Original author: Yilan, LD Capital

Introduction

When delving into Thorchain's new lending module launched on August 22, we discovered shadows of Terra LUNA, with the similarity being that the collateral deposited by users is exchanged for RUNE. In reality, the inflation and deflation of RUNE is determined by the fluctuation of the RUNE-collateral exchange rate, just like how LUNA absorbs the volatility of UST through inflation and deflation. However, the two differ in their performance (RUNE participates in lending and is destroyed and minted during loan opening and closing, while LUNA participates in stablecoin anchoring and is destroyed and minted by arbitrageurs when UST is unanchored) and the amount of risk behind them (LUNA has no upper limit on minting, while RUNE has an upper limit on inflation and deflation, and only 50% of the collateral for synthetic assets is RUNE). Additionally, the lending protocol has strict risk control and risk isolation measures, so the overall risk is relatively small and will not produce systemic risks like Terra LUNA, even if a negative spiral occurs, it will not affect Thorchain's other functions.

1. Understanding Thorchain's Lending Mechanism

Thorchain's lending feature is characterized by zero interest, no liquidation risk, and no time limit (during the initial period, the minimum loan term is 30 days). For users, it essentially means holding collateral assets in empty USD and long BTC/ETH; for the protocol, it essentially means holding empty BTC/ETH and long USD. Debt is denominated in TOR (Thornchain's USD equivalent), so users are similar to buying BTC's OTM call options in a gold standard period, and the protocol/RUNE holders are the counterparties.

Opening a new loan will have a deflationary effect on $RUNE assets, while closing a loan will have an inflationary effect on $RUNE assets. BTC collateral will be exchanged for RUNE, then destroyed, and finally minted into the assets required for RUNE exchange. In this process, the difference between the value of the collateral and the debt, minus fees, corresponds to the net destruction value of RUNE.

If the collateral rises during repayment and 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 not to mint so much RUNE. If the price of RUNE falls, inflation will be more severe. If the collateral falls during repayment and the price of RUNE remains unchanged, the user may choose not to repay (no minting will occur).

If the value of RUNE relative to $BTC remains unchanged during loan opening and closing, then $RUNE will not have a net inflationary effect (the amount destroyed is equal to the amount minted minus the exchange fee). However, if the value of collateral relative to RUNE increases between loan opening and closing, then the supply of $RUNE will experience net inflation.

In order to address the inflation issue, lending control measures are already in place - if minting causes the total supply to exceed 5 million RUNE, there is a circuit breaker design. In this case, reserves will intervene to redeem loans (rather than further minting), the entire lending design will stop and be discontinued, but other aspects of THORChain will continue to operate normally.

Therefore, the entire lending process has a significant impact on the inflation and deflation of RUNE. However, when the overall lending cap is low, there is a limit to both inflation and deflation. When the RUNE-collateral ratio continues to rise, the maximum deflation is capped at the current maximum opening amount of 15mln*0.33 (0.33 is the lending lever, which might change), which is 4.95mln (may increase in the future). In the case of an infinite drop in the RUNE-collateral ratio, inflation is also controlled by a circuit breaker within 5mln.

Specifically, if a user over-collateralizes by 200% and borrows 50% of the required assets, the other 50% is minted based on the RUNE collateral rate upon redemption. This step is essentially similar to LUNA, but under the Thorchain Lending mechanism, the product capacity is smaller due to only 50% of Rune being backed, resulting in relatively lower overall risk and no systemic risk like Terra LUNA. This risk is isolated and will not affect other Thorchain functions even in the event of a negative spiral.

1. How to understand the design of lending is similar to a deep virtual, resettable strike price call option for users

When Alice gives 1 BTC, she also receives 50% cash (when CR is 200%) and the opportunity to purchase 1 BTC with this cash.

If BTC rises when repayment is due (assuming one month later), Alice will repay the debt (i.e. the value of 50% of BTC one month ago), and buy one BTC at the price of one month ago if it is higher. If BTC drops significantly, more than 50%, Alice chooses not to repay the debt, and the protocol will not generate inflation caused by mint rune (which means Alice's long position fails).

2. How to understand no borrowing interest

Can be seen as the user paying multiple swap fees instead of interest rates, and its essence is also a CDP product. If borrowing interest is charged again, the attractiveness of this product to users will be even smaller.

The entire process of borrowing and lending is as follows:

Users can deposit native assets as collateral (BTC, ETH, BNB, ATOM, AVAX, LTC, BCH, DOGE). In the initial stage, collateral is limited to BTC and ETH. The maximum amount of collateral that can be accepted per vault (vault ceiling) is determined by the hard cap (15mln), lending lever, and pool depth coefficient. Over-collateralization generates debt, and the proportion of debt that can be obtained is determined by CR.

