Annualized 20%? How does Anchor Protocol achieve economic balance?

Author: Footprint Analytics/Anchor Dashboard

On February 10, 2022, Terra officials announced that they would inject $450 million into the Anchor Protocol in the form of UST to help maintain the set annual yield of 20%. Coincidentally, in May 2021, the Terraform Labs Foundation had injected approximately $70 million.

It is evident that the Anchor Protocol is temporarily unable to withstand significant downward pressure. Therefore, Terra officials have intervened multiple times to force a lifeline. How is this annual yield of 20% generated? What is its significance to Terra? This article will analyze these questions one by one.

Background of Anchor Protocol

Anchor Protocol (hereinafter referred to as Anchor) is a DeFi platform launched by Terra officials in March 2021, essentially functioning as a lending platform similar to Compound. However, what makes Anchor unique is its extremely high APY (Annual Percentage Yield), which consistently hovers around 20%.

Anchor has three main features:

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

Principle of Anchor Protocol

As a lending platform, Anchor defines a money market between lenders and borrowers. The annual yield in this market is not determined by traditional supply and demand relationships but is balanced through coordinating rewards from multiple PoS blocks to stabilize around 20%.

• Lender

Lenders deposit aTerra into the Anchor money market and receive minted aTerra as a receipt for their deposits. To redeem deposits, proportionally earn interest, and receive lender subsidies, aTerra must be used. The interest payable to lenders is generally covered by the yield reserve or ANC (the governance token of Anchor) earned by borrowers.

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

• Borrower

Borrowers provide bAssets (the collateral for loans in the money market) from the whitelist to create loan positions by locking them in, thus obtaining loans and liquidity. The LTV (Loan To Value) of the loan position must remain below the Max value set by the money market; otherwise, the bAssets will be liquidated.

Providing liquidity can earn ANC rewards, which can be used to repay loan interest. Currently, the whitelist only includes LUNA and ETH.

• Liquidator

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

Data Performance of Anchor Protocol

• The TVL performance is quite good, occupying half of Terra's market share, which is an important reason why Terra can rank among the Top 5 public chains.

According to data from Footprint Analytics over the last 180 days, the historical peak of Anchor's TVL occurred on January 17, 2022, at $9.46 billion, while the lowest point was $2.51 billion on September 21, 2021.

Footprint Analytics - TVL of Terra

• The price of token ANC is highly correlated with LUNA and closely follows the price trends of BTC and ETH, particularly showing a consistent downward trend on January 20, 2022.

Considering the only two whitelist bAssets of LUNA, it can be inferred that the price of ANC is somewhat influenced by LUNA. Overall, ANC still remains affected by the broader trends in the cryptocurrency market.

Footprint Analytics - Price of ANC, BTC, ETH & LUNA

• The Market Cap has remained relatively stable over the past 180 days, fluctuating around $450M, with a peak of $773M. Overall, it shows a steady growth trend.

Footprint Analytics - Market Cap of ANC

Importance of Anchor to Terra

From the data performance of Anchor, it is clear that although it has been online for less than a year, it has already achieved impressive results. However, behind this impressive data lies the forced injection of funds by Terra officials to keep it alive.

From its inception, Anchor's positioning has been to provide high APY on stablecoin deposits that the industry cannot offer, setting a benchmark for the industry. This may explain the actions of Terra officials. But is it really just to maintain the 20% APY? Not necessarily. From the relationship between Anchor and the Terra chain, as well as data analysis, we may find the answer.

• From the data, as of February 24, Anchor provided 71.07% of the TVL for Terra.

On February 10, if the Terraform Labs Foundation had not proposed the capital injection, Anchor would have faced the dilemma of depleting its reserves. Depositors would be unable to cash out their interest, and the 20% APY would significantly decrease.

This would violate the original setting of Anchor's establishment. If Anchor collapsed, its corresponding TVL would drop to zero, potentially causing Terra to fall out of the Top 10 public chains. After all, the $8.71 billion TVL provided by Anchor accounts for 71.07% of Terra's TVL.

Footprint Analytics - TVL of Terra by Protocol

• In terms of correlation, Anchor is highly interconnected with the Terra chain ecosystem, where a single change can affect the whole system.

The aTerra used for collateral in Anchor is primarily UST. The minting of UST must be generated by LUNA and is pegged to the US dollar to maintain a value of $1. If there is insufficient or excessive supply of UST, 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 overturn Terra, which is why Terra officials have injected funds multiple times.

Reflections on Anchor Protocol

External capital injection is not a sustainable long-term solution. Once a bear market arrives, the capital injection from Terra officials would be like a drop in the bucket. Ultimately, one must rely on their own strength; the Anchor project needs to improve its current model to enhance its ability to withstand the downward risks of cryptocurrency. Anchor can consider the following three points:

• Expand the whitelist. Currently, the whitelist only supports LUNA and ETH, which is quite limited. There are too few collateral options for creating bAssets.
• Maintain the peg of UST to the US dollar, or enhance the construction of the Terra ecosystem. Improve the stability of LUNA, reduce large-scale arbitrage opportunities for aUST, and maintain the stability of the Anchor ecosystem.
• Refine the model. Introduce borrowing incentive mechanisms to increase borrowers' willingness to collateralize assets, maintaining the balance of income and expenditure for Anchor. Alternatively, the yield from the reserve fund could be opened up.

Even though the 20% annual yield is highly attractive, my suggestion is to deposit a small amount of funds for interest as a trial, but not to rely on it as a primary source of investment. After all, the risks associated with cryptocurrency are relatively high. Additionally, Anchor also faces risks such as potential hacking and the decoupling of UST from the US dollar. Users should carefully consider whether they can bear the risks before proceeding with investments.