How will the myth of stablecoins with a fixed 20% interest rate continue? Possible next steps for the Anchor Protocol

The algorithmic stablecoin UST in the Terra ecosystem has attracted significant attention this year, with much of the discussion focused on Anchor, the largest application within the Terra ecosystem, and whether it can continue to offer depositors 20% interest on UST. Recently, amidst the buzz, Anchor has introduced the concept of a new version of the protocol and adjusted the lending limits on collateral in an effort to improve the protocol's current deficit situation.

At the end of January, a series of storms triggered by Wonderland had a huge impact on the algorithmic stablecoin MIM under Abracadabra, which in turn led to a close examination of UST, the algorithmic stablecoin in the Terra ecosystem. The focal point of the discussion lies in Anchor, the largest application within the Terra ecosystem, and whether it can sustainably provide depositors with 20% interest on UST.

Looking at Anchor's current operational status, the total value locked has benefited from the rebound in LUNA prices and the return of borrowing demand, resulting in a recent increase in TVL. However, the amount of deposits still far exceeds the amount of borrowing, putting pressure on the protocol itself to pay depositors high interest rates while facing a deficit.

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In situations where there is an imbalance between income and expenses, the protocol will continue to use funds from the Yield Reserve to make up the difference. At the time of writing, the balance in the Yield Reserve is less than 15 million UST. If we extrapolate based on the consumption rate of the past few weeks, it is likely to be depleted in less than two weeks. At that point, Anchor may be forced to reduce deposit interest rates to a level close to borrowing interest rates in order to achieve a balance between income and expenses, prompting market participants to rethink their intentions.

The Solution at Hand?

The quickest short-term solution is to continue injecting funds into the Anchor yield reserve, as indicated by a recent tweet from the founder of Terra, suggesting that they have been considering this possibility. This funding of the yield reserve was executed once last summer, successfully aiding the protocol's expansion during subsequent bullish market conditions, making a repeat seem feasible.

Recently, a proposal has been made on Luna Foundation Guard LFG to provide a total of $450 million to Anchor, but both the appropriateness and the specific source of this funding are still under discussion.

How to Improve Protocol Revenue and Expenditure in the Medium to Long Term?

In early February, Anchor announced some initial ideas about the new version of the protocol on Twitter:

1. Expand the types of assets that can be collateralized, such as AVAX.
2. Under the new model, collateralized assets will appreciate over time.
3. Users will retain their staking rewards and interest will be calculated based on the basic borrowing rate and the average weighted staking reward percentage by collateral type. The interest paid by users in the new version will not be higher than in the old version, and depending on the collateral type, the final interest paid may be less.

Expanding the types of assets that can be collateralized can reduce the protocol's current high correlation with LUNA, diversify risk, and allow the protocol to generate revenue from a more diverse range of assets. The other two points mainly aim to increase incentives for borrowing against collateralized assets in the protocol to bridge the current gap between borrowing and lending.

Recently, Anchor announced an increase in the loan-to-value (LTV) ratio for bLUNA from the original 60% to 80%, while simultaneously raising the borrowing limit from 50% to 75%. This means that the maximum amount of UST that can be borrowed against bLUNA, which originally had a collateral value of $100, has increased from 50 to 75, theoretically amplifying the loan amount based on current collateral to increase protocol interest revenue.

The decision did not simultaneously adjust the LTV for bETH, maintaining it at 60%. Therefore, if both bLUNA and bETH are used as collateral, the system will automatically calculate the user's borrowing limit based on the weighted average of the two.

Furthermore, some have suggested finding ways to increase the utility of the ANC token, such as setting staking tiers where a certain amount of ANC may be required to earn a 20% interest rate, otherwise a lower interest rate will be offered, thereby reducing selling pressure on ANC in the secondary market.

The most critical issue at present is addressing the depletion of the yield reserve. While Anchor could wait for the yield reserve to naturally deplete and let market mechanisms determine the flow of funds after interest rates decrease, both in terms of TVL ratio and the exchange mechanism between UST and LUNA, Anchor and the entire Terra ecosystem are undoubtedly in a delicate state, making it worth continuing to monitor and observe future developments.