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September 2, 2021

THORChain Data Digest: Block Rewards and the Incentive Pendulum

THORChain has a very competitive APY range when it comes to assets like Bitcoin and stablecoins like BUSD. Earning 30-40% annually on your pooled assets is nothing new in the THORChain ecosystem but did you know that block rewards actually make up 75% of the total income generated by LPs and Node operators?

According to research done by Alex Simpson, 721,145 Rune was paid out in Block Rewards from launch of MCCN until the first halt, while just 237,869 Rune was earned in fee revenues.

According to the same research, the Incentive Pendulum is also massively inflating rewards to LPs. Bond wars between Node Operators, coupled with limited caps raises to add liquidity, is consistently forcing THORChain into an inefficient (overbonded) state, boosting APYs to LPs.

Block Rewards

THORChain started out with high block rewards with an idea to reduce them over time. Block rewards will slowly decrease by 1/6th each year over a period of 10 years. This approach, in theory, incentivizes early adoption of the platform.

This graph illustrates the difference between generated fees and block rewards.

Fee revenues have seen two large peaks, 45 and 74 days after launch of MCCN, which were caused by market crashes. Market crashes boost fee earnings as investors rush to stable coin pools to protect their portfolios.

Maintaining High APY When Block Rewards Subside

A total of 721,145 Rune has been emitted in block rewards. A total of 237,868 Rune has been earned in fees. A 1/6th decline in block rewards meaning a 120,191 Rune reduction in earnings. This will require just over a 50% increase in fee revenues to compensate.

Volume: THORChain has seen 105,118,374 Rune total volume across all pools since launch of MCCN. To increase fee revenues by 120,191 Rune, we need a 53,114,511 Rune increase in volume. This translates to an increase in daily average volume from 1,118,280 to 1,683,329 Rune.

User Growth: Current unique swappers on THORChain is 19,876. Extrapolating from this, THORChain would need to grow by 10,043 users to increase volume sufficiently.

These are no extraordinary expectations considering that Uniswap went from 24,963 users to 57,976 in July alone.

Block Rewards as a Cost to the Reserve

Impermanent loss protection (ILP) may seem costly to the THORChain reserve but numbers tell us a different story.

  • A total of 721,145 Rune has been paid out in block rewards since launch of MCCN, but just 11,516 Rune has been paid out in ILP.
  • ILP payments peak 45 and 74 days after launch, which coincides exactly with peak earnings to the reserve. This is because both ILP and fee revenues follow largely the same pattern, peaking in market crashes.
  • In periods of market greed, the average ILP payout is just 43.9 Rune per day, but in periods of market fear this increases to 646 Rune.

A detailed breakdown of ILP payouts can be found here:

Breakdown by Pool

If you take a closer look at every single pool, you will come to the conclusion that none of them is a liability at this point. It appears that fee revenues and ILP payouts are closely correlated.

The Incentive Pendulum And Inflated LP Rewards

  • The optimal state for THORChain is to have bonded capital match pooled capital. In this efficient state, 67% of system income (block rewards + fees) go to Node operators, and 33% goes to LPs.
  • When the system is overbonded, the incentive pendulum swings to favour LPs. Earnings increase past the 33% equilibrium, encouraging Nodes to move some of their bonded capital to pools, and bring the system back into balance.
  • Data shows that LP earnings are consistently higher than node earnings.

For comparison, the image on the left is showing Node and LP earnings when THORChain system is in Efficient State while the image on the right shows Node and LP earnings on THORChain since launch of MCCN.

Conclusion

It is more than clear that high APYs on THORChain aren’t coming from the trading volume itself but from block rewards and the Incentive Pendulum. Block rewards currently make up 75% of all system income and that will remain unchanged in the short to medium term. Moving forward, network volume and increased user numbers should take over as the main fee income stream.

Source - Alex Simpson Medium

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