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Intro

The rapid growth of alt layer 1 (L1) blockchains, which began in 2016-2017, has created a huge market opportunity for innovations that enable seamless blockchain interoperability. THORChain has emerged as a groundbreaking protocol that reshapes the decentralized exchange (DEX) landscape by enabling native L1 cross-chain swaps. Established in 2018 by a team of pseudonymous developers, THORChain is built on the Tendermint and Cosmos-SDK frameworks, distinguishing itself by enabling trustless swaps between native assets across multiple chains without relying on centralized exchanges (CEXs) or the complexities of cross-chain bridges or wrapped tokens. This article delves into the mechanics, advantages, and security dynamics of THORChain, illustrating its role in addressing the challenges of cross-chain interoperability and liquidity fragmentation within the cryptocurrency ecosystem.

THORChain

THORChain represents a departure from traditional single-chain automated market makers (AMMs) by providing a similar experience but allowing the swapping of native assets across multiple chains. The protocol is designed with the highest levels of decentralization and security in mind, ensuring BTC (and other supported assets) is secured in an over-collateralized fashion by an anonymous, permissionless set of validators.

THORChain is an independent blockchain and decentralized exchange (DEX) facilitating seamless cross-chain native asset swaps. It stands out by enabling direct exchanges between various cryptocurrencies, such as bitcoin (BTC) and ether (ETH), without the need for cross-chain bridges or wrapped tokens—a common need within the current crypto ecosystem that subjects users to additional (and often exploited) risks. THORChain's mission is to address and streamline the complexities surrounding cross-chain swaps and the fragmented liquidity landscape, offering a unified and decentralized liquidity network accessible to all chains. As of 2024, THORChain supports native asset swaps between Bitcoin, Ethereum, BNB Chain, Avalanche, Cosmos Hub, Dogecoin, Bitcoin Cash & Litecoin.

Crypto’s “Cross-chain” Evolution 

The expansion of the crypto economy over the years, fueled by the emergence of Layer 1 blockchains and the evolution of DeFi, demands interoperability across various blockchain networks. This has led to the development of cross-chain technologies and bridges that enable the transfer of assets, enhancing the functionality and accessibility of different blockchain ecosystems.

Centralized exchanges (CEXs)traditionally facilitated asset transfers across blockchains but are inherently limited by their centralized nature. This centralization introduces counterparty risk, as users must rely on the exchange's internal systems and custodial services, which can become points of vulnerability, as evidenced by historical failures (e.g., FTX).

Blockchain bridges, designed to connect disparate blockchain networks, promise improvements over CEXs by enabling direct asset swaps without custody risk. However, these bridges have their own set of challenges, including security risks, centralization concerns, and the reliance on "wrapped" assets. Wrapped assets, representing IOUs of the original asset on a different blockchain, add complexity and introduce risks not present with native assets. 

Wrapped assets are inferior to native assets because:

• Wrapped assets are IOUs on the original asset (an IOU is never as good as the real thing because it involves some form of counterparty risk)
• Wrapped assets fragment and compete with liquidity from the native asset
• Wrapped assets as collateral in DeFi can “depeg,” resulting in liquidations not possible if holding the native asset
• In some instances, wrapped assets require an external oracle for pricing, which is another vector of risk

In contrast, solutions like THORChain don’t suffer from these  limitations enabling direct asset swaps, utilizing its Bifröst Protocol for cross-chain interoperability. This approach not only mitigates the risks associated with wrapped assets and centralization but also unlocks significant value by leveraging dormant capital in a trust-minimized environment, setting it apart from traditional CEXs and bridges.

How Does THORChain Solve Cross-chain Swaps?

As previously mentioned, THORChain enables native asset swaps across multiple chains, such as converting native BTC to ETH, without necessitating intermediaries or the custody risk inherent in using a CEX. In addition, pricing on THORChain is both transparent and independent of any centralized entities. This approach ensures that users receive consistent and transparent pricing, devoid of manipulation by external parties. Finally, it completely removes the need for bridges and wrapped assets. 

At its core, THORChain is driven by state machines, which are used to manage asset exchange logic and coordinate external transactions. These state machines ensure that the platform can synchronize its internal state with other chains, enabling a seamless flow of assets across different blockchain ecosystems. This synchronization is achieved through one-way state pegs, which allow THORChain to accurately reflect the status of assets on connected blockchains in real time.

