Anchor, which runs on the Terra blockchain, is one of the most interesting DeFi protocols in the cryptocurrency ecosystem. Currently Anchor is offering 20% yields on stablecoin deposits, which is significantly higher than what’s available on other protocols like Compound and Yearn.
In this article, we’ll explain how Anchor works, where the yield comes from, how it’s different from MakerDAO and the most significant risks of using Anchor. Even though Anchor is quickly building a name for itself, it’s still a relatively new protocol and investors should understand both the good and the bad before they put any of their money into the platform.
Anchor Overview
Anchor is a decentralized lending platform. Borrowers deposit assets and take out collateralized loans, while depositors can lock up stablecoins and earn interest on their deposits.
Here’s how the creators of Anchor describe the project on their website. “In Anchor Protocol, depositors are incentivized to lend Terra stablecoins to Anchor's money market, which is borrowed out by borrowers through bAsset collateralized loans. Interest paid by borrowers are given to depositors, along with subsidies generated from rewards of deposited bAsset collaterals.”
To help make sense of that tightly condensed sentence, let’s break down some of the key terms.
Depositors
A depositor is a person that deposits stablecoins into the Anchor protocol. Currently the only token that can be deposited is Terra Luna’s native stablecoin: UST. Users are incentivized to deposit their stablecoins into Anchor because they can earn an ultra-high ROI of 20% (that number may decrease in the future).
Anchor pools the UST deposits and lends them out to borrowers.
Borrowers
Borrowers deposit assets into Anchor and take out secured UST loans. Borrowers must over-collateralize their loans, and if the loan-to-value ratio falls below a set percentage the assets are sold off to repay the loan.
Other protocols like MakerDAO accept more than a dozen assets as collateral, including ETH, USDC, WBTC, LINK, UNI, etc. Although Anchor plans to accept more assets in the future, currently only two Bonded Assets (bAssets) can be used to collateralize loans.
According to Anchor, “bAssets” are: “liquid, tokenized representations of staked (bonded) assets in a PoS blockchain.” In other words, bAssets are tokens that represent claims on staked coins. Anchor receives the staking reward from that token when a user takes out a loan using a bAsset. More information about bAssets is available here.
ANC Token Distribution
Anchor incentivizes users to take out loans by distributing ANC tokens to borrowers. Currently the borrowing interest rate is quite high for loans on Anchor at about 15%. ANC is a governance token similar to UNI or SUSHI. The token also captures a portion of the protocol fees and distributes them to ANC stakers. Anchor also uses protocol fees to buy ANC tokens from the marketplace and send them to stakers. A more detailed overview of the ANC token and its tokenomics is available on Anchor’s website.
How Anchor Guarantees the 20% Yield
Anchor is currently paying a 19.48% deposit APY to anyone who locks up their UST in the protocol. Realtime interest rates can be checked via the Anchor dashboard. Anchor has three ways of sustaining the unusually high yield.
1) bAssets
Anchor collects the staking rewards from the bAssets that users deposit to collateralize their loans. These staking rewards are distributed to depositors.
2) High Fees
Borrowing fees on Anchor are exceptionally high, well above average. For example, the borrowing rate on Anchor is currently 15% while the borrowing rate for Ethereum backed DAI on MakerDAO is just 2.75%. Why would anyone pay 5x more just to borrow on Anchor? Users are incentivized to borrow on Anchor because they can receive the ANC token, whereas MakerDAO does not distribute a token.
3) Yield Reserves
The protocol saves the excess income whenever Anchor generates more yield than it pays out to depositors. In the event that Anchor earns less than what it’s paying out to depositors, it can subsidize the yield by tapping into reserves. In addition, whenever a loan is liquidated on Anchor, 1% of the collateral value is sent to the yield reserve.
Anchor Protocol Risks
At the highest level, there is a risk of a cascading selloff. Or, put differently, a bank run. Terra’s UST token is a synthetic stablecoin. The entire project has been created out of thin air and the value of UST is not backed in the same way that other stablecoins are. DAI is backed by the value of the collateral (mostly ETH) and USDC is backed by dollars and other assets held by Circle and Coinbase.
If too many people redeemed their UST for Luna at the same time, it could cause the price of Luna to crash, which could lead to even more selloffs in a self-perpetuating cycle. Ultimately that style of selloff could bring the entire Terra ecosystem down, including Anchor.
Is a large-scale selloff likely? Probably not. Terra has numerous safeguards to prevent this, however, it’s not impossible. Terra Luna is arguably the greatest algorithmic stablecoin ever invented, however, algorithmic stablecoins have a long history of failing and it’s important to understand the risks.
Risks to the 20% Yield
Some community members are concerned that if Anchor can no longer pay a 20% yield on deposits it could cause depositors to withdraw their assets and move to other protocols. Realistically this is probably not a huge risk, since even a 10% yield is astronomically better than what anyone can earn in their bank account.
However, if Anchor reduces the yield it could slow growth.
ANC Price Drop
The ANC yield farming reward is one of the key reasons Anchor has grown its TVL (Total Value Locked) so quickly. Depositors are willing to pay high interest rates to get ANC tokens.
So far that’s worked fine, but if there was a significant drop in the price of ANC it could cause borrowers to withdraw their funds. If that happens the interest rate that Anchor pays to depositors would also likely drop.
Learn More About Anchor
Anchor has an excellent dashboard that displays all sorts of statistics like TVL, borrow rates, deposit rates and how much UST is left in reserves. Further information about the protocol is available in the help section of the Anchor website.
Anchor is an ingenious protocol that offers much higher interest rates than other decentralized lending platforms. Although Anchor’s success is not assured, it certainly stands a good chance of becoming one of the most popular lending platforms in the entire crypto ecosystem.
