Original author: 1984 is today, Thorchain core member
Original translation: zhouzhou, BlockBeats
Editors note: Thorchain faces serious debt problems. Despite the risks, the protocol still has huge business potential, generating more than $30 million in fees each year. Measures such as freezing lending and depositor positions, deleveraging, and tokenizing debt can save the protocol and maintain its core liquidity. At the same time, an economic design committee is established to ensure that the protocol returns to basic principles, improves capital efficiency, and prevents it from falling into debt again.
The following is the original content (for easier reading and understanding, the original content has been reorganized):
THORChain goes bankrupt, and in the event of a large debt redemption or depositor deleveraging with synthetic assets, TC will be unable to fulfill its debts denominated in Bitcoin and Ethereum.
The validators decided to pause the network while they vote on a reorg plan. I’m not going to beat around the bush and pretend that everything is fine, because it’s not.
Thorchain’s liabilities:
$97 million in loan liabilities (ETH BTC)
~$102 million in depositors and synthetic liabilities (ETH BTC)
Thorchain’s assets are $107 million of external liquidity injected into the liquidity pool. If there is a panic, LPs can withdraw these assets at any time, or rune holders can sell them. Lending obligations are satisfied by minting RUNE and selling them into the liquidity pool, which makes the design highly inverse and the situation is worse than it looks. After paying off $4 million of RUNE liabilities yesterday, the protocol still owes millions of RUNE.
By design, the protocol is short Bitcoin and Ethereum. I have been warning about the dangers of hidden leverage since I joined the community (since ILP). I have been advocating for deleveraging since the launch of streaming exchanges, and protocols require less capital to fill because now active liquidity can participate in filling them.
I am not happy writing this, please do not blame the messenger, I am speaking out because Thorchain has become so complex that only a few people can fully understand how leverage features and liquidity interact and affect the underlying assets. If no action is taken, it will become a race to escape and the value of the entire protocol will disappear.
Thorchain has two options:
1. Let things continue to develop, about 5-7% of the value will be extracted by a few people first, RUNE will enter a downward spiral, and THORChain will be destroyed.
2. Default, bankruptcy, salvage the valuable part, and develop it as much as possible to repay the debt without affecting the feasibility of the agreement.
Option 1: The first $75 million to exit are repaid in full, and $1.5 billion in value is wiped out.
Option 2: The value of the network is preserved and everyone works together to restore the $200 million in capital.
To make option 2 possible, we need to be guided by the principle of saving the network and increasing its value. This starts with the partners, which I will elaborate on later. I just want the partners to read this and know that if this proposal is accepted, they will be the priority class again.
Thorchain is valuable, it generated over $30 million in fees last year, is currently running at higher rates, and is fully capable of getting out of this mess. I have been working with the few people who really understand Thorchains economic design to come up with this solution. Steve will post it on the developer Discord, and he writes it better than I can.
The current proposal is equivalent to Chapter 11 bankruptcy protection. Bitfinex has done something similar and ultimately succeeded in getting its users fully compensated.
There are two types of liquidity in the ecosystem that are necessary for exchanges to continue:
The first people to be protected are LPs.
Arbitrageurs using trading accounts are not affected by this freeze.
Thorchain is too complex and must return to basic principles to grow. Until then, no smart capital can buy RUNE or LPs because the risk is too great. A public large debt will become liquidation bait, as we have seen many times in DeFi.
Here’s what we think Thorchain needs to do if it is to survive this crisis and thrive after it:
All lending and depositor positions will be permanently frozen.
Take a snapshot of debt (value for depositors, BTC/ETH debt for borrowers).
Tokenize all loans and depositors’ claims.
Create a Relief Module that will automatically receive 10% of the systems revenue.
Create an auction determined by buyers where tokenized claim holders can sell their claims at any time to available liquidity in the unwind module, and any seller who obtains this liquidity will burn their claims.
Create a secondary market for P2P trading of tokenized claims.
