LeoFinance - Anchor Protocol Where is 20% APR Coming From?

How does the Terra Blockchain's Anchor protocol able to provide 19.5% APY interest to the UST stable coin? That is what this post will try to answer.

For newer folks to Anchor protocol here is a short explanation of what the protocol does. Anchor protocol is a lending platform and it can lend out UST stable coin. On top of that it provides investors of UST an interest of 19.5% APY in UST for any amount of UST deposited. There are a few more elements involved in Anchor as it has its own native token called Anchor and is used as to pay out borrowers as an incentive for using the platform.

Depositing and Lending

I will try to summarize best I can as to the reason why the deposit UST interest can be 19.5% and if this is sustainable? With that we focus on Anchor's liquidity inputs and outputs to see where the 19.5% comes from.

On the deposit side it is pretty straight forward. You put UST into the EARN tab and you will automatically earn 19.5% yield. Interest is paid daily and automatically staked on top of the original principal therefore you are earning interest on top of interest daily. UST can be traded on popular exchanges such as Binance and Kucoin. It is design to be pegged to a $USD, 1 UST = $1 USD.

On the borrow tab Anchor will accept two tokens bETH or bLuna. To keep this post short just understand both bETH and bLuna are wrapped tokens of ETH and Luna respectively and are 1 : 1 in value will be sufficient.

What Anchor will lend out is UST and in order to lend they require borrowers to provide collateral either in bETH or bLuna. Once the collateral tokens are provided the borrower is allow to borrow up to 50% in value of the total amount in $USD value they have provided as collateral.

A quick summary above is the current status of UST deposits and UST borrow. In addition the APR % earned for each. Yes its not an error, borrowers who borrow UST are paying an interest that is currently at 14.99% APR. You maybe thinking who is willing to borrow from Anchor if interest rate is so high? Well Anchor's work around is to reward borrowers with Anchor token which currently not only nullifies the UST interest paid but provides borrowers with income to borrow.

Borrowers are paying 14.99% in interest but earning 15.22% back making it a net +0.23% for the borrower. This rate is not fixed and will move but it has been within +/- 2% overall making it a very low interest rate to borrow stable coin UST on Anchor.

Above image is the current total collateral provided to Anchor protocol by borrowers. In terms of $ USD it is $4,248.5 million for bLuna and $378.67 million for bETH. What is not shown is these collateral controlled by Anchor is earning Anchor interest through Lido.

Lido is a protocol on the Ethereum blockchain than can stake cross chain tokens such as bLuna from Terra blockchain and stSOL from Solana blockchain. We focus on only bETH and bLuna and can see on Lido if Anchor is to stake those tokens they will earn 4.7% APR and 8.0% APR respectively.

Sustainable Deposit Interest Yield?

Above chart is a quick summary of the borrowing input into Anchor and the deposit interest given output to users. The eye catching difference is a net negative currently where it is almost to a a 2:1 between how much Anchor is paying out to depositors and how much it is earning from borrowers. This is actually not ideal as it can not be sustained if Anchor continues on this path.

A few things Anchor can do to maintain its operation. One it can reduce its deposit earning yield. Or it can be withdrawing from its reserve yields to pay for the cost difference. Currently the yield reserve on Anchor is:

The yield reserve is Anchor's stash of money obtain through its initial protocol investors and since added stake of assets it sells such as some Anchor tokens. The bottom line is the protocol currently is not on track as the cost difference between investors and borrowers is at $ -412.87 million a year while the reserve is only $ +64 million and change.

Based on daily reserve values from Anchor since earlier December 2021 the protocol has been depleting its reserve in order to pay out the 19.49% yield to depositors. At this rate Anchor will be in the red within two months.

Conclusions

For those who know me and follow me will know I am more Terra bullish than be a bearish. I am just giving the data that is set forth to me via Anchor data and computing the results as it is. Currently the deposit side of the protocol is heavily skewing the earnings making it difficult for the protocol to be sustainable at its current form.

With the current down turn in the crypto market it is likely that the borrowing of UST may continue to drop as people do not want to leverage into buying assets that have price depreciation. At the same token Anchor has something up their selves in balancing the costly interested payments to depositors.

When a borrower fails to meet their collateral they are liquidated. This means their contract with Anchor is broken and Anchor fire sales the borrower's bETH or bLuna. Remember Anchor only allows up to 50% borrowing of one's collateral? There by when it gets to 60% of the collateral the borrower gets liquidated and the proceeds goes back to borrower with an additional 1% fee tacked on to pay Anchor. That means Anchor earns 1% of that exchange that can be used to pay down the interest payments to depositors.

In addition Anchor has a governing system in place therefore stake holders can introduce polls to provide a course of action for what to do to handle the depleting reserves. This is where stakers can implement the reduction of depositor's rates in order to continue maintaining operation of Anchor. This is easy to do since its closest competitors on stable coin yields are no where near 19.4%. Lowering the yield will buy the protocol more time to develop or withstand the tail wind of the current crypto market.

None of what I write is financial advice. It is for entertainment purposes only. Thanks for reading!