With huge liabilities of nearly US$200 million, will THORChain be in trouble?

Original author: 1984 is today, core member of thorchain
Original compilation: zhouzhou, BlockBeats

The following is the original content (the original content has been edited for ease of reading and understanding):

THORChain goes bankrupt and TC is unable to meet its Bitcoin and Ethereum denominated debt in the event of large debt redemptions or depositor deleveraging with synthetic assets.

Validators have decided to pause the network, during which they will vote on the reorganization plan. I’m not going to beat around the bush and pretend everything is fine, because it’s not.

Thorchain 's liabilities:

• $97 million in borrowing liabilities (eth btc)
• Approximately $102 million in depositors and synthetic assets (eth btc)

Thorchain's assets were injected into the liquidity pool with $107 million of external liquidity. If panic occurs, LPs can withdraw these assets at any time, or rune holders can sell them. Borrowing obligations are met by minting RUNE and selling it into liquidity pools, making the design highly contrarian and the situation worse than it seems. After paying off $4 million in RUNE liabilities yesterday, the protocol still owes several million more RUNE.

By design, the protocol is short Bitcoin and Ethereum. Ever since I joined this community (starting with ILP), I have been warning about the dangers of hidden leverage. I have been advocating for deleveraging since the launch of streaming exchanges, where protocols require less capital to fill because now active liquidity can participate in filling them.

I'm not happy when I write this, please don't blame the messenger, I'm standing up because Thorchain has become so complex and only a few people can fully understand how the leverage characteristics and liquidity interact and affect the underlying asset of. If no action is taken, this will become a race to escape and the value of the entire agreement will be lost.

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, rescue 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 will be 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 guiding principle of saving the network and increasing its value. This starts with the partners, which I will elaborate on later. I just hope partners read this and know that if this proposal is accepted, they will be a priority again.

Thorchain has value, it generated over $30 million in fees last year, is currently running at higher speeds, and is well-positioned to emerge from this predicament. I've been working with the few people who really understand Thorchain's economic design to come up with this solution. Steve will post it on the Developers Discord and he can write it better than I can.

The current proposal amounts to Chapter 11 bankruptcy protection, and Bitfinex did something similar and ultimately succeeded in getting users fully compensated.

There are two types of liquidity in the ecosystem that are necessary for exchanges to continue:

• The first thing that needs to be protected is LPs.
• Arbitrageurs using trading accounts are not affected by this freeze.

Thorchain is too complex and must go back to basics to grow. Until then, no smart capital can buy RUNE or LP because the risk is too great. A large public debt would be a recipe for liquidation, as we have seen many times with DEFI.

Here 's what we think thorchain needs to do if it's going to survive this crisis and thrive in its aftermath:

• All lending and depositor positions will be permanently frozen.
• Take a debt snapshot (savers' value, borrowers' BTC/ETH debt).

Tokenize the claims of all borrowers and savers.

• Create a "disarm module" that will automatically receive 10% of system revenue.
• Create a buyer-determined auction where tokenized claim holders can sell their claims to the available liquidity in the unwinding module at any time, and any seller who obtains that 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, closing the RUNE pool within a month.
• Destroy all POL wallet keys, thus preventing further intervention by central planners in POL.

Thorchain's value has been suppressed because it was unavailable for purchase for so long. Smart capital will not participate in LP, once they analyze its complexity, they will find something is wrong. The product itself is not only working successfully, it's even thriving, generating roughly $200,000 in fees every day.

If Thorchain is to grow and have a chance of fully compensating users, it needs a fresh start. Any unsustainable debt burden must be eliminated.

CRV's Mitch Will once had what appeared to be relatively reasonable leverage, and despite gaining adoption, the CRV price plummeted until he was liquidated. I think we are very close to reaching a similar consensus with Thorchain.

In the case of Thorchain, the debt is at the protocol level and is more inverse than CRV because the protocol is shorting Bitcoin and selling uncirculated RUNE. The "collateral" displayed on the dashboard is backed by uncirculated RUNE, not liquidity.

Not only does the loan redemption mechanically sell RUNE, but the protocol actually shorts $175 million in 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 be repaid. Due to the price volatility since lending began, we are already facing a shortfall of 30 million RUNE from lending activity, which could trigger a kill switch if all redemptions proceed in a chaotic manner. At that time the price of RUNE will fall below $1. Depositors still have $100 million in redemption demand.

This future selling pressure will go into increasingly illiquid pools. And as the market reaction spreads, we simply cannot risk the RUNE price collapsing and being unable to repay these people.

Again, Thorchain's saving grace is that with over $30 million in annual exchange fees and a growing revenue run rate, it still has a great business and 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 the original philosophy of Thorchain: back to basic principles.

The situation can still be corrected and we can clear everything up over the next week. If market panic spreads and everyone sells RUNE and redeems assets, it will lead to bankruptcy. Every day counts, and in this case, once the market understands and panics, it's already too late.

This will have the effect of bringing Thorchain back to its basic principles: LPs and trading accounts will provide liquidity for exchanges. There is no situation in which everyone is immediately reimbursed in full. This scheme retains those who are critical 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 liquidity pools needs to be based on fundamental principles. It is a factor in returns and expected volatility. The trading volume of each pool is related to debt/handling fees, and the liquidity pool will naturally attract more liquidity to join. All these incentives create additional impermanent losses, and LPs are treated the worst as a result. They sit in the worst seats. From now on, they will be sitting in the best seats.

The original founding team designed and drove the implementation of these reverse leverage features, please don't blame the messenger 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 that thorchain can be successful by:

• Improve capital efficiency
• Never build leveraged features into it again
• Ensure Rujira does not compromise the L1 ecosystem

I already have three candidates who are some of the brightest minds in DEFI.

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 losses. We need to do more with less.

This is the worst situation I and other developers have ever been involved in, some of them almost threw up. If there is any other way I would suggest it. This is a life or death situation. I have always been against lending/savers/ILP/POL. Throughout this process I advised my clients to vote against these, and some did, but not enough.

If there's only one lesson I've learned, it's that sometimes it's better to start a civil war when you foresee an outcome in advance than to stand on the sidelines and watch. I'm sorry it turned out this way, I've barely slept the past few days, knowing this ending was inevitable. That timeline was accelerated by $12 million in loan redemptions.