How does Anchor Protocol achieve economic equilibrium with 20% APY?

The fragile yet resolute Anchor Protocol, how should it grow?

Written by: Footprint Analytics Community Contributor
Date: February 2022
Data Source: Anchor Dashboard

On February 10, 2022, Terra announced that it would inject $450 million in UST into Anchor Protocol to help maintain the 20% annualized setting. Similarly, in May 2021, Terraform Labs Foundation injected around $70 million.

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It is evident that Anchor Protocol is currently unable to withstand significant downward pressure. Therefore, Terra has intervened multiple times to sustain it. How is this 20% annualized rate generated? What significance does it hold for Terra? This article will analyze these questions step by step.

Anchor Protocol (referred to as Anchor hereafter) is a DeFi platform launched by Terra officially in March 2021, essentially a Lending platform similar to Compound. However, what sets Anchor apart is its exceptionally high APY (Annual Percentage Yield), consistently maintained at around 20%.

Anchor has three main features:

• Simplicity. By depositing UST into Anchor, one can earn fixed income and high interest rates.
• Stability. Stable rates are achieved through rewards from multiple PoS blockchains.
• High Yield. The APY fluctuates between 19%-21%, but generally stays around 20%.

As a Lending platform, Anchor defines a money market between lenders and borrowers. The annual rate of this market is not determined by traditional supply and demand, but by coordinating rewards from multiple PoS chains to balance rewards, stabilizing at around 20%.

• Lender

Lenders deposit aTerra into the Anchor money market and receive minted aTerra as a receipt for the money market deposit. Redeeming deposits, earning interest proportionally, and subsidies for lenders all require the use of aTerra. Generally, interest accrued by lenders is paid by income reserves or ANC (Anchor's governance token) obtained by borrowers.

The aTerra deposited by lenders is aggregated through the money market and lent to borrowers.

• Borrower

Borrowers provide bAssets (money market loan collateral) within the money market whitelist to create loan positions and obtain loans and liquidity. The LTV Loan To Value of the loan position needs to be below the Max value set by the money market, otherwise bAssets will be liquidated.

Providing liquidity earns ANC rewards, which can be used to pay off loan interest. Currently, the market whitelist only includes LUNA and ETH.

• Liquidator

Liquidators monitor risky loans. Once the LTV exceeds the Max value, liquidators bid on the contract being liquidated. They propose to purchase the bAssets of the liquidated party (borrower) at a certain discount rate, with payment in UST.

- TVL performs well, occupying a significant portion of Terra's total value locked, which is a key factor in Terra's position in the Top 5 public chains.

According to data from Footprint Analytics in the past 180 days, Anchor's TVL hit a peak of $9.46 billion on January 17, 2022, and a low of $2.51 billion on September 21, 2021.

- Token ANC shows a significant correlation with LUNA, closely following the price trends of BTC and ETH, especially the downward trend around January 20, 2022.

With only LUNA and ETH as the two whitelisted bAssets, it can be inferred that the price of ANC is to some extent influenced by LUNA. Overall, ANC is still affected by the general trends in the cryptocurrency market.

- Market Cap has remained relatively stable in the past 180 days, fluctuating around $450 million, with a peak of $773 million. Overall, it shows a steady growth trend.

From Anchor's performance data, it is evident that despite being operational for less than a year, Anchor has achieved commendable results. However, behind these positive figures lies Terra's official injection of funds to sustain it.

In the early stages of its establishment, Anchor's positioning was to provide stablecoin deposits with high APY that the industry could not offer, setting the benchmark for the industry. This may explain Terra's official actions. But is it really just to maintain a 20% APY? Not necessarily. By examining the relationship and data analysis between Anchor and the Terra chain, perhaps the answer can be revealed.

- Data shows that as of February 24, Anchor accounts for 71.07% of Terra's TVL

On February 10, if the Terraform Labs Foundation did not pass the funding proposal, Anchor would face a dilemma of depleted reserves. Depositors' expected interest payments would not be met, and the 20% APY would significantly decrease, contradicting Anchor's initial setup.

If Anchor collapses, the corresponding TVL will drop to zero, potentially causing Terra to fall out of the Top 10 public chains. After all, the current $8.71 billion TVL provided by Anchor accounts for 71.07% of Terra's TVL.

- In terms of correlation, the relationship between Anchor and the Terra chain ecosystem is highly significant, affecting the entire ecosystem.

The most commonly used asset for collateral in Anchor is aTerra, with UST being the primary choice. The minting of UST must be generated by LUNA and pegged to the US dollar at $1. Once there is a shortage or excess of UST supply, the price of LUNA will be affected, further impacting the Terra ecosystem.

In this light, the importance of Anchor to Terra is significant enough to potentially disrupt Terra, prompting multiple injections of funds from Terra's official side.

External funding is not a sustainable long-term solution. Once a bear market arrives, Terra's official funding behavior is akin to a drop in the bucket. Ultimately, self-reliance is crucial, and the Anchor project must improve its current model to enhance its ability to withstand the downside risks of cryptocurrencies. Anchor can consider the following three points.

• Expand the whitelist. Currently, the whitelist only supports LUNA and ETH, which is relatively limited. There are too few collateral assets for creating bAssets.
• Maintain the peg of UST to the US dollar, or enhance the Terra ecosystem. Improve the stability of LUNA, reduce large-scale arbitrage opportunities for aUST, and maintain stability in the Anchor ecosystem.
• Enhance the model. Increase borrowing incentives, raise the willingness of borrowers to collateralize assets, and maintain the financial balance of Anchor. Alternatively, the returns from the reserve fund can be made transparent.

Even though a 20% annual yield is highly attractive, it is advisable for readers to consider placing a small amount of funds as an experiment to earn interest, but not as a primary source of investment. After all, the risks of cryptocurrencies are relatively high. Additionally, Anchor is also exposed to risks such as hacking attacks and the UST breaking its peg with the US dollar. Users should carefully assess whether their investment can withstand the risks before proceeding.