Exploring THORChain Lending Module: Revealing the Hidden Shadow of Terra LUNA

Author: Yilan, LD Capital

Introduction

In-depth study of the new loan module launched by Thorchain on August 22, we found the shadow of Terra LUNA, and the similarity with LUNA is mainly reflected in the fact that the collateral deposited by the user is converted into RUNE, which is actually RUNE-the exchange rate of the collateral rises and falls Determine the inflation and deflation of RUNE, that is, RUNE absorbs the volatility of RUNE-collateral exchange rate through inflation and deflation, just like LUNA absorbs the volatility of UST, but the two manifestations (RUNE participates in lending, in the loan opening Destroy and mint when holding and closing positions, LUNA participates in stablecoin anchoring, destroys and mints through arbitrageurs when UST is unanchored)) and the risk volume behind it (LUNA has no upper limit for casting, RUNE has an inflation and deflation upper limit and The collateral of synthetic assets is only 50% RUNE). Moreover, the lending agreement has implemented strict risk control and risk isolation measures,** so the overall risk is relatively small and will not cause systemic risks similar to Terra LUNA, even if a negative spiral occurs, it will not affect other functions of Thorchain. **

one. Understanding Thorchain Lending Mechanism

The characteristics of Thorchain lending are that there is no interest, no liquidation risk, and no time limit (initial period, the minimum loan period is 30 days). **For users, the essence is to be short USD and more BTC/ETH mortgage assets; for the agreement The essence is to short BTC/ETH and long USD. **The debt is denominated in TOR (the USD equivalent of Thornchain), so the user is similar to the gold standard option to buy the OTM call of BTC, and the holder of the agreement/RUNE is the counterparty.

Opening new loans has a deflationary effect on $RUNE assets, and closing loans has an inflationary effect on $RUNE assets. The BTC collateral will be exchanged for RUNE first, then burned, and finally the assets required for RUNE exchange will be minted. In this process, the difference between the collateral value and the debt, excluding the handling fee, corresponds to the net destruction value of RUNE.

If the collateral rises during repayment, then when the price of RUNE remains unchanged, more RUNE needs to be minted to exchange for the required assets, which will lead to inflation; if the price of RUNE rises, then there is no need for mint so many RUNE is ideal In this situation, if the price of RUNE falls, the inflation will be more serious. If the collateral falls during repayment, the price of RUNE remains unchanged, and the user may choose not to repay (no minting).

If the value of RUNE relative to $BTC remains the same as the loan opens and closes, then $RUNE will have no net inflationary effect (the same amount burned as the amount minted minus swap fees). However, if the value of collateralized assets relative to RUNE increases between the opening and closing of the loan, then the $RUNE supply will be net-inflationary.

To account for inflation, lending controls are in place - there is also a circuit breaker design if minting causes the total supply to exceed 5 million RUNE. In this case, the reserve will step in to redeem the loan (instead of further minting), and the entire lending design will cease and be decommissioned, but other aspects of THORChain will continue to function normally.

Therefore, the entire borrowing process has a greater impact on RUNE's inflation and deflation, but there is an upper limit for inflation and deflation when the overall lending cap is low. When the RUNE-collateral exchange rate rises infinitely, the maximum deflation will be the largest The open position is currently 15mln*0.33 (0.33 is the lending lever, might change), that is, 4.95mln (may increase in the future). In the case of the RUNE-collateral exchange rate falling infinitely, inflation is also controlled within 5mln by the circuit breaker.

**Specifically, if the user overcollateralizes 200% of the collateral to lend 50% of the required assets, the other 50% is minted according to the RUNE-collateral exchange rate when redeeming. This step is essentially similar to LUNA, except that under the Thorchain Lending mechanism, since the Rune back part is only 50% and the product capacity is small, the overall risk is relatively small, and there will be no systemic risk similar to Terra LUNA. Partial risk isolation, even if a negative spiral occurs, it will not affect other functions of Thorchain. **

1. How to understand that the design of lending is similar to a bullish option with deep out-of-the-money and resettable strike price for users

When Alice gives 1 BTC, she also gets 50% cash (in the case of 200% CR) and the opportunity to buy 1 BTC with this cash.

If BTC rises during repayment (assuming one month later), Alice repays the debt (that is, equivalent to 50% of the value of BTC a month ago), and buys this BTC at the price of BTC a month ago. If it falls a lot, it exceeds 50 %, Alice chooses not to repay the loan, and the agreement will not generate inflation caused by mint rune (for Alice, she failed to do long).

2. How to understand without borrowing interest

It can be seen that the user has paid multiple swap fees instead of the interest rate, and its essence is also a CDP product. If borrowing interest is charged, this product will be less attractive to users.

The whole process of borrowing is as follows:

The user deposits the collateral of the original assets (BTC, ETH, BNB, ATOM, AVAX, LTC, BCH, DOGE). In the initial stage, the collateral is limited to BTC and ETH. How much collateral each debt warehouse can accept (debt warehouse upper limit) is determined by the hard cap (15mln), Lending lever, and pool depth coefficient. Overcollateralization creates debt, and the proportion of available debt is determined by CR.

