A Second Life For Anchor Protocol
by Martin Gaspar
Anchor: Terra’s Primary Borrow/Lend Protocol
Anchor, Terra’s primary borrow/lend protocol, is notorious for it’s ~20% yields on stablecoin UST, which is much higher than what is available on most other DeFi protocols these days. It seemed too good to be true and it is now proven that the high yields were not sustainable, with Anchor’s reserve fund down to only several more days of run rate as of February 11, 2022. A deep-pocketed benefactor has now come to its rescue, with the Luna Foundation Guard agreeing to top up Anchor with 450 million UST to keep it afloat. Before we delve into it, let’s recap what led to this.
Does Anchor Pay Out Yield?
On a fundamental level, Anchor pays out yield to UST depositors through the rewards earned from the staked assets borrowers post as collateral. Considering that borrowers must be overcollateralized (as of writing, Anchor borrowers are roughly 120% overcollateralized), Anchor earns considerable yield from this collateral.
Bonded LUNA (bLUNA) currently earns around 9% APY, which means that Anchor receives income of roughly 20% from bLUNA collateral that borrowers post. However, one issue is that not all of the collateral is bLUNA. Approximately $600 million of collateral is in bETH (bonded/staked ETH). Staked ETH pays out lower than staked LUNA, (5% vs. 9%). So, protocol income from staked ETH is relatively lower. On a blended basis, the protocol is earning approximately 18%, but targets pay outs of ~20%. So, there is a significant gap in terms of fund inflows versus outflows.
The Inherent Imbalance
A further consideration is that Anchor pays out ANC token rewards to borrowers, incentivizing loan origination. Consequently, a portion of Anchor borrowing is not natural â it is just users taking advantage of an artificial lower cost of capital. Once ANC rewards run out or are minimized, these borrowers will likely close their loans on Anchor. Less staked collateral means even lower funds generated by Anchor to pay out their ~20% yields to depositors. Moreover, the ANC rewards fuel a virtuous cycle. Savvy users simply take out a UST loan at an APR of close to 2.5% and then deposit that UST back into Anchor to earn 20%. In fact, lending/stablecoin protocol Abracadabra offered a similar leverage loop strategy on UST via Anchor that promised 100% yields. The point is that there is inherently an imbalance â there is far more demand for the 20% yields from depositors than there is demand from borrowers for UST at the moment. Without the ANC incentives, there would not be enough borrowers, and hence enough collateral posted to pay 20%. Thus, yields paid to depositors would need to be lowered dramatically to be sustainable.
Anchor had a “yield reserve” fund whose purpose was to plug the deficit the protocol was incurring. If the protocol was earning more than it paid out to depositors, the reserve would grow, but if it was earning less than its obligations, funds would be drawn from the reserve to pay depositors. The reserve has been shrinking for several months now, and remains at approximately $10 million as of February 11, 2022, down from nearly $70 million in December 2021.
The Non-Profit Supporting The Growth Of Terra
Last week, the Luna Foundation Guard (LFG), a non-profit formed to support the growth of Terra and the stability of the UST peg, agreed to recapitalize the Anchor yield reserve with 450 million UST over several days starting February 11, 2022. Such a move should be seen as supporting the ecosystem by marketing (high yields bring users to Terraecosystem/UST) and as a solution to kick the can down the road until Anchor expands cross-chain and its v2 borrowing and tokenomics kicks in. It’s very doubtful whether Anchor can sustain its ultra-high rates, so I ultimately see this solution as simply buying time in hopes for UST use cases to further proliferate.
Right now, much of UST is tied to Anchor, with nearly 53% of UST in circulation deposited in the protocol. Ultimately, Anchor will likely need to give way in the end by either lowering its payout rate to one that is sustainable or by finding more use cases that will generate sustainable demand from borrowers to pay up for UST loans.
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