RUNE Token and Protocol Security

The RUNE token and its utility are at the heart of THORChain's entire economic security model. Specifically, THORChain incentivizes the locking of RUNE at a rate 3x the value of non-RUNE assets within the ecosystem. 

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To maintain the network's security and incentivize sufficient liquidity, THORChain utilizes a dual incentive mechanism. Participants lock three dollars of RUNE for every dollar of non-RUNE assets on the platform.  This 3:1 ratio establishes a foundational value for RUNE, underpinning the token's economic model. Such a structure not only promotes a high degree of liquidity but also plays a crucial role in securing the assets on the network. Through this innovative economic design, THORChain not only addresses common challenges in the DeFi space, such as liquidity fragmentation and security vulnerabilities, but also provides a compelling value proposition for both investors and users within the cryptocurrency ecosystem.

CLPs and Key Entities

Central to THORChain's operational model is the utilization of a continuous liquidity pool (CLP), with RUNE serving as the intermediary asset in every transaction. This innovative approach ensures that when users wish to exchange two different assets, the swap is conducted through two distinct liquidity pools. For instance, converting USDT to BTC involves an initial swap from USDT to RUNE, followed by a subsequent exchange from RUNE to BTC. This process is streamlined by the THORChain state machine, which handles asset conversion seamlessly with no need for users to interact directly with RUNE.

The liquidity model employed by THORChain adapts to the changing demands for liquidity. This is further augmented by the different actors within the THORChain ecosystem, which include liquidity providers, traders, and node operators. Each plays a critical part in ensuring the network's efficiency and reliability. Liquidity providers contribute assets to the pools, earning rewards in the form of block rewards and transaction fees, which are determined by their share in the pool and the pool's overall activity. 

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THORChain prioritizes the interests of liquidity providers, treating them as essential participants within its ecosystem and taking significant measures to safeguard their capital. In contrast, node operators are viewed differently; while they are compensated for their services, they are also subject to removal should they fail to adhere to the platform's standards.

Swappers form the user base that engages in asset exchanges, while traders leverage arbitrage opportunities to align the prices within THORChain's pools with those in the broader market, thereby maintaining equilibrium. Node operators, on the other hand, bond RUNE to support the network's security and consensus mechanism, operating under a veil of anonymity and subject to rotation to ensure network integrity.

Technology Stack

The THORChain network uses a series of technologies to deliver its vision. Overall, THORChain was built using the Cosmos SDK platform, a stack that lets developers build Proof of Stake (PoS) blockchains. The stack has a number of necessary pre-built modules that are relevant to THORChain to assist developers, such as transaction authentication or staking solutions. THORChain facilitates cryptocurrency swaps using its own AMM design, using the RUNE token as the intermediary powering a peer-to-pool economic model. 

In addition to Cosmos SDK, THORChain also uses several other novel technologies that come together to facilitate the permissionless, cross-chain swaps.

Tendermint Consensus

THORChain, as part of the Cosmos ecosystem, leverages Tendermint Core for its consensus mechanism. Tendermint Core is a versatile, language-agnostic algorithm that allows for the replication of decentralized applications (dApps) across various programming languages. It is built on a Byzantine Fault Tolerant (BFT) consensus model, which ensures that the network can continue to operate reliably and reach agreement on transactions and state changes even if up to one-third of the network's nodes fail arbitrarily.

In the Tendermint system, validators play a crucial role. They are responsible for confirming transactions and casting cryptographic "votes" to agree on the network's state. This process occurs in rounds, with validators working together to maintain the integrity and consistency of the system. THORChain employs a unique approach to managing its validators, capping the number at 120, thereby promoting competition among potential would-be validators. The 120 validators are "churned" every three days based on several different factors. Nodes that commit the largest amount of RUNE are selected to join the network, while those with the smallest commitments, as well as the oldest and least efficient nodes, are removed. 

Additionally, THORChain made the conscious decision not to enable delegated staking. The decision against public delegation stems from concerns that it could lead to a concentration of power among a limited number of validators, undermining the network's decentralization. This is a behavior observed in other delegated Proof of Stake (dPoS) networks, where node operators engage in activities designed to attract delegated funds, such as marketing campaigns and offering lower commissions. THORChain's stance is designed to prevent such dynamics, ensuring a more equitable and decentralized ecosystem.