Borrowing: Alice deposits 1 BTC, which is first exchanged for RUNE in the BTC-RUNE swap pool. These RUNE are then sent to a V BTC pool where they are destroyed and converted into a derivative asset called Thor.BTC. The collateral for the synthetic asset is a constant product liquidity, which is always 50% of the asset, with the remaining 50% being RUNE. The derivative asset Thor.BTC is then sent to an Internal module, where a dynamic CR (collateral ratio) determines how much loan can be obtained, and Thor.Tor (similar to USD) tokens are generated as a means of accounting for the loan. These steps are entirely for internal accounting purposes, and then USDT loans are generated and given to Alice for her use.

Repaying loans: When Alice repays the loan, she sends all USDT or other Thorchain-supported assets to the protocol and converts them to RUNE. RUNE will mint Tor, and the protocol will check if the user has repaid all loans priced in Tor. If all loans are repaid, the collateral will be released and converted to derived collateral (Thor.BTC), and then this derived asset will be minted back to RUNE and swapped back to L1 BTC. RUNE is minted during this process.

It should be noted that these swap and convert processes will incur transaction fees (at least 4 swap fees per loan), so the total amount of repayment needs to be slightly higher than the actual amount to cover these swap fees. Although there is no interest, the collection of these multiple transaction fees can be seen as a substitute for interest. Despite the significant wear and tear, the RUNE-form transaction fees generated are destroyed, which is a real deflationary measure.

3. How to understand the absence of clearing and no repayment time limit

Due to the fact that the debt of TOR stablecoin pricing is fixed, when borrowers repay, they can choose to repay with any asset, but in reality, it will be exchanged for RUNE through the market, and liquidity providers and depositors will not directly lend their assets to borrowers. The pool is only a medium for exchanging collateral and debt, and the whole process is a gambling behavior, which is the reason for no liquidation. The protocol needs to use RUNE to repay enough TOR (complete repayment) to help users get back their collateral. If the price of collateral drops significantly, users may choose not to repay (and this part of RUNE will not be re-minted, resulting in net destruction). In fact, the protocol does not want users to repay. If users repay when the price of collateral rises and the price of RUNE falls, it will cause inflation.

4. Understanding the inflation and deflation of RUNE as a transaction medium

First of all, the total upper limit of all lending pools is determined by multiplying the RUNE Burnt in the gray area of the following figure by the Lending lever. The 15 million RUNE Burnt is the result of the protocol burning non-upgraded BEP2/ERC20 RUNE in the past. Therefore, it can be seen that the protocol currently has a space of 15 million before reaching the maximum supply of 500 million RUNE for inflation.

The previous section also introduced the role of RUNE in the entire borrowing process (you can review the mechanism part in the previous section). Opening a new loan will have a deflationary effect on the RUNE asset, while closing a loan will have an inflationary effect on the RUNE asset.

If the collateral rises during repayment and 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 mint less RUNE. If the price of RUNE falls, inflation will be more severe. If the collateral falls during repayment and the price of RUNE remains unchanged, the user may choose not to repay (no minting will occur).

If the value of RUNE relative to BTC remains unchanged during loan opening and closing, then RUNE will not have a net inflationary effect (the amount destroyed is equal to the amount minted minus the exchange fee). However, if the value of collateral assets relative to RUNE increases between loan opening and closing, then the supply of RUNE will experience net inflation.

In order to address the inflation issue, lending control measures are already in place - if minting causes the total supply to exceed 5 million RUNE, there is a circuit breaker design. In this case, reserves will intervene to redeem loans (rather than further minting), the entire lending design will stop and be discontinued, but other aspects of THORChain will continue to operate normally.

If calculated based on the parameters in the figure, the total amount of all debt pools is currently only 4.95mln RUNE. That is, all debt pools can accept collateral equivalent to 4.95mln RUNE.

Source：GrassRoots Crypto

The entire Reserve's RUNE Burnt is the buffer for all debt positions and the last resort for inflation. The total amount of 4.95 million RUNE Burnt* Lending lever in Reserve (currently) will be allocated according to the depth of each debt pool. The deeper the depth, the more Reserve buffer will be allocated. For example, if the depth of the BTC Lending pool is twice that of the ETH Lending pool, then the value of the depth coefficient of Reserve's Rune Burnt*Lending lever* in this lending pool is the maximum collateral limit that can be borne. Therefore, when the price of RUNE rises, the amount of collateral that can be accepted in this pool also increases. It can also be seen that Lending lever and the price of RUNE jointly determine the upper limit of collateral that the lending pool can accommodate.

