Chapter V: THORFi — Interest-free, liquidation-free, and oracle-free loans
Setting the scene
THORFi is the missing component within the complex DeFi stack with its permissionless cross-chain liquidity solution.
So, what is the rationale behind interest-free, liquidation-free, and oracle-free designs?
The THORChain core developers decided that these design principles would offer a more attractive loan than ordinary loans.
We’ll go into a lot more detail below, but in a nutshell, THORChain is hungry for collateral that it can use to generate a yield (mainly through AMM swaps). Hence, the interest-free and liquidation-free attributes are designed to attract borrowers who post collateral to obtain a loan. The oracle-free design means that the protocol does not rely on an external oracle, making it more robust and less prone to attack and error.
Right, let’s get to it.
Interest-free
The idea
THORChain doesn’t need to charge interest on its loans. As a cross-chain decentralized exchange (DEX), loan collateral is the crucial element sought by the protocol. Offering a 0% interest rate on loans, in theory, will incentivize a high volume of borrowers of TOR (a stablecoin) who will post collateral in the process of borrowing.
Loan collateral is vital to the protocol as it generates yield passed on to the savers (further discussed under the ‘liquidation-free’ section).
For more information on the intricacies of THORFi lending and savings, check out our previous article here.
The mechanism
As a borrower, you signal that you wish to give up the yield you are entitled to as a Liquidity Provider (LP) in return for the TOR loan. You can think of the 0% interest as compensation for forgoing the yield from their collateral.
To ensure the network produces yield on this LP collateral, all loans must be open for 100 days. For repaying early, a penalty is applied of 1% of the loan per day linearly across the 100 days.
Key takeaways:
- The network needs loan collateral (liquidity) to earn a yield for the savers.
- The protocol is prepared to charge 0% on loans to attract more borrowers and collateral.
- The savings side is vital because users deposit derived assets, such as THOR.BTC, RUNE is burned in the process.
Liquidation-free
The Idea
The loan collateral is independent of the loan, which enables there to be zero liquidations. The protocol does not require liquidation of the collateral value that falls below the loan value. This is because of the relationship between lending and savings discussed below under ‘the mechanism.’
The mechanism
No collateral liquidations are executed even if the collateral value drops below the loan value. In the TradFi world, this would seem like a jaw-dropping idea. Well, it is incredibly innovative — let’s unpack it.
How does the protocol remain solvent when the collateral value falls below the loan value?
To ensure solvency, the lender (the protocol) always gets immediately repaid due to the RUNE burning mechanism on the savings side.
To recap, when a loan is opened, the lender (THORChain) mints TOR which is issued to the borrower, minus a fee. The borrowers’ loan collateral is added to the liquidity pool, which enables the protocol to utilize it to generate a yield that can be passed on to the savers.
The THORChain core developers presume that actors will chase the highest yields and, therefore, be incentivized to swap from TOR to another RUNE asset, inflating the RUNE supply.
To counter the RUNE inflation (caused by the swap), THORChain has created economic incentives for users to enter THORSavings to benefit from the APY generated by the loan collateral on the borrowing side. You’ll know from following our article on derived assets when a user deposits BTC.BTC in pursuit of yielding the BTC.BTC is swapped for RUNE, the RUNE is then burned, and a derived asset is minted. In this case, it would be THOR.BTC. Hence, there is a symbiotic relationship between lending and savings; one feeds the other.
Key takeaways
- If the collateral value falls below the debt value, a rational actor is unlikely to repay at a loss. This means the locked LP units remain within the protocol, thus, maintaining deep liquidity pools during bear markets.
- The protocol is kept solvent by aligning economic incentives between borrowers and savers.
- All loan collateral is yield-producing blue-chip assets (BTC.BTC), and all debt is denominated in USD. Therefore, THORChain users are long-crypto and short-USD, meaning they view that, over time, blue-chips like BTC.BTC will appreciate relative to the USD.
Oracle-free
The idea
Put; oracles provide a link between off-chain and on-chain data. They facilitate communication between smart contracts and the outside world, which is vital for the global adoption of blockchains.
In a recent article, ChainLinkGod explained that:
“without oracles, blockchains are like computers without an internet connection. They’re cut off from the outside world and can only reference information native to the blockchain’s internal ledger”.
It’s worth noting that there are two types of oracles: centralized and decentralized. Let’s briefly outline each one.
Centralized
Centralized oracles act as a single entity that provides data from an external source to a smart contract operating with security features. Such oracles are controlled by a single entity and are the only information provider for smart contracts. Since they work similarly to the traditional financial system where a single entity is responsible for everything, centralized oracles suffer from a bottleneck problem (otherwise known as a single point of failure).
Decentralized
Decentralized oracles do not rely on a single source of truth. Therefore, they increase the authenticity of the information provided to smart contracts. Unlike their centralized counterparts, such oracles rely on multiple external sources and aim at achieving trustlessness. They utilize the ShellingCoin mechanism, where all the independent sources report the data without coordinating with one another. But this mechanism is vulnerable to various problems like cooperation between parties, signaling, and even bribery.
The THORChain solution
Let’s dig deeper into how THORChain works without an external oracle.
The mechanism
THORChain depends on its continuous liquidity pool design and arbitrageurs to set prices. When pools become imbalanced, arbitrage bots trade to rebalance them.
THORChain ‘knows’ the exchange rates between external asset pairs because RUNE binds all pools together. The word ‘bind’ here describes how the different pools are connected.
RUNE is the settlement asset for all liquidity pools, facilitating swaps between two pools. A 1:1 ratio of RUNE:ASSET is required for each pool. For example, a pool with $100,000 in BTC will need to hold $100,000 worth of RUNE. Hence, RUNE will exist in every liquidity pool, thus binding the pools together.
Unbalanced pools represent a profit opportunity for arbitrage traders. If a trader can purchase a token at a lower price on THORChain and sell it for a profit elsewhere, like on Binance, they will be incentivized. These trades re-balance the pool and ensure that prices accurately reflect the market value. These pool balancing trades happen 24/7 via arbitrage bots interacting directly with the protocol’s API.
In essence, arbitrageurs benefit from the differences between the on-chain (THORChain) and off-chain (CEXs/other DEXs) prices.
Key takeaways
- DeFi needs decentralized infrastructure. Otherwise, the purpose of DeFi is defeated.
- THORChain provides an organic system whereby economic incentives drive bots and humans to arb pools to equilibrium on-chain and off-chain prices.
Conclusion
After a whistle-stop tour, you now have an overview of three innovative design principles currently built into THORFi.
Ultimately, THORFi is an idea to promote a 100% trustless and permissionless way for users to borrow/save with 0% interest and liquidation risk.
There is a lot more work to be done, but a strong foundation has been laid for more exciting developments to be released.
What has surprised you the most about THORFi? Let us know your thoughts.
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