**Borrowing: **Alice deposits 1 BTC, and this BTC will be exchanged for RUNE in the BTC-RUNE swap pool first, and these RUNE will enter a V BTC pool and be destroyed and converted into a derivative asset Thor.BTC at the same time, **synthesized The collateral of the asset is the constant product liquidity, which is always 50% of the asset, and the remaining 50% is RUNE. ** Then the derivative asset Thor.BTC is sent to an Internal module, where there is a dynamic CR (mortgage rate) to determine how much loans can be obtained, and Thor.Tor (similar to USD) tokens are generated as credits for loans account means. The steps that take place here are purely for internal accounting purposes, followed by the creation of a USDT loan at Alice's disposal.

Loan Repayment: When Alice repays the loan, she sends all USDT or other Thorchain-backed assets to the protocol and converts them to RUNE, RUNE will mint Tor, and the protocol checks whether the user has returned all Tor-denominated loans, and if so All returns, the collateral will be released and converted into derived collateral (Thor.BTC), and then the derived asset will be minted back to RUNE, and then swapped back to L1 BTC. During this process RUNE is cast.

It should be noted that these swap and convert processes will generate handling fees (a loan will generate at least 4 swap fees), so the total amount of repayment needs to be more than the actual amount to pay these swap fees. Although there is no interest, this kind of The collection of multiple handling fees can actually be regarded as a substitute for interest. Although the wear and tear is huge, the generated RUNE fee is destroyed, which is a real deflation.

3. How to understand no liquidation and no repayment time limit

Since the debt denominated in the TOR stable currency is fixed, in fact, although the borrower can choose any asset to repay the repayment, it will actually be converted into RUNE through the market,** and liquidity providers and depositors will not directly transfer their assets lend to the borrower. The pool is just a medium for exchanging between collateral and debt, and the whole process is a gambling behavior, which is why there is no liquidation**. The protocol needs to use RUNE to repay enough TOR (full repayment) to help users get back the collateral. If the price of collateral drops a lot, the user chooses not to repay (at the same time, this part of RUNE will not be recast, resulting in net destruction). **In fact, the agreement does not want users to repay. If the price of collateral rises and the price of RUNE falls, user repayment will cause inflation. **

4. How to understand the deflation and inflation of RUNE as a trading medium

First of all, the total upper limit of all lending pools is determined by multiplying the RUNE Burnt part in the gray part of the figure below by the Lending lever, and the RUNE Burnt of 15mln is the result of burning non-upgraded BEP2/ERC20 RUNE in the previous protocol. Therefore, it can be seen that the agreement is currently 15mln away from the maximum supply of 500mln RUNE for inflation.

The above also introduces the role of RUNE in the entire borrowing process (you can review the above section on the mechanism). Opening new loans has a deflationary effect on RUNE assets, and closing loans has an inflationary effect on RUNE assets.

If the collateral increases during repayment, then when the price of RUNE remains unchanged, more RUNE needs to be minted to exchange for the required assets, which will lead to inflation; if the price of RUNE rises, it is ideal to not need to mint so many RUNE In this situation, if the price of RUNE falls, the inflation will be more serious. If the collateral falls during repayment, the price of RUNE remains unchanged, and the user may choose not to repay (no minting).

If the value of RUNE relative to BTC remains the same when the loan is opened and closed, then RUNE will have no net inflationary effect (the amount burned is the same as the amount minted minus swap fees). However, if the value of collateralized assets relative to RUNE increases between the opening and closing of the loan, then the RUNE supply will be net-inflationary.

To account for inflation, lending controls are in place - there is also a circuit breaker design if minting causes the total supply to exceed 5 million RUNE. In this case, the reserve would step in to redeem the loan (instead of further minting), and the entire lending design would cease and be decommissioned, but other aspects of THORChain would continue to function normally.

If calculated with the parameters in the figure, in fact, the total amount of all debt warehouse pools is only 4.95mln RUNE at present. That is, all debt warehouses can accept collateral equivalent to 4.95mln RUNE.

Source：GrassRoots Crypto The RUNE Burnt of the entire Reserve is the Buffer of all debt warehouses and the last resort where inflation occurs. The total amount (currently) of 4.95mln of RUNE Burnt* Lending lever in the Reserve will be allocated according to the depth of each debt warehouse pool, and the deeper the depth is allocated The more Reserve buffers are obtained, for example, the depth of the BTC Lending pool is twice the depth of the ETH Lending pool, then the value of the Rune Burnt*Lending lever*depth coefficient in the Reserve is the maximum mortgage limit that can be borne in this lending pool , therefore, when the price of RUNE rises, the pool can accept more collateral. It can also be seen that the price of Lending lever and RUNE jointly determine the upper limit of collateral held by the lending pool.

The THORChain protocol and all RUNE holders are counterparties to each loan. RUNE's burn/mint mechanism means that RUNE condenses/dilutes (among all RUNE holders) when debt is opened and closed. When the exchange rate of RUNE-collateral falls, inflation occurs, and vice versa, deflation occurs.

