Anchor Protocol’s quick rise to prominence has made headlines for extremely positive reasons but with its success also comes its fair share of detractors who believe the protocol will not be able to sustain itself. This article takes a deeper look into the best platform to park your UST.
What is Anchor Protocol?
Anchor Protocol is a decentralized lending protocol on the Terra blockchain. It was built by Terraform Labs, the same South Korean software company that created Terra. It went live in March 2021 and is now the largest dApp on Terra by TVL with close to 20 billion dollars locked, and nearly 14 billion dollars deposited into the protocol.
Anchor’s reason for its rise to the spot of number one yield farming protocol is its ability to provide depositors with a 19.5% annual percentage yield (APY) on the UST stablecoin. This rate, as far as we know, is by far the most attractive for any USD-affiliated stablecoin in the world of DeFi, and hundreds of times better than any traditional bank can offer. Roughly 70% of all UST in circulation is locked up in the protocol.
[Option 1: Embed Boxming video (by Gemmy) https://www.youtube.com/watch?v=u06iAKuEMqQ]
The success of Anchor Protocol is all thanks to the TerraLuna ecosystem. Terra (LUNA) has to be burned to mint UST at a 1:1 ratio. This is the only way to obtain UST and take advantage of the 19.5% interest on Anchor Protocol, which has created huge upwards demand for LUNA as it aims towards breaking $100 a coin.
The Problem of Sustainability
This model makes it an algorithmic stablecoin. An algorithmic stablecoin is one that can keep its peg using only software and rules. Historically, all algorithmic stablecoins have failed because of what’s known as the ‘death spiral’ – a sequence of events that inevitably lead to the demise of a protocol. In very basic terms, this could happen if the price of LUNA falls drastically enough to cause investors to panic-sell their UST for LUNA amid fears of it losing its peg, thus increasing the LUNA supply and continuing its price decline.
This has not happened to UST (that Anchor continues to dominate) because TerraLuna creator Do Kwon so far appears to have cracked the code on inventing the perfect algorithmic stablecoin. 1 LUNA can be exchanged for 1 UST at any time, and vice versa. If the value of UST drops below a dollar, the market takes advantage of this arbitrage until the 1:1 peg returns. This elegant mechanism has worked every time the UST peg has dropped below a dollar so far, even during strong market corrections.
Anchor Protocol also has what is called a Yield Reserve that covers interest payments to depositors whenever the number of borrowers is too few to sustain the protocol mathematically, and the amount of money in that pool stands at nearly UST 223 million. Previous algorithmic stablecoins have failed in the past when the number of borrowers decreased too much and the yield reserve couldn’t cover the higher interest rate anymore. When this happens the interest rate has to keep decreasing to remain sustainable, until all users of the protocol withdraw and move to a platform with a better interest rate.
The developers are aware of the need to improve the sustainability of the platform and have suggested technical proposals to deal with the matter. To read more about that, check out this detailed tweet thread by Anchor Protocol that explains what they’re doing to address these concerns.
However, as long as Anchor keeps offering the highest stablecoin APY in the market, it will remain the DeFi platform of choice. And while theories about how the ecosystem could collapse are valid, there is a strong counter-argument that the TerraLuna is becoming simply too big to fail. TerraLuna’s seed investors know this, and have doubled down on their support for the ecosystem’s continued sustainability (more on this below).
Is Anchor Protocol a Ponzi Scheme?
Yet the debate continues about whether Anchor will be able to sustain its 19.5% interest rate, especially considering that it rewards borrowers with its own token, ANC, in exchange for depositing ‘bonded’ collateral such as bLUNA or bETH. By adding collateral, users can borrow more UST and repeat the process, and the number of depositors on Anchor Protocol keeps increasing.
Borrowers have to pay interest on their loans, but naysayers have accused Anchor of resembling a Ponzi scheme due to the fact that borrowers are basically getting paid in ANC tokens to borrow more UST, which offsets or even negates their interest burden. At the moment, it appears to be a win-win situation for users of the platform, and this is evidenced by the continuously rising TVL. Ponzi or not, the system is working.
The TerraLuna Insurance Policy
Looking to the future, to strengthen its grip on the market and ensure UST remains a trusted stablecoin, Do Kwon and TerraLuna have taken major steps to ensure confidence in their protocols is maintained.
A stakeholder group comprising seed investors and major industry heavyweights called the Luna Foundation Guard (LFG) has recently purchased billions of dollars of Bitcoin (BTC) as a reserve fund to provide another safety net as an added insurance policy. It is there in the event of a worst-case scenario, when BTC holdings will be able to cover any potential black swan events that may threaten UST, LUNA, or Anchor.
(Terra Founder Do Kwon reassures supporters)
In short, Do Kwon is doing everything possible to ensure any fears about UST losing its peg are allayed. This can only be good for Anchor Protocol, which now essentially has the considerable might of the LFG behind it.
To date, Anchor Protocol remains strong. The BTC fund the Luna Foundation Guard has opened to double down on insurance has increased confidence in the whole TerraLuna ecosystem. As of now, this is the only place anybody wants to lock up their UST. And as we know, the market is always right.