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Monolith Spotlights: Anchor Protocol, Terra’s fixed yield stablecoin platform

Here at Monolith HQ we spend a lot of time researching DeFi. As the DeFi space has grown over the last two years, many users have found that they can use their crypto assets for activities like yield farming, lending and borrowing. The rush of innovation in DeFi is of particular interest to us for as we’ll be leveraging opportunities to help users capture yield through groundbreaking DeFi primitives. The vast majority of DeFi runs on Ethereum today, but as crypto has grown, it’s become increasingly clear that the space is heading towards a multi-chain future. One of the most promising DeFi ecosystems to have emerged in recent years can be found on Terra, the stablecoin-focused blockchain for real world payments. In this guide, we explore one of the leading projects in Terra’s DeFi ecosystem: Anchor Protocol.

Please note: We want to highlight that this article does not constitute investment or financial advice or an endorsement of any product. The information presented is for educational purposes only. Monolith takes no responsibility for the stability of any protocol mentioned.

Terra is a Layer 1 payments-focused blockchain powered by decentralised stablecoins.

It has a huge user base in South Korea and has seen increased adoption as its DeFi ecosystem has evolved in recent months.

It’s built on the Cosmos SDK and operates a Proof-of-Stake consensus mechanism.

Terra aims to function as a blockchain for real world payments. Its network includes a suite of algorithmic stablecoins, which track the price of fiat currencies.

Its biggest stablecoin is UST, which is pegged to the US dollar.

The UST supply adjusts according to the level of demand among Terra users. The blockchain has its own native token called LUNA, which helps adjust the UST supply.

When UST gets minted, the equivalent amount of LUNA gets burned.

Similarly, when UST gets burned, the equivalent amount of LUNA gets minted.

LUNA absorbs UST’s volatility because users and arbitrageurs can burn tokens and collect the ​​seigniorage.

Terra’s focus on creating a decentralised network for stablecoins has led to the emergence of a burgeoning DeFi ecosystem. Many of the DeFi projects built on Terra share some similarities with those built on Ethereum, catering to use cases like lending, borrowing and yield farming.

One of the most popular DeFi projects built on Terra is Anchor Protocol.

Anchor is a lending protocol built on Terra.

It launched in March 2021 and has quickly become one of the most used products in its DeFi ecosystem.

Today, Anchor has a market cap of just over $336 million, while the total value locked in the protocol is $10.3 billion.

The total value locked in Anchor (Source: Anchor Protocol)

Anchor primarily serves as a platform to let users lend or borrow Terra-based stablecoins.

It offers low volatility yields to stablecoin lenders. Unlike most other lending protocols, it currently offers a fixed 19.59% interest rate, which is among the highest found in DeFi today.

It lets depositors lend out stablecoins such as UST, while borrowers can add liquid staking derivatives or bonded assets as collateral.

Depositors are not subject to lockup periods on Anchor, and there’s no minimum deposit.

In the next section, we’ll dive into how it works.

Anchor is built to let lenders deposit their stablecoins to lending pools. These stablecoins are lent out to borrowers.

In order to borrow stablecoins on Anchor, borrowers must put up collateral — an amount that gets deposited and can be liquidated in the event that someone defaults on their loan.

In Anchor, borrowers put up collateral in yield-bearing assets known as liquid staked assets or bonded assets (bAssets).

Liquid staking is a process in which users receive stake tokens representing their staked assets. These tokens can be used in DeFi to earn an additional yield.

Anchor supports bonded Luna (bLUNA) and bonded Ethereum (bETH) and will also add support for liquid staked Polkadot, Solana and Cosmos tokens in the future.

Anchor’s bAssets, bonded Luna (bLUNA) and bonded Ethereum (bETH) (Source: Anchor Protocol)

The protocol pays a fixed 19.59% interest rate known as the “Anchor Rate” to stablecoin lenders. It achieves this rate by generating revenue from two sources: the yield-generating collateral deposited by the borrowers, and the interest rate the borrowers pay to borrow the stablecoins.

