Your average bank offers you 0.05% interest on your bank deposits. Well what if I told you, that is terrible. DeFi (Decentralized Finance) has enabled a revolutionary savings protocol: Anchor. Imagine earning 20% fixed interest on your savings deposits. This is no longer an imagination, it’s reality…
Anchor Protocol. What is it? a savings protocol built on the Terra Ecosystem that offers you stable yields on your Terra stablecoins and the so-called “stripe for savings”. Anchor is a decentralized money market between lenders and borrowers. Lenders are looking for fixed yields on stablecoins (20%), while borrowers are looking to borrow those coins against crypto assets they bring (Link).
For the user, the key is the stable yield, from 18–20%(18% being worst-case scenario). The user deposits UST, the Terra stable coin, into anchor and immediately starts receiving 20% stable APY, the highest stable interest you can find. Banks offer 0.05% on your deposits, just as a comparison. This rate is set in the smart contracts/code of the protocol. The protocol makes money by taking benefit of the proof-of-stake (POS) mechanism of the Terra blockchain. But 20%, that sounds way too good to be true. How is it even achievable?
How is the 20% return achievable?
Anchor protocol consists of Borrowers and Lenders. Let’s start off by being a Lender. We can infer you have $100,000 in your savings and you are trying to get some good passive income on your savings. Your bank isn’t doing the job. Well…Anchor is the answer. You convert your 100k into UST, a stablecoin that is 1:1 with the USD. Now with 100,000 UST you deposit it into anchor, expecting 20,000 UST in return at the end of the year. That’s it, deposit.. and done. You can earn 20% interest on your money in just a few clicks.
Now to being a borrower. Let’s say you are a Luna holder and believer. Well, now you can Borrow against your Luna tokens. As price goes up, you can borrow more. You go on Anchor and bond/give your Luna to the protocol. Bonding is converting your Luna into bLUNA(fully collateralized loan position). No worries, the value of bLUNA is pegged 1:1 to Luna in dollar value. The protocol protects bLUNA with a lock up period of 21 days so that you can’t just walk away with your LUNA without waiting. Now let’s say you have 20,000 LUNA as a borrower in your Terra Station wallet, which at $5 has a value of $100,000. You go on anchor, mint 20,000 bLUNA, and provide it to Anchor. Now you can borrow up to 40% against your LUNA value in dollars. The max borrow position you can have is 50% of you assets value, so in this case $50,000 (1/2 of 20,000 Luna). The percentage of your borrow is known as LTV or loan to ratio value and you want to always be able to keep your LTV under control. It is important to note that you pay interest on your borrow. Where does the UST come from? It comes from the Lender.
Back to being a lender, hoping for 20% interest. How is the 20% created? Anchor happens to have two mechanisms to achieve this. The first is driven by taking advantage of the PoS (proof of stake) mechanism of the collateral position on the borrowers bLUNA and the second is to create an interest in the borrowed value from the borrower. So by taking an interest in the borrowed value, it takes from the $40,000 that the borrower takes from the lender.
In good circumstances, Anchor is generating more than 20% yield. The staking rewards for LUNA are currently around 14%. So, anchor can create 14% on the borrowers $100,000 Luna value: $14,000. Other than that, it takes 15% on the borrowers borrow. It is important to remember that the borrow position is $40,000, thus allowing the protocol to capture $6,000. Together, including the 14k from the Borrowers Luna and the 6k from 14% staking reward, we now have $20,000 created from the borrower. And those $20,000 loop right around and go straight to the lender who is awaiting $20,000 back the $100,000 deposit into anchor. That is the beauty of anchor. It enables financial freedom for everyone.
But sadly that is not always the case. It isn’t all that simple. There is a risk when borrowing and that is: LIQUIDATION!
As a borrower you are bullish on LUNA/you think the value will rise. If it does rise, all is well, but if the markets say otherwise, we run into a bit of an issue. If LUNA loses value, against the dollar, you can get liquidated to stay below the 50% LTV threshold. Liquidation is when anchor takes the bLUNA that you minted and sells it on the market at a premium. This ensures that the protocol maintains the deposit safety by paying off debts at risk. Let’s take a deeper dive into how all of this plays out:
Let’s say Bitcoin drops 20% causing the entire market to drop with it. LUNA happens to fall 25% in value, which isn’t uncommon as crypto is very volatile. In this scenario, the borrowers position drops 25% to $75,000. But the issue is, the borrower has already borrowed 40% of the initial $100,000, which is $40,000, making the borrowers LTV go to 53% (over the threshold). With all of the above mentioned circumstances, the protocol is unable to pay the Lender the 20% interest.
What is the solution: 1: The borrower provides more LUNA to anchor, bringing the LTV back below 50%, 2: the borrower pays off their loan with UST, or 3: the protocol liquidates the borrower and sells so much of the borrowers LUNA on the markets needed to repay the borrowers position until it comes back under 50%. Having a portion of the borrowers position liquidated, makes his bLUNA amount drop and disappear.
