THORChain’s situation is “eerily similar” to the Terra Luna implosion, says Osmosis co-founder

THORChain has found itself in a severe financial crisis, with a debt of nearly $200 million forcing the decentralized cross-chain liquidity protocol to suspend its network operations. This move has drawn comparisons to the Terra Luna collapse of 2022, with many in the crypto community drawing unsettling parallels between the two events. Sunny Aggarwal, Co-Founder of Osmosis, a decentralized exchange within the Cosmos Hub ecosystem, recently commented on the situation, stating that the crisis at THORChain is “eerily similar” to the Terra Luna disaster.

THORChain’s financial woes have come as a result of its design, which places the protocol’s solvency inextricably linked to the price performance of its native token, RUNE. Much like Terra Luna’s reliance on the value of its LUNA token, THORChain’s stability is dependent on RUNE maintaining or increasing in value. The protocol is set up in a way that it is “reflexively long” on its native token, meaning its solvency is directly tied to the performance of RUNE relative to other assets such as Bitcoin and Ethereum, which serve as collateral within the protocol.

However, recent market trends have not been kind to RUNE, and its poor price performance has led to mounting financial instability for THORChain. The protocol is now grappling with over $97 million in borrowing liabilities and $102 million in depositor and synthetic asset liabilities. This situation has left THORChain teetering on the brink of bankruptcy. In response to the escalating crisis, THORChain has been forced to halt its lending and savings programs, including BTC and ETH withdrawals, as part of a 90-day restructuring plan designed to stabilize the system and mitigate further risks.

Sunny Aggarwal pointed out that THORChain’s situation mirrors the Terra Luna collapse of May 2022. At the time, Terra was one of the largest crypto ecosystems, but it collapsed in a matter of days, erasing $50 billion in value. The collapse was largely driven by Terra’s heavy dependence on its native token LUNA. Aggarwal noted that, much like Terra, THORChain’s current predicament highlights the risks of building a protocol that is too reliant on the price of its native token for solvency.

Aggarwal also expressed concerns about THORChain’s ability to recover, stating that there is uncertainty about whether lenders and depositors can be fully compensated. Some have suggested that the shortfall could potentially be covered by future protocol fees. However, Aggarwal dismissed this notion, pointing out that ThorFi, the platform that provides most of THORChain’s liquidity, plays a critical role in the protocol’s overall financial health. He argued that it doesn’t make sense to treat THORChain and ThorFi as separate entities, as ThorFi is a vital component in keeping the protocol’s liquidity flowing.

As THORChain works through this crisis, the situation highlights the risks associated with protocols that are too heavily reliant on their native tokens for solvency. The Terra Luna collapse serves as a cautionary tale about the dangers of a design that exposes users to the volatility of a single token. For THORChain, the challenge moving forward will be managing risks more effectively, ensuring sustainable liquidity, and providing a more resilient framework for its ecosystem.

Aggarwal pointed out the difficulty THORChain will face in maintaining long-term liquidity, especially since its lenders and savers on ThorFi will likely want to withdraw their funds en masse. This creates an environment where liquidity could quickly dry up, leading to further financial instability for the protocol. As such, the future of THORChain may depend on its ability to convince users to keep their funds locked in and restore confidence in the protocol’s solvency and ability to weather the storm.