However, THORChain does accommodate private delegation within specified limits. This arrangement permits node operators to maintain a whitelist of up to ten bonders, preventing the scalability issues associated with broader public delegation. This model is predicated on mutual trust among bonders and operators, with the expectation that operators fulfill their obligations while maintaining the network's integrity.

To qualify as an independent validator within THORChain, there is a substantial entry requirement: a minimum bond of 300,000 RUNE, which is double the amount of external assets held in the network's liquidity pools to ensure full underwriting. However, while 300,000 RUNE is the protocol’s hard-coded minimum, the actual minimum to break into the top 120 validators is currently 700,000+ RUNE. This high threshold serves as a deterrent against malicious actions, as any validator found guilty of misconduct or theft faces severe penalties, including a bond slash of at least 1.5 times the value of the stolen assets.

Validators are also required to operate a node on each blockchain supported by THORChain, which is integral to the functioning of the Bifröst Protocol, THORChain's mechanism for enabling cross-chain transactions. While this requirement underpins the protocol's security and interoperability, it also adds a layer of complexity to the operation of nodes, demanding significant commitment and technical expertise from validators. This system ensures that THORChain remains secure, decentralized, and resilient against attacks, making it a robust part of the broader Cosmos ecosystem.

Bifröst

At the core of THORChain's functionality are THORNodes and the Bifröst protocol. THORNodes operate the internal logic in each node, while Bifröst is the service that monitors each chain and reports to THORNodes. The Bifröst Protocol, in a sense, acts as a bridge, allowing for the seamless transfer of assets. This interoperability is significant because it overcomes the limitations and security vulnerabilities associated with traditional cross-chain bridges while handling impressive volumes in the billions of USD per month (image below).

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In the THORChain ecosystem, these native assets are managed through Asgard Vaults, which are secured by multi-signature keys managed by anonymous THORNodes, thereby avoiding potential collusion. Transactions require a 2/3 consensus among the 20 nodes managing a vault, with a Threshold Signature Scheme (TSS) ensuring random signatory selection to further enhance security.

Each node within THORChain's network is equipped with a Bifrost service. The Bifrost service is tasked with connecting to various blockchains and monitoring vault addresses for inbound transactions. This service plays a crucial role in ensuring that THORChain remains updated with all transactional activities across the networks it interfaces with.

When users initiate transactions, such as swaps, assets are deposited into these vaults and monitored until a consensus is reached, prompting THORNode to execute the action desired by the user, such as making a swap or adding liquidity.

For processing chain-specific transactions, THORChain utilizes a Bifrost Chain Client. This client is responsible for taking the transaction schemes created by the Signer, serializing them into the appropriate destination transaction format, and executing them using the respective chain client. This process ensures that transactions are accurately and efficiently processed according to the unique requirements of each connected blockchain.

Threshold Signature Schemes (TSS)

The Threshold Signature Scheme (TSS) is a sophisticated cryptographic protocol employed by THORChain to enhance the security and decentralization of cryptocurrency transactions, such as swaps. This method diverges from traditional practices that often rely on a singular trusted entity to manage private keys. Instead, TSS spreads the responsibility for key management across a network of nodes, with THORChain's implementation involving about 100 nodes, aiming for an expansion to 120. This distributed approach requires a consensus of two-thirds of the node operators for the execution of transactions, significantly increasing security and resistance to unauthorized access or attacks.

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The operational framework of THORChain's TSS is broken down into three fundamental steps:

• Key Generation: The initial phase where key pairs necessary for transaction verification are created collaboratively by the participating nodes. This ensures that no single node holds the complete key, maintaining security and decentralization.
• Sign: In this phase, the distributed nodes work together to sign transactions. This process is critical for authorizing transactions in a way that ensures the signature is valid only if the agreed threshold of participants consents.
• Verify: The final step involves the verification of the signature by the network to confirm the transaction's legitimacy. This ensures that the transaction has been authorized by the requisite number of nodes.

THORChain's TSS model is particularly notable for its end-to-end encryption and a bond model that disincentivizes attacks on the network. It operates through a sequence of well-orchestrated steps, beginning with accepting transaction requests. It then organizes the requisite parties for the key generation and signing process, efficiently managing communication and coordination through a peer-to-peer network. This setup ensures that all parties are synchronized in the key generation phase, which is essential for the distributed management of the TSS secret key. Since the secret key is dispersed among the participants, no single entity can unilaterally authorize transactions, thereby bolstering the system's security and integrity.

