Sunny Aggarwal, Co-Founder of Osmosis, believes THORChain’s liquidity issues mirror the 2022 Terra Luna collapse.

THORChain, a decentralized cross-chain liquidity protocol, has paused its network operations due to a significant debt crisis amounting to nearly $200 million. 

This move has drawn parallels to the 2022 collapse of Terra/Luna, with Sunny Aggarwal, Co-Founder of Osmosis, a decentralized exchange in the Cosmos (ATOM) ecosystem, commented on the situation to crypto.news.

“The situation unfolding with THORChain is eerily similar to what happened with Terra/Luna implosion in 2022, where the protocol’s solvency was too heavily dependent on the price performance of the native token,” Aggarwal said.

THORChain’s design inherently positions it as reflexively long on its native token, RUNE. This means the protocol’s solvency is contingent upon RUNE’s price outperforming assets like Bitcoin (BTC) and Ethereum (ETH), which are used as collateral. 

Recent market trends have not favored RUNE (RUNE), leading to financial instability.

The protocol currently faces $97 million in borrowing liabilities and $102 million in depositor and synthetic asset liabilities, pushing it to the brink of bankruptcy.

In response, THORChain has suspended its lending and savings programs, particularly affecting BTC and ETH withdrawals. This decision is part of a 90-day restructuring plan aimed at stabilizing the system and mitigating further risks.

Terra Luna collapse

The situation mirrors the Terra/Luna collapse, where the protocol’s dependence on its native token’s value led to catastrophic failure. In May 2022, Terra, the third-largest cryptocurrency ecosystem at the time, collapsed within three days, wiping out $50 billion in valuation.

Aggarwal further stated that “it’s uncertain whether lenders can be fully compensated. Some have suggested that the shortfall could be covered by protocol fees collected over time. But this overlooks an important point: the bulk of THORChain’s liquidity comes from its lending and savers platform, ThorFi. So it doesn’t make sense to consider THORChain and ThorFi as separate entities.”

As THORChain navigates this crisis, it is clear there are inherent risks associated with protocols heavily reliant on the value of their native tokens, similar to Terra.

Effective risk management and sustainable design are crucial to prevent such scenarios and protect users’ funds.

“Essentially, Thorchain needs to maintain significant liquidity over the long term. But this will be challenging because ThorFi’s lenders and savers will logically be trying to withdraw their funds en masse,” Aggarwal said.