Anchor’s 19.59% interest rate is higher than many other DeFi protocols, which has raised questions over whether it is sustainable. For now, the protocol is able to achieve the Anchor Rate because staking tokens earns high yields, and the interest rate to borrow stablecoins is as high as 24%.

As there is high demand for leverage in DeFi, many users are prepared to pay a high rate to borrow stablecoins. By paying a high rate, they can offset their costs by putting the stablecoins to work across various branches of the DeFi ecosystem.

Anchor is also able to attract borrowers by incentivising usage through its native token, ANC. Borrowers earn the token when they deposit collateral, which reduces the impact of paying a high rate to borrow stablecoins.

There are four types of user in the Anchor ecosystem:

Depositors — depositors lend out stablecoin tokens such as UST and receive Anchor Terra (aTerra) tokens, which represent their claim in the stablecoin pool. Depositors receive the interest accrued on their assets in the pool.

Borrowers — borrowers put up collateral in the form of bonded assets (bAssets) to open a loan position. This allows them to borrow stablecoins. Their loans can get liquidated, so they are required to maintain the loan-to-value ratio to ensure that their loan stays overcollateralized. This means that the amount of collateral deposited must stay high enough relative to the amount borrowed.

Liquidators — liquidators monitor loans to ensure that they are overcollateralized. When the collateral falls below the loan-to-value ratio, they can liquidate loans by setting a bid to Anchor’s Liquidation Contract. This lets them purchase the collateral at a discounted rate.

Liquidity providers — liquidity providers are required to provide liquidity to the ANC-UST pool on Terraswap, another pillar of Terra’s DeFi ecosystem. This allows for ANC to be distributed as an incentive to borrowers.

Anchor also needs Oracle Feeders to provide crucial pricing infrastructure:

Oracle Feeders — Oracle Feeders are required to provide accurate price data for bAsset collaterals, allowing the borrowers’ collateral values to be calculated.

There are four types of token used in Anchor:

UST — UST is Terra’s native and most widely used stablecoin. In Anchor, depositors lend UST out to borrowers, who pay an interest rate to borrow the tokens.

bAssets — bAssets are bonded or liquid staked assets. There are currently two bAssets in Anchor: bonded Luna (bLUNA) and bonded Ethereum (bETH). Borrowers use bLUNA or bETH to provide collateral, and the yield generated gets paid to stablecoin depositors.

aTerra — aTerra is Anchor Terra, a token lenders receive when they deposit stablecoins to a pool. It represents their claim to the pool and accrues interest for the lender.

ANC — ANC is Anchor’s native governance token. ANC token holders are charged with governing the protocol and determining the Anchor Rate. Currently, the Anchor Rate is set to 19.59%, but it could change over time. ANC gets distributed to borrowers to incentivise protocol usage.

Anchor offers a fixed interest rate to stablecoin lenders.

The protocol has a “yield reserve” denominated in UST, which is used to maintain the Anchor Rate.

When the yield earned from borrowers exceeds 19.59%, the additional yield gets stored in the “yield reserve”. The ANC incentives for borrowers also drop by 15% weekly, which balances out the amount earned as they are less inclined to put up collateral.

When the yield earned from borrowers falls short of 19.59%, the protocol draws the remaining yield from the yield reserve. ANC incentives also increase by 50% weekly, meaning that borrowers are more incentivised to use the protocol. The process continues until the protocol achieves the Anchor Rate.

Anchor is an innovative DeFi project built on one of the most widely used Layer 1 blockchains today. As Terra’s DeFi ecosystem evolves, it’s likely that Anchor will see increased adoption in the future. While this could mean a change to the Anchor Rate, for now, the protocol is offering one of the most attractive opportunities to earn yield on stablecoins in DeFi. While Ethereum’s DeFi ecosystem has also shown huge promise, the emergence of protocols like Anchor shows that DeFi will exist on multiple chains in the future. After significant adoption in 2021, Terra could be one of them, which bodes well for Anchor Protocol.

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