Trade Execution

A critical aspect of decentralized exchanges is the need for accurate pricing to enable users to swap across supported assets effectively. THORChain addresses this challenge by harnessing the intrinsic design of its liquidity pools and engaging arbitrageurs to maintain exchange rate accuracy. This strategy eliminates the dependence on external resources such as oracles or weighted averages, which are susceptible to manipulation and attacks.

THORChain’s internal pricing mechanism works similarly to other AMMs, adjusting the price of each asset based on the ratio of the assets in the liquidity pool. This approach enables the system to determine not only the instantaneous price of an asset but also its relative purchasing power. This distinction is crucial for applications such as collateralizing debt, where understanding an asset's purchasing power is as important as knowing its spot price.

All swaps conducted on THORChain are governed by the platform's State Machine, ensuring that only valid transactions are finalized while invalid ones are rejected. This process is quite efficient, with all swaps being confirmed within a brief 5-10 second window.

Additionally, as of Q2 2023, THORChain has introduced “Streaming Swaps,” designed to enhance the execution of large transactions by dividing them into multiple, smaller sub-swaps over time. This novel approach mirrors the concept of a Time Weighted Average Price (TWAP) trade but is confined to a 24-hour timeframe. 

Streaming Swaps operate by allowing users to specify two critical parameters: the Swap Interval and the Swap Count. The Swap Interval, measured in THORChain blocks (approximately six seconds each), dictates the time delay between each sub-swap, thereby facilitating arbitrage opportunities that help maintain the balance of the liquidity pools throughout the transaction process. The Swap Count determines the number of sub-swaps into which the original transaction will be divided, aiming to reduce slippage by decreasing the size of each transaction leg. Should a user set the Swap Count to zero, THORChain automatically adjusts the swap size to minimize the liquidity fee to five basis points, optimizing the cost-efficiency of the transaction.

From the perspective of users, particularly those looking to execute large trades, Streaming Swaps present a compelling alternative to traditional trading methods on decentralized exchanges. Streaming Swaps distribute the liquidity demand over a series of moments, allowing for arbitrage to adjust prices more effectively in real-time. This mechanism not only improves price execution but also enhances the capital efficiency of THORChain without necessitating an increase in Total Value Locked (TVL). By enabling transactions to be broken down into smaller, more manageable parts, Streaming Swaps reduces the impact of slip-based fees, a common hurdle in large-scale DeFi transactions. This innovation allows THORChain to offer competitive liquidity fees as low as five basis points, making it an increasingly attractive platform for high-volume traders seeking efficient, cost-effective trading solutions in the decentralized space.

Security

The governance mechanisms and security protocols of blockchain networks are critical to their functionality, safety, and performance. THORChain employs a multi-layered security strategy to safeguard the network's solvency and minimize the impact of potential exploits. This comprehensive approach ensures the integrity of transactions and the safety of user funds.

Governance Through Mimir

At the heart of THORChain's governance model is Mimir, a sophisticated feature that empowers the network's nodes with the authority to modify various constants and parameters crucial for the network's operation. Through a consensus mechanism requiring more than 66% agreement, active nodes can vote to adjust network parameters such as reserve emissions, minimum bond, churn speed, and more. These adjustments are pivotal for maintaining the network's optimal performance and ensuring its security. By enabling node operators to influence network parameters directly, THORChain ensures that its governance is distributed among those who have a vested interest in the network's success. 

Security Monitoring and THORSec

THORChain's security framework is bolstered by several innovative features designed to safeguard the network against a range of threats. One such feature is the automatic security flagging mechanism embedded within the network's code. This mechanism is programmed to emit events under specific conditions, such as unauthorized transactions, attempts at double-spending, or unusually large withdrawals. These events are immediately reported to a dedicated monitoring channel on THORSec Discord for swift review. THORSec’s Red Team is a dedicated group of cybersecurity professionals responsible for reviewing code, monitoring protocol health, and providing incident response services. This team plays a critical role in maintaining the network's security posture through continuous oversight and emergency preparedness.

Granular Halting Controls

Contrary to the rest of the chain’s hands-off approach to chain design, THORChain has implemented granular halting controls. These controls enable Node Operators to exercise precise command over the network's operations, enhancing its safety. Through Mimir, nodes can issue commands to halt signing for a specific chain, pause trading for a specific chain, or even halt all operations for a particular chain. This level of control is crucial for addressing chain-specific issues such as forks, syncing problems, or exploits without disrupting the entire network's operations.

