importance of THORChain

THORChain fills a gap seen in today’s exchanges by allowing users to swap assets without an intermediary (in other words, decentralized). Uniswap, an automated market maker on Ethereum does this too, however, Uniswap only provides such swapping for ERC20 tokens. THORChain enables users to exchange native, non-wrapped, assets across chains. You can swap BTC on the Bitcoin network for ETH on the Ethereum network out of your own BTC wallet. You can also receive ETH back into your ETH wallet without transferring your tokens anywhere else. Centralized exchanges, on the other hand, typically require you to send tokens to them, meaning they will have custody over your tokens for the transaction.

THORChain has great memes
THORChain wouldn’t even be visible compared to other big exchanges
Tokenomics of Thorchain

THORChain Protocol

  • RUNE has a total supply of 500m tokens. The distribution at its initial launch was approximately: a little under 220.5m allocated to the protocol reserve for paying node operators and liquidity providers; 52.5m allocated to operational reserve for staff incentives, sales, etc.; 52m allocated to the community; 50m allocated to the team & advisors; 26m allocated to seed investors; and a little over 99m in circulation.
THORChain supply distribution
  • The protocol also enables a pendulum functionality to balance capital in liquidity pools against capital bonded by THORNodes. This has to do with the control that THORNodes have over liquidity pools. A large enough deposit from node operators will ensure the safety of the network (more on this in the “THORNodes” section below).

Exchanges

  • Users connect to THORChain via exchanges. THORChain is the L1 solution providing all the infrastructure to make the decentralized exchange process work. Exchanges can use this infrastructure via APIs (Midgard) and implement their own solutions (see THORSwap and Shapeshift).
  • Fees for swaps are paid by the user in RUNE and such fees are then distributed to the liquidity provider and THORNode operators. Users are required to use RUNE in order to pay for swaps on THORChain.

Liquidity

  • Liquidity pools are a common concept of other automated market makers (AMMs) such as Uniswap and Sushiswap. The key difference with these AMMs is that THORChain makes it so that every pool is matched to RUNE. Accordingly, THORChain’s ETH pool will have an equivalent amount of RUNE, instead of being matched to the currency it might be swapped to. For comparison, Uniswap has pools for every possible trade pair (like USDT:ETH, USDT:SUSHI, USDT:UNI, etc.).
  • Fewer pools means that the pools are going to be deeper. All ETH can be in one pool, regardless of the currency it is swapped with. It just needs to be matched to RUNE.
  • Liquidity providers (LP) can deposit an equivalent amount of RUNE or have their deposit token converted into RUNE automatically. The protocol will sell half of the LP’s deposit (e.g., ETH) for RUNE in order to ensure that the proper balance is maintained.
  • Technically, liquidity pools are just wallets for different chains that are controlled by THORNodes.

THORNodes

  • To control the wallets of liquidity pools, THORNodes have to run a node for each blockchain that they support plus an additional THORChain node.
  • In order to execute a swap between ETH and BTC, a THORNode will observe the Ethereum network for locking of funds, and will then release funds in the Bitcoin wallet once the lockup on Ethereum is completed.
  • Once completed, the THORNodes sign the outgoing transaction using a threshold signature scheme (TSS) that works with cryptography instead of smart contract logic. This allows the THORNodes to interact with chains like Bitcoin (which does not support smart contracts). In principle, TSS is like a multisig wallet and requires a majority of THORNodes to sign the transaction.
  • Similar to staking, THORNodes have to deposit a bond of RUNE in order to become active validators. The bonding amount depends on the total amount of RUNE in the liquidity pools. The total RUNE bonding of all THORNodes needs to be twice as much as the amount of all RUNE held in liquidity pools. Remember, pooled amounts are matched 1:1 with RUNE.
  • In summary, every $1 of assets is backed by $3 in RUNE.
  • The functionality creates protection from sybil-attacks, where an attacker tries to take over the majority of a network to get access to pooled assets. The amount of RUNE bonded and in pools helps prevent this attack, since RUNE would accordingly drop in value on the occurrence of such an attack and thereby make the attack unprofitable.
  • An incentive pendulum keeps bonds and pools in balance by incentivizing liquidity providers to pool more assets when over-bonded, and incentivizing node-operators to bond more assets when under-bonded. The current stats can be found here or here. As of writing, bonding yields ~15% and pooling ~20%.
Optimal distribution
Unsafe distribution
inefficient distribution
  • The fees are currently supported by protocol inflation (issuance) but are planned to be fully paid by swap fees obtained in connection with swapping.

Other Projects on THORChain

THORChain is not just about cross-chain swaps, as it is building an ecosystem around pooled cross-chain assets.

Closing Thoughts

A decentralized exchange, as an alternative to Binance or Coinbase, is what crypto users really need. Decentralised exchanges offer custody over your tokens during the whole process and reduce the risk of having to trust in a centralised entity to take care of your funds. THORChain might not offer all of the tokens that one may want to trade, but it is a big step in the right direction. Based on demand, more will follow and could turn THORChain into THE place to swap tokens.

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Florian Strauf

tech guy curious about investing, crypto, decentralization and technology in general.