You might be wondering why a borrower would take this risk:
The borrower could be less greedy and only borrow 20% LTV or $20,000. However, to maximize profits, anchor has a reward system to subsidize a high borrowing rate:
“The protocol leverages bAsset rewards to catalyze a positive usage cycle: subsidies incentivize new stablecoin deposits, lowering the borrow rate, which incentivizes more bAsset-collateralized loans, and enables more bAsset rewards to be collected.”
What this means is, the borrower is rewarded with tokens to borrow. Yes , you heard that right. You get paid to borrow money… The rewards are paid in the Anchor token ($ANC). If the protocol creates gains, it takes the additional net profits and creates a yield reserve for bad times (market downturns, market crashes, etc.) This created the statement: “Don’t fear the bear! Anchor is here”.
This leads us to having to make the decision: become a borrower or a lender? Or both!
The choice is simple and goes as follows:
For the average person trying to get some passive income and doesn’t want to get too involved with crypto and Terra, choose to become a lender. Deposit UST into Anchor and enjoy life. Not having to sit on your computer all day, just let your money work for you 24 hours a day and 7 days a week.
If you are a crypto enthusiast, love to take risks, and believe heavily in the Terra ecosystem, then borrowing is for you. Get some Luna, mint bLUNA, and provide it to anchor. Be prepared for the worst and be aware of the risks and downsides. Watch your LTV and come up with a strategy to maximize profits, but also keep your money safe.
The whole idea, is that anyone and everyone can use anchor in all of its ways. With fiat on/off ramps and new dApps coming to Terra, the opportunities on Anchor are endless and changing finance forever…
To finish off this Anchor Overview, let’s take a deeper dive into the anchor token: ANC. As previously stated, borrowers are paid to borrow in ANC tokens and they are free to sell them on the market at any time. However, we want people to hold their anchor. Here’s why: ANC is the governance token for anchor, which means holders of the token can participate in the governance of the protocol. This enables endless possibilities for anchor because more additional bAssets can be whitelisted. Also, the ANC token captures part of the yield created by the protocol. Take a look ate the anchor docs for more info: https://docs.anchorprotocol.com/protocol/anchor-token-anc.
You might be concerned about the safety and long term vision of the protocol. Is the 20% sustainable? Is the 20% safe?
If you are concerned about security, you should know that there are two takes on security. First, the ecosystems success is tied to the UST peg stability. If you are unaware, UST is an algorithmic stablecoin, meaning when UST goes above peg, LUNA is burned as collateral to mint more UST to bring the value back to $1. If the peg drops below $1, more LUNA is minted to reduce the UST supply, thus making it return to $1. In the recent market downturn, we saw the strength of the UST peg. With a market drop of that magnitude, the entire Terra ecosystem performed very well, even compared to some of the biggest stablecoins. That was just one test that proved UST peg strength. If you want to see a very nice dashboard by a friend of mine on Peg variance, check out this Flipside dashboard by Shreyash: https://app.flipsidecrypto.com/dashboard/terra-stablecoins-are-they-H4uNMJ
Lastly, there is the smart contract risk. We trust and have faith in the Terra developers and creators, but everything is subject to error. So far, everything has performed flawlessly, but there is always risk of a bug and a malicious actor can take advantage of that. It is important to note that we are still very early investors. Terra is just starting and anchor is only a few months old. However, on the bright side, as early adopters/investors, we get paid to offset the risk in additional yield.
In my honest opinion, anchor is one of the most ingeniously designed and executed marketing tools ever created. If you take a deeper dive into Terra and Anchor and how they work, I guarantee you will be as mindblown as I am about this ecosystem. From the growth of stablecoins to the rapidly expanding ecosystem of decentralized applications, Terra is one of a kind, enabling financial freedom for everyone. The Anchor Protocol is the best stable yield possibility on the market. The demand for UST is programmed to explode from here, as there is no better, more secure, and easily accessible opportunity for saving out there. Another massive addition to Anchor was Orion Money, enabling anchor on ETH. With Orion you can now use ETH based stablecoins, such as USDT, USDC, and DAI on anchor.
More people earning the extraordinary APY’s also requires more borrowers. Since the May crash, the protocol runs on a net minus using the yield reserve to hold the 20% APY. Luckily, the yield reserve has been filled since its inception during the bull run. The borrow side of things need more assets. This can be accomplished by adding more LUNA tokens, leading to an increase in the LUNA market value, and most importantly implementing more PoS assets, such as bETH. Patience is the key to Terra. Time will tell. The question then is: Will you last?
With everything mentioned above, we can conclude that Anchor is an amazing tool, creating a stable 20% APY for all and changing the idea of savings one step at a time…