With nearly $200 million in liabilities, will THORChain suffer a rug pull?

Original Author: 1984 is today, Thorchain Core Team Member
Original Translator: zhouzhou, BlockBeats

Editor's Note: Thorchain is facing a serious debt issue. Despite the risks, the protocol still has tremendous business potential, generating over $30 million in fees annually. By implementing measures such as freezing lending and liquidity provider positions, deleveraging, and tokenizing debt, the protocol can be rescued and its core liquidity maintained. Additionally, establishing an Economic Design Board to ensure the protocol adheres to fundamental principles, improves capital efficiency, and prevents falling back into debt is crucial.

Below is the original content (slightly reorganized for readability):

THORChain is bankrupt. If there is a large debt redemption or LPs and synthetic assets deleverage, TC cannot fulfill its Bitcoin and Ethereum-denominated debts.

Validators decide to halt the network, during which they will vote on a restructuring plan. I will not beat around the bush or pretend everything is fine because the truth is far from it.

Thorchain Debt:

· $97 million in borrowing debt (ETH, BTC)

· Approximately $102 million in LP and synthetic asset debt (ETH, BTC)

Thorchain's assets are $107 million external liquidity injected into the liquidity pool. In case of a panic, LPs can withdraw these assets at any time, or RUNE holders can also sell them. The borrowing obligation is met by minting RUNE and selling it into the pool, making the design highly recursive, a situation worse than it appears. After repaying $4 million of RUNE debt yesterday, the protocol still owes millions of RUNE.

From a design perspective, the protocol is short BTC and ETH. Ever since I joined this community (since ILP), I have been warning about the dangers of hidden leverage. Ever since the launch of Cross-chain Asset Swap, I have been advocating for deleveraging as the protocol needs less capital to fill, as the currently active liquidity can participate in filling them.

I am writing this article in displeasure, please do not blame the messenger, I am speaking out because Thorchain has become so complex that only a few understand fully how leverage and liquidity interact and impact the underlying assets. If action is not taken, this will turn into a run on the bank, and the value of the entire protocol will evaporate.

Thorchain has two options:

1. Let things play out, where about 5-7% of value will be front-run by a few, RUNE will downward spiral, and THORChain will be destroyed.

2. Default, go bankrupt, salvage what's valuable, try to develop it to repay debts while maintaining protocol feasibility.

Option 1: The first out $75m get fully repaid, $1.5b value will be wiped.

Option 2: The network's value is preserved, everyone bands together to recover the $200m capital.

For Option 2 to be possible, we need to be guided by saving the network and increasing its value. This starts with partners, which I will elaborate on later. I only ask partners to read this, knowing that if this proposal is accepted, they will once again be at the top of the list.

Thorchain is valuable, generating over $30m in fees last year, running faster now, fully capable of coming out of this. I've been working with a few who truly understand Thorchain's economic design, proposing this. Steve will post on the developer Discord; he articulates better than I.

The current proposal is akin to Chapter 11 bankruptcy protection; Bitfinex has done something similar, ultimately succeeding in fully compensating users.

There are two types of liquidity crucial for exchange continuation in the ecosystem:

· Firstly, LPs need to be protected.

· Arbitrageurs using trading accounts are not affected by this freeze.

Thorchain is too complex, needing to go back to basics to grow. Until then, no smart capital can buy RUNE or LP because the risk is too high. A public massive debt will become a liquidation bait, as we've seen multiple times in DEFI.

This is what we believe thorchain to do if it's to survive this crisis and thrive post-crisis:

· All lending and depositor positions will be permanently frozen.

· Take a debt snapshot (depositor value, borrowers' BTC/ETH debt).

Tokenize all loan and depositor claims.

· Create a "Liquidation Module" that automatically takes 10% of system revenue.

· Create a buyer-determined auction where tokenized claims holders can sell their claims to available liquidity in the Liquidation Module at any time, with any seller burning their claim upon receiving that liquidity.

· Establish a secondary market for P2P trading of tokenized claims.

· Implement a kill switch and incentivize withdrawal from the RUNE pool, shutting down the RUNE pool within a month.

· Destroy all POL wallet keys to prevent further meddling with POL by central planners.

The value of Thorchain has been suppressed because it was unbuyable for so long. Smart capital doesn’t LP; as soon as they analyzed its complexity, they found issues. The product not only works but thrives, generating around $200k in fees daily.

If Thorchain is to grow and have a shot at making LPs whole, it needs a clean slate. Any unsustainable debt burdens must be wiped out.

Mitch Will's CRV had seemingly reasonable leverage, gained adoption, but CRV price tanked until he got liquidated. I feel like we are close to a similar consensus on Thorchain.

In Thorchain’s case, the debt is at the protocol level and more inverted than CRV, as the protocol shorts BTC and sells off unreleased RUNE. The "collateral" displayed on the dashboard is backed by unreleased RUNE, not liquidity.

Not only does a loan redemption mechanically sell RUNE, but the protocol is essentially short $175M worth of BTC/ETH/other assets. For borrowers, these collateral has been converted to RUNE to reduce its supply.

Upon exit, Thorchain has to mint RUNE and sell it for BTC/ETH to repay. Due to price fluctuations since the loan inception, we have faced a 30M RUNE shortfall from loan activities, which could trigger a kill switch if all redemptions happen in a disorderly fashion. RUNE would then plummet below $1. Depositors still have $100M in redemption demand.

This future selling pressure will enter a pool with increasingly poor liquidity. Moreover, as the market reaction spreads, we cannot afford to risk a RUNE price collapse and be unable to repay these individuals.

Once again, it is emphasized that Thorchain's lifeline is the annual exchange fee of over $30 million and the continuously growing income velocity, with still an excellent business that simply needs to shake off the toxic debt on its balance sheet. ThorFI needs to be seen as a mistake, and we need to return to Thorchain's original idea: back to basics.

The situation can still be corrected, and we can address all issues within the next week. If market panic spreads and everyone starts selling off RUNE and redeeming assets, it will lead to bankruptcy. Every day is crucial, and in this scenario, once the market understands and panics, it will be too late.

This will serve to bring Thorchain back to basics: LPs and trade accounts will provide liquidity for swaps. There is no situation where everyone can be immediately fully reimbursed. This proposal retains those crucial to the secure operation of the protocol, ensuring that the protocol can continue to operate securely.

The goal of all these incentives is to grow liquidity to irrational levels. Liquidity in the pool needs to be based on basics. It is a factor of yield and expected volatility. The trading volume of each pool is related to debt/fees, and liquidity pools naturally attract more liquidity. All of these incentive measures create additional impermanent loss, so LPs are treated the worst. They sit 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 messenger or the current development team; they are cleaning up the aftermath. The two founders are no longer involved in day-to-day operations.

After all this is completed, I will propose the establishment of an Economic Design Board to help ensure Thorchain's success, with specific steps as follows:

· Increase capital efficiency

· Never build leverage features into it again

· Ensure Rujira does not endanger the L1 ecosystem

I already have three candidates in mind, who are the smartest minds in the DEFI field.

I have written some content on optimizing capital efficiency, but I will reserve this 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've been involved in as a developer, and some people were almost throwing up. If there's any other way, I would suggest it. This is a life or death situation. I have always been against borrowing/lending/Cust/ILP/POL. Throughout the process, I advised my delegators to vote against these, some did indeed vote, but it wasn't enough.

If the only lesson I've learned is that sometimes when you foresee an outcome in advance, starting an internal war is better than standing by and watching. I'm sorry things have evolved this way; for the past few days, I've hardly slept, knowing this outcome was inevitable. The $12 million loan redemption accelerated this timeline.

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