Anchor protocol is a DeFi savings and lending protocol on the Terra blockchain. Anchor has grown rapidly since its launch in April 2021, with the total value locked (TVL) on the protocol now approaching $10 billion. Much of this growth has been driven by the attraction of Anchor’s high interest rates, with the protocol consistently offering 20% APY on deposits of $UST, the main stablecoin on the Terra network. Many have questioned the long-term sustainability of these rates, and it seems like their time could finally be up.
Where does the money come from?
The vast majority of Anchor’s income comes from its lending operations. Anchor provides loans in the form of $UST to investors that deposit crypto as collateral. The protocol currently charges an interest rate of 14% APY on loans, and will also stake the assets provided as collateral to generate further income. Lending interest and staking rewards comprise the majority of Anchor’s income, but a smaller amount is also gained from borrower liquidations, with around 1% of the fee for all liquidations on Anchor being added back to the treasury.
Anchor’s revenue depends heavily on the rate at which people are borrowing. This borrowing rate is constantly changing, however the savings APY has remained static at 20%. This is rare in the world of DeFi, where most protocols constantly alter the amount of interest provided to ensure they maintain financial equilibrium. This constant variation in rate can make it very challenging to determine the actual rate of interest over a one-year period. Anchor overcomes this by use of a ‘yield reserve’ to maintain a constant rate. When protocol income exceeds the amount distributed in interest, the excess money is added to the yield reserve. If the amount of money distributed exceeds income, then the funds in the yield reserve can cover the difference.
In mid-December 2021, the Anchor yield reserve stood at over 70 million $UST. Today, this figure stands at only 14 million. If current trends continue, the fund will run dry within the next two weeks. Without the reserve to dip into when needed, Anchor’s stable 20% rate will be no more.
Why is the reserve falling?
The depletion in yield reserves can be explained by a supply-demand mismatch, driven by investor psychology. In market downturns, investors generally become more risk-averse. Anchor’s 20% return on stablecoin holding is very attractive to risk-averse traders, and as such, deposits into Anchor have continued to rise throughout January. By the same token, investors are not looking to add further risk by borrowing against their crypto investments, and thus borrowing on the platform has plateaued. This has left Anchor with an increasing daily interest bill, without a corresponding increase in revenue to fund it.
Can the problem be solved?
Do Kwon, co-founder of Terra and CEO of Terraform labs, attempted to allay concerns around the depleting treasury, tweeting, “[the reserve] was created to be used precisely in situations like this.” He added that even if the reserve dried up, Anchor would still be able to offer a rate of 15-16% APY on stablecoins, which would beat most similar protocols. Kwon seems confident that Anchor would continue to be successful even if the reserve ran dry, however recognised the importance of the current rate as a driver for the growth of Anchor and adoption of the Terra ecosystem as a whole, stating he is “resolved to find ways of subsidizing the yield reserve.”
During the last major market drawback in May 2021, Terraform labs provided a cash injection of 70 million $UST to boost the reserve in a similar situation. Many are hopeful for a repeat of this in the coming days. In the longer term, upcoming changes in Anchor’s ‘V2’ model hope to increase borrowing on the platform, yet it is likely that doubts over the sustainability of the 20% rate will remain. If we do see the yield reserve topped up in the coming days, it could signal the last chance to enjoy Anchor’s famed 20% APY!
UPDATE 11/02/2022
The Luna Foundation Guard (LFG.org) yesterday voted to top up Anchor’s yield reserve with 450 million $UST. The Luna Foundation Guard is also headed by Do Kwon, and was set up just three weeks ago with a mission statement dedicated to the advancement of open-source technology, with a focus on growth of the Terra ecosystem. Terraform labs gifted 50 million $LUNA to the foundation at launch, and it is these $LUNA reserves that will fund the yield stimulus, with 9.5 million $LUNA tokens to be burnt over a 5-10 day period in order to mint $UST. This move confirms Kwon’s dedication to preserving Anchor’s 20% rate in the short term, now all eyes will be on Anchor V2 to see if this can be sustainable..