Implement a kill switch and incentivize withdrawals from the RUNE pool, shutting down the RUNE pool within a month.
Destroy the keys to all POL wallets, thus preventing further interference with POL by central planners.
The value of Thorchain has been suppressed because it has been inaccessible for so long. Smart capital will not participate in LPs, and once they analyze its complexity, they will find that something is wrong. The product itself is not only operating successfully, but even thriving, generating approximately $200,000 in fees per day.
If Thorchain is to grow and have any chance of fully compensating its users, it needs a fresh start. Any unsustainable debt burden must be eliminated.
Mitch Will of CRV had what seemed like relatively reasonable leverage, and despite adoption, CRV price kept falling until he was liquidated. I think we are very close to a similar consensus for Thorchain.
In the case of Thorchain, the debt is at the protocol level and is more inverse than CRV, as the protocol is short Bitcoin and selling uncirculated RUNE. The “collateral” shown on the dashboard is backed by uncirculated RUNE, not liquidity.
Not only do loan redemptions mechanically sell RUNE, but the protocol is actually shorting $175M of BTC/ETH/other assets. For borrowers, this collateral has been exchanged for RUNE to reduce the supply of RUNE.
On exit, Thorchain must mint RUNE and sell it for BTC/ETH to repay. Due to price volatility since lending began, we are already facing a 30 million RUNE shortfall from lending activity, which could trigger a kill switch if all redemptions were made in a chaotic manner. The price of RUNE would then fall below $1. Depositors still have $100 million in redemption demand.
This future selling pressure will go into an increasingly illiquid pool. And as the market reaction spreads, we simply cannot risk having the RUNE price crash and not being able to pay these people back.
Again, Thorchain’s saving grace is over $30 million per year in interchange fees and a growing revenue run rate, it still has a fantastic business that just needs to get rid of the toxic debt on its balance sheet. ThorFI needs to be seen as a mistake, and we need to return to what Thorchain was originally built for: a return to first principles.
The situation can still be corrected and we can clean up everything in the following week. If we let the market panic and everyone sells RUNE and redeems their assets, it will lead to bankruptcy. Every day is critical and in this case, once the market understands and panics, it will be too late.
This will have the effect of bringing Thorchain back to first principles: LPs and trading accounts will provide liquidity to the exchange. There is no scenario where everyone will be reimbursed in full and immediately. This scheme preserves those who are essential to the safe operation of the protocol, ensuring that the protocol can continue to operate safely.
The goal of all these incentives is to grow liquidity to irrational levels. Liquidity in pools needs to be based on fundamental principles. It is a factor of returns and expected volatility. The volume of each pool is related to the debt/fees, and the liquidity pool will naturally attract more liquidity to join. All these incentives create additional impermanent loss, and LPs are treated the worst because of this. They sat in the worst position. From now on, they will sit in the best position.
The original founding team designed and drove the implementation of these inverse leverage features, please do not blame the messengers or the current development team, they are picking up the pieces. The two founders are no longer involved in day-to-day operations.
Once this is complete, I will propose the formation of an Economic Design Committee to help ensure Thorchain is successful by:
Improve capital efficiency
Never build leverage features into it again
Ensure Rujira does not endanger the L1 ecosystem
I already have three candidates who are the smartest minds in the DeFi space.
I wrote a bit about capital efficiency optimization, but I’ll save that for another ADR. This is important because if we are to allocate a certain percentage of income to debt, LPs still need to overcome impermanent loss. We need to do more with less.
This is the worst situation I and other developers have ever been involved in, some of them are almost throwing up. If there was any other way, I would suggest it. This is a life or death situation. I have always been against lending/depositors/ILP/POL. Throughout this process, I have suggested that my delegators vote against these, and some did, but not enough.
If there is only one lesson I have learned, it is that sometimes it is better to start a civil war than to stand aside and watch when you foresee a certain outcome in advance. I am sorry that things have turned out this way, and I have barely slept in the past few days, knowing that this outcome was inevitable. The $12 million loan redemption accelerated this timeline.
