MT Capital Research Report: Chainflip's Emerging Competitors in the Native Cross-Chain Exchange Market

By Severin, MT Capital

TL; DR

Chainflip enables native inter-chain value conversion with a higher degree of decentralization, security, and composability.

$FLIP tokens will remain inflationary in the near term, and we do not expect the token buyback burns from trading volume to be sufficient to cause $FLIP to enter deflation in the short term.

Chainflip has a better product experience and design than Thorchain, but Thorchain itself has first-mover advantages, such as high market visibility and market share. Therefore, we predict that it will be difficult for Chainflip to completely replace Thorchain in the short term.

Chainflip has a market cap of around 90M and an all-rare market cap of around 460M. Thorchain has a market cap of 2.1B and an all-rare market cap of 3B. From a comparable valuation perspective, $FLIP still has room for imagination close to 8x. However, Thorchain’s market capitalization is supported by its total trading volume of 68B and its recent average daily trading volume of 100M+, while Chainflip has not generated any transactions yet.

We will only remain cautiously bullish on the future of $FLIP in general, and will pay special attention to whether the incentive program for Chainflip’s recent mainnet launch can lead to a significant increase in trading volume.

Chainflip: A decentralized cross-chain liquidity network

Native inter-chain value conversion

Unlike cross-chain solutions that use wrapped assets or need to mint/burn assets in an intermediate process, Chainflip chooses to use a native inter-chain value conversion approach.

This means that on each chain supported by Chainflip, there is a pool of liquid native assets, thus forming a common settlement layer between chains to meet users’ needs for inter-chain asset conversion. The advantages of value conversion between native chains are as follows:

Value conversion is chain-agnostic and wallet-agnostic, and Chainflip supports users to use ordinary wallets to convert value on any chain.

The value conversion does not involve any packaged assets, synthetic assets and other assets, and users only need to submit an ordinary transaction for exchange, and users will not face any other asset risks after the exchange is completed.

Chainflip does not require additional on-chain deployment or execution of other protocols, has higher compatibility and versatility, and puts as much computing as possible off-chain to reduce gas consumption for users.

Chainflip’s native inter-chain value conversion method can lower the operation threshold for users, reduce users’ risk exposure, and bring users a better user experience.

Image source: Momentum Capital

Decentralization

Another advantage of Chainflip over other solutions is its higher degree of decentralization. Chainflip’s validator network consists of up to 150 validators. Validators will maintain network security, participate in consensus, listen to external on-chain events, and jointly control system funds. The process of becoming a validator is also permissionless, and users only need to stake enough $FLIP and win the auction to become one of them. At the heart of Chainflip’s idea is the use of MPC (Multi-Party Computation) and specifically TSS (Threshold Signature Scheme) to create aggregate keys held by a permissionless network of 150 validators. All operations and state changes in Chainflip need to be confirmed by more than 2/3 of the node consensus to ensure higher security. Compared with the cross-chain value exchange of centralized exchanges and some cross-chain bridges with a high degree of centralization, users do not need to worry about the evil risk of centralized exchanges and the evil risk of cross-chain bridge centralized servers. Chainflip avoids single points of failure and the risk of malpractice for a single node through a higher degree of decentralization, thereby greatly improving the security of the system as a whole.

Image source: Momentum Capital

JIT AMM

The calculation process of inter-chain value conversion is completed by the Just In Time AMM (JIT AMM) on the state chain built by Chainflip based on Substrate. JIT AMMs are built on top of Uni V3, but instead of a series of smart contract sets on different chains, JIT AMMs only perform virtual calculations on state chains for value transformations. That is, Chainflip’s bookkeeping and computation functions are stripped off and completed on the state chain, while the underlying settlement relies on the vaults set up by Chainflip on each chain. This workflow greatly simplifies the operational complexity of performing inter-chain value exchange calculations, bookkeeping, and settlements on different chains, effectively reducing gas costs for users. In addition, Chainflip’s state chain can also support more customization requirements of JIT AMMs. For example, Chainflip supports LPs to update incoming order quotes in a timely and dynamic manner, preventing MEV bots from preemptively trading through LP competition, improving the efficiency of LP’s capital use, and enabling users to obtain better market prices with lower slippage.

Image source: Momentum Capital

Composability

Compared to existing cross-chain bridges, Chainflip also has better composability. Developers can easily integrate the functionality of Chainflip’s native inter-chain value exchange into existing protocols or products through the Chainflip SDK. Just as Uniswap’s Swap functionality is widely integrated with DeFi use cases, higher composability will bring more use cases to Chainflip. With the emergence of highly composable use cases represented by full-chain games, when the Lego bricks at the application layer are stacked, it will also stimulate users’ demand for the liquidity of underlying assets between multiple chains. However, the current situation is that the liquidity gap between L1 and L2 is becoming more and more serious, and the value exchange between native chains represented by Chainflip may become an indispensable embedded function of multi-chain projects.