5. Is the CDP protocol a good chain storage model?

**For the Lending launched by Thorchain, it is such a disguised storage and uses RUNE as an indispensable medium in the process of borrowing and repaying, adding destruction and casting scenarios. **

**Then is there an advantage to this storage mode? First, let’s look at the storage modes of other tracks. **

CEX is the most obvious beneficiary of the deposit absorption model, because at the same time as the custodian, this part of the funds can generate more income in many cases (this part of the income is much less than before after the reserve is required to be disclosed), how to protect the user custody funds Security This is also something that the regulatory framework needs to clarify, and regulators usually want exchanges to fully reserve.

The situation on-chain is completely different.

After DEX absorbs reserves, it needs to give LP a high incentive. Therefore, the purpose of absorbing reserves is to deepen liquidity. It cannot directly use the "deposits" provided by LPs to generate benefits, but forms a liquidity moat through huge reserves.

Pure Lending is similar to Aave or compound. It needs to pay the interest rate cost for deposit absorption. The whole model is no different from traditional lending. For example, it needs to actively manage the borrowing position, and there is a time limit for repayment.

In contrast, the CDP model is a healthier model for deposit absorption. Due to the high volatility of mortgage assets, most of the over-collateralized CDPs in the market are users who over-mortgage certain assets and obtain certain stablecoins/other assets. In this process, the CDP agreement actually obtained more "deposits". And there is no need to pay interest on this part of the deposit.

Thorchain also belongs to this CDP model, so where is the collateral hosted? In fact, collateral is exchanged for RUNE through liquidity pools. Therefore, no one "stores" collateral. As long as the THORChain pool is healthy and functioning, any collateral deposited will be swapped for RUNE, and then the arbitrageur will rebalance the pool as usual. It can be seen here that the collateral is deposited in Thorchain's RUNE pair pool against other currencies. **Because BTC and other collaterals have entered the circulation market rather than being escrowed in the agreement, although the generated debt is 100% mortgaged, the difference between the value of the collateral and the debt is determined by the value of RUNE, thus The whole mechanism is covered with a shadow similar to Terra LUNA. **

Capital Sink may be one of the goals that Thorchain lending wants to achieve. The user's mortgage assets are deposited into the asset liquidity in the swap pool. As long as the user does not close the loan and the price of RUNE does not drop sharply, the agreement will keep Assets, RUNE produces deflation, forming a good positive cycle. Of course, doing the opposite creates a negative spiral.

6. Risk

**BTC and other collaterals have entered the circulation market rather than being escrowed in the agreement. Therefore, although the generated debt is 100% collateralized, the difference between the value of the collateral and the debt is determined by the value of RUNE, thus giving the entire The mechanism casts a shadow similar to Terra LUNA. **Because the RUNE that turns on the loan burn and the RUNE that turns off the loan mint are not necessarily exactly equal, there will be two situations of deflation and inflation. It can also be understood that the price of RUNE rises during repayment, resulting in deflation, and vice versa. If the price of RUNE falls below the price of the lending lever when the position was opened, the circuit breaker will be triggered. Throughout the lending process, the price of RUNE plays a decisive role in deflation and inflation. When the price of RUNE goes down, a large number of users choose to close their loans and the risk of inflation is still very high. **However, the protocol has strict risk control and risk isolation measures, so the overall risk is relatively small and will not cause systemic risks similar to Terra LUNA. Even if a negative spiral occurs, it will not affect other functions of Thorchain. **

The three factors of Lending lever, CR and whether to open different collateral debt positions become the three pillars of Thorchain lending risk control.

In addition, Thorchain has a history of being stolen and its code is relatively complex, and Thorchain Lending may also have vulnerabilities that need to be suspended or fixed.

two. in conclusion

The launch of Thorchain Lending products will generate network linkage benefits, additional transaction volume, and higher pool capital efficiency to drive the system to generate real income, increase the total amount of Total bonded, and enable Thorchain to gain potential growth by reducing the total amount of circulation (in RUNE- When the collateral exchange rate rises).

Capital sink (storage absorption may be a goal that Thorchain lending wants to achieve) uses the user's mortgage assets to deposit as asset liquidity in the swap pool. As long as the user does not close the loan and the price of RUNE does not drop sharply, the agreement retains the assets and RUNE When deflation occurs, a good positive cycle can be formed.

But in fact, the opposite market trend leads to inflation and a negative spiral is entirely possible. In order to control risks, Thorchain lending has limited use and a small capacity. Generally speaking, deflation and inflation will not have a fundamental impact on the price of RUNE in terms of the current cap volume (up to 5 million RUNE).

In addition, Thorchain’s capital efficiency is not high for users. CR is between 200%-500%, and may eventually fluctuate between 300%-400%. It is not the best product from the perspective of leverage. And although there is no borrowing fee, the wear and tear of multiple internal transaction fees is not friendly to users.

Only evaluating the product of lending cannot represent the development of the entire Thorchain defi product matrix. There will be a series of analyzes on other Thorchain products in the future.