Moreover, in situations requiring immediate and broad action, nodes have the authority to halt trading globally across the network. This emergency control mechanism, while controversial to some, is a critical safeguard that ensures the network can be quickly stabilized in response to significant threats.

Additional Security Measures and Protocols

• Conformation Counting: This mechanism protects against double-spend attacks and non-instantaneous block reorganizations, enhancing the network's reliability.
• Outbound Transaction Throttling: To prevent large-scale fund extractions, outbound transactions are limited in value per block and subject to maximum processing times, with these parameters adjustable by Node Operators.
• Distributed Outbound Requests: Large transactions are dispersed across multiple blocks to maintain system stability and prevent bottlenecks, ensuring the network can handle significant outflows without compromise.
• Solvency Checkers: Both reactive and proactive solvency checkers are deployed. Reactive checkers compare vault values with actual wallet amounts, while proactive checkers anticipate insolvencies before transactions are executed, significantly reducing the risk of financial discrepancies.
• Audits and Bug Bounty Program: THORChain has undergone rigorous audits by leading security firms such as Kudelski, Halborn Security, and Trail of Bits. These audits are meticulously documented and accessible via a dedicated GitHub repository. Furthermore, a formal bug bounty program managed by Immunefi encourages the discovery and reporting of vulnerabilities, ensuring that security concerns are promptly and effectively addressed.

Economic Security Model

THORChain's approach to maintaining economic security within its ecosystem is both innovative and intricate, leveraging a balance between liquidity provision and the securing of assets through a mechanism known as the Incentive Pendulum. This model is designed to ensure that the value secured by nodes, through bonding, is always proportionate to the value held within the network's liquidity pools. The architecture of this system embeds a hard cap within the THORChain codebase, effectively pausing new deposits into the pools once a certain threshold is reached, thereby preventing an imbalance that could jeopardize the network's security and efficiency.

The Incentive Pendulum plays a pivotal role in this economic security model by dynamically adjusting the distribution of block rewards and transaction fees between those who bond (the bonders) and the liquidity pools. This adjustment mechanism is critical for maintaining a delicate balance: when the total value in the pools begins to exceed the value bonded by nodes, the pendulum swings to favor the bonders with increased rewards. This incentivizes bonders to commit more RUNE to their bonds, thereby enhancing the network's overall security posture. Conversely, if the value bonded surpasses the value in the pools, the pendulum shifts to favor liquidity providers, encouraging more deposits to rebalance the system.

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For THORChain to function optimally, the ideal state is one where the value of bonded capital is equal to the value within liquidity pools, maintaining a 67-33 balance between RUNE bonding and pooling. This balance is predicated on the composition of liquidity pools, where half of the value is in RUNE and the other half in external assets.

The effectiveness of THORChain's economic security model hinges on the assumption that market participants will respond rationally to these incentives. However, the reality is that the barriers to entry for node operation—both in terms of technical expertise and the financial requirements for bonding—mean that this activity may be confined to a relatively small, tech-savvy, and financially robust segment of the market. This limitation could potentially slow the growth of bonded capital despite the incentives designed to encourage it.

Conclusion

As the crypto ecosystem strides towards greater complexity and connectivity, THORChain's contribution to enhancing cross-chain interoperability cannot be overstated. By removing the pitfalls associated with CEXs and traditional blockchain bridges, THORChain presents a robust, decentralized solution for the seamless exchange of native assets across various chains. Its unique economic model, leveraging the RUNE token to incentivize liquidity and secure the network, along with sophisticated security protocols like the Threshold Signature Scheme (TSS), positions THORChain as a pivotal player in the DeFi landscape. As the protocol continues to evolve and expand its reach across various blockchain networks, its innovative approach to cross-chain swaps and liquidity provision sets a new standard for decentralized exchanges, promising a more interconnected and efficient future for the crypto economy.

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Disclaimer: This report was commissioned by Thorchain. This research report is exactly that — a research report. It is not intended to serve as financial advice, nor should you blindly assume that any of the information is accurate without confirming through your own research. Bitcoin, cryptocurrencies, and other digital assets are incredibly risky and nothing in this report should be considered an endorsement to buy or sell any asset. Never invest more than you are willing to lose and understand the risk that you are taking. Do your own research. All information in this report is for educational purposes only and should not be the basis for any investment decisions that you make.

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