Team Background

Chainflip’s team consists of 26 experienced global talents. Simon Harman is the founder and CEO of Chainflip and he is also a member of the board of directors of the Oxen Foundation. Prior to Chainflip, Simon led the team building products including Session, a messaging application based on the Signal protocol. Martin, CTO, was previously the founder of Coiant Labs and the CTO and CSO of Finea. The Chainfllip team has a rich Crypto background, and nearly 60% of the staff are developers, and the overall team composition is relatively high-quality.

Tokenomics model

On November 23, 2023, Chainflip announced the launch of the mainnet and the issuance of $FLIP tokens. $FLIP was an instant hit with the market and is currently trading at around $5, which is close to a 2.7x increase from the $1.83 ICO.

$FLIP is Chainflip’s ERC-20 native token with an initial supply of 90M and follows a dynamic token supply model. Currently, Chainflip expects an annualized 8% token inflation to incentivize validators. In addition, Chainflip’s transaction fees will also be repurchased and $FLIP burned, making it possible for $FLIP to be in a deflationary state. $FLIP’s token empowerment is mainly reflected in the fact that it is used for staking verification and the value capture of the protocol.

Image source: Momentum Capital

FLIP Staking Verification

Similar to most validation networks, since 150 Chainflip nodes will control all of the system’s funds and operations, nodes must stake a full amount of $FLIP as a slash penalty to participate in validation, in order to prevent nodes from doing evil. $FLIP The more nodes that stake, the higher the chance of becoming an authoritative validator and thus receiving additional validation rewards.

It is currently expected that the 7% annualized token reward will be split equally among authoritative validators. Ordinary backup validators will also distribute an annualized 1% token reward according to the proportion of the staked $FLIP. Therefore, it is not difficult to find that the amount of staking in **$FLIP will significantly affect the validator’s validation reward, which will amplify the node’s demand for holding and staking $FLIP tokens. **Chainflip also expects the pledge rate of $FLIP to account for 37%-66% of the total supply, and a large token staking is conducive to maintaining the stability of the token price and reducing market selling pressure.

Image source: Momentum Capital

FLIP Value Capture

For every token swap made through Chainflip, Chainflip charges a 0.1% fee. This fee will be charged in the form of USDC and will be used to purchase $FLIP. The purchased $FLIP tokens will be burned directly. Similarly, gas fees on the state chain are also used to buy $FLIP and burn. Chainflip aims to make the value generated by the protocol dynamically reflected in the $FLIP price through the token repurchase and burning mechanism, giving back to $FLIP holders and enhancing the value capture ability of $FLIP. Of course, since $FLIP itself has token inflation, Chainflip also needs to get enough daily trading volume for its token buyback burn to drive up the price of $FLIP.

Future Expectations

Addressable market

With the successive launch of a large number of L1 and L2, the problem of liquidity fragmentation between chains is becoming more and more serious. According to DeFiLlama data, there are a total of 71 chains with a TVL of more than 10M. The rise of rollups as a service and application chains will further exacerbate the problem of liquidity fragmentation. Traditional cross-chain bridges with frequent hacking problems are no longer the first choice for users to solve cross-chain liquidity, and native inter-chain token swap schemes represented by Thorchain and Chainflip may go mainstream. At present, the cumulative value on the cross-chain bridge is about 12B, while the TVL of Thorchain is only about 300M, and the native inter-chain token swap scheme still has a market space of dozens of times.

vs Thorchain

On the whole, Chainflip’s market positioning is similar to Thorchain’s, but there are some differences in product experience and product design:

1. Product experience: Thorchain requires a separate multi-chain wallet, while Chainflip only needs an ordinary on-chain wallet to use, making the user experience more convenient. Of course, Thorchain is also currently compatible with mainstream wallets to gradually bridge the wallet experience gap.
2. Degree of decentralization: Thorchain currently has a total of 104 nodes to maintain the security of the on-chain vault, while Chainflip’s decentralized verification network consists of 150 nodes. In terms of the number of nodes, Chainflip will have a relatively higher degree of decentralization, but there is no obvious gap between the two.
3. Product design: Thorchain’s pool formation and token swap rely on $RUNE as an intermediary medium, while Chainflip does not rely on a specific token. As a result, Chainflip’s pool and token swap process are not exposed to the risk exposure of a particular token, and are relatively more secure.

Image source: Momentum Capital

To sum up, the current user experience, decentralization and security of Chainflip will be slightly better than that of Thorchain, but Thorchain’s own first-mover advantage, market visibility and market share are also its important competitive advantages. Therefore, we predict that it will be difficult for Chainflip to completely replace Thorchain in the short term. It is more likely that Chainflip will continue to erode the market share of cross-chain bridges together with Thorchain, as Thorchain officials said.

Image source: Momentum Capital

Currently, Chainflip has a market cap of around 90M and an all-dilute market cap of around 460M. Thorchain has a market cap of 2.1B and an all-rare market cap of 3B. From a comparable valuation perspective, $FLIP still has room for imagination close to 8x. However, Thorchain’s market capitalization is supported by its total trading volume of 68B and its recent average daily trading volume of 100M+, while Chainflip has not generated any transactions yet. Therefore, we will only remain cautiously bullish on the future of $FLIP in general, and will pay special attention to whether Chainflip’s recent mainnet launch incentive plan can lead to a significant increase in trading volume.

Source: Golden Finance