THORChain protocol and all RUNE holders are counterparties for each loan. The mechanism of burning/minting RUNE means that RUNE is condensed/diluted (among all RUNE holders) when debt is opened and closed. When the RUNE-collateral ratio drops, inflation occurs, and vice versa for deflation.

5. Is CDP protocol a good on-chain absorption mode?

For Thorchain's launch of Lending, it is a disguised way of attracting deposits and using RUNE as an essential medium in the borrowing and repayment process, which increases the scenes of destruction and casting.

So, is this kind of fund-raising model advantageous? Let's first take a look at some other fund-raising models in different fields.

CEX is the most obvious beneficiary of the storage mode, as it also serves as a custodian, and in many cases, this portion of funds can generate more profits (after the reserve requirements are disclosed, this portion of profits has decreased significantly compared to before). How to protect the security of user custodial funds is also something that regulatory frameworks need to clarify, and regulators usually hope that exchanges will fully reserve funds.

The situation on the chain is completely different.

After DEX liquidity mining, LP needs to be highly incentivized. Therefore, the purpose of liquidity mining is to deepen liquidity, and cannot directly generate profits from the "deposits" provided by LP. Instead, it forms a liquidity moat through a large reserve.

Pure Lending, similar to Aave or Compound, requires paying interest costs to attract deposits. The entire model is no different from traditional lending, such as the need to actively manage loan positions and have repayment deadlines.

Compared to excess collateralized debt position (CDP), absorption mode is a healthier mode. Due to the high volatility of collateralized assets, most excess collateralized CDPs in the market are currently users' excess collateralization of certain assets to obtain stablecoins or other assets. In this process, the CDP protocol actually obtains 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 held? In fact, the collateral is exchanged for RUNE through the liquidity pool. Therefore, no one "stores" the collateral. As long as the THORChain pool is healthy and running normally, any collateral deposited will be exchanged for RUNE, and then arbitrageurs will rebalance the pool as usual. This can be seen as the collateral being deposited in Thorchain's RUNE pair pool with other currencies. Because BTC and other collateral enter the circulation market instead of being held in the protocol, although the generated debt is 100% collateralized, the difference between the collateral value and the debt value is determined by the value of RUNE, which casts a shadow over the entire mechanism similar to Terra LUNA.

Capital Sink may be one of the goals that Thorchain lending wants to achieve, using users' collateral assets to settle as asset liquidity in the swap pool. As long as users do not close the loan and the price of RUNE does not drop significantly, the protocol retains assets, and RUNE generates deflation, forming a good positive cycle. Of course, the opposite will create a negative spiral.

6. Risk

BTC and other collateral have entered the circulation market instead of being held in the protocol, so although the generated debt is 100% collateralized, the difference between the collateral value and the debt is determined by the value of RUNE, which casts a shadow over the entire mechanism similar to Terra LUNA. Due to the fact that the RUNE burned for opening loans and the RUNE minted for closing loans may not be exactly equal, there may be both deflationary and inflationary situations, which can be understood as deflation when the price of RUNE rises during repayment and inflation when it falls. If the price of RUNE falls below the lending lever multiple at the time of opening, the circuit breaker will be triggered. Throughout the lending process, the price of RUNE plays a decisive role in determining deflation and inflation. When the price of RUNE falls, the risk of inflation is still high as many users choose to close their loans. However, the protocol has strict risk control and risk isolation measures, so the overall risk is relatively small and there will be no systemic risks similar to Terra LUNA, even if a negative spiral occurs, it will not affect other functions of Thorchain.

Lending lever, CR, and whether to enable different collateral debt warehouses have become the three pillars of Thorchain lending risk control.

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

二． 结论

translates to

2. Conclusion

in English.

The launch of Thorchain Lending product generates network effects, additional trading volume, and higher pool capital efficiency, driving the system to generate real returns and increase the total bonded amount, allowing Thorchain to potentially gain upward momentum by reducing the circulating supply (when the RUNE collateralization ratio increases).

Capital sink (perhaps a goal that Thorchain lending wants to achieve) uses users' collateral assets to deposit liquidity into the swap pool. As long as the user does not close the loan and the price of RUNE does not drop significantly, the protocol retains the assets and RUNE generates deflation, forming a good positive cycle.

However, in fact, the reverse market trend may lead to inflation and negative spirals. In order to control risks, the use of Thorchain lending is limited and the capacity is small. In terms of overall deflation and inflation, it will not have a fundamental impact on the price of RUNE in the current capped volume (at most 5 million RUNE impact).

Additionally, for users, Thorchain's capital efficiency is not high, with a CR between 200%-500%, which may ultimately fluctuate between 300%-400%. From a leverage perspective alone, it is not the best product. Furthermore, although there are no borrowing fees, the multiple internal transaction fees can also be unfriendly to users.

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

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