Lessons learned from the “May Crash” (Anchor Protocol)
It’s been a few months since the infamous “May Crash” where we saw 50% drawdowns of the entire market and LUNA’s price crashing more than 70%. During those stressful weeks, the entire Terra ecosystem was put to test and the Terra community was in distress.
Many LUNAtics were affected due to being exposed to leverage on Anchor. A popular strategy that many have used was the recursive lending strategy, this involved:
- 1. Depositing bLUNA as collateral on Anchor
- 2. Borrowing UST to buy LUNA
- 3. Swap LUNA to bLUNA to repeat Step 1
This essentially allowed many to leverage up their LUNA holdings. This was fine as long as LUNA’s price kept going up, but when the “May Crash” came, many were left panicking trying to pay back their loans.
In this article, I will highlight several lessons that I learned from that experience. Hopefully, this will provide new LUNAtics with a better understanding of the risk involved in borrowing on Anchor.
Total LUNA holdings in Anchor
Your strategy for managing risk will depend upon how much of your total LUNA holdings are on Anchor. In general, if a higher percentage of your total LUNA holdings is on Anchor you should be more conservative, if you have a lower percentage of your total LUNA holdings on Anchor you can be riskier.
While this is highly dependent on your individual situation, I personally wouldn’t have 100% of my total LUNA holdings on Anchor. This is due to a number of risks such as liquidation risk and smart contract risk. If any of those were to occur, losing 100% of my total LUNA holdings would be devastating as it would mean losing everything.
Safe LTV
Having a safe LTV is extremely subjective because there are many definitions of what is considered safe. Anchor’s own recommended LTV is at 45%, leaving you some breathing room with the max LTV at 60%.
Your LTV is the first line of defense against liquidations. Having a low LTV will buy you time to readjust your borrowing position in times where you aren’t able to keep track. A good example of how a low LTV helps is in extremely volatile market conditions, where the value of your collateral might experience a sharp drop. Having a low LTV in this instance will help you prevent immediate liquidations from that drop in price and allows you time to pay back your loan.
In general, finding the right LTV for yourself is highly dependent on your risk appetite. If you aren’t able to sleep overnight, you are probably taking too much risk.
Keep Borrowed Funds Liquid
What you do with the borrowed UST is extremely important as it is the main way you are able to pay back your loan. Typically, the best strategy would be to use the borrowed UST and deposit it right back into Anchor Earn. This allows you to earn 20% on your borrowed money which should be a plus considering you are already earning through Anchor borrowing incentives.
But if you do decide to use your borrowed UST for something else, here are some things to keep in mind.
- Do not use 100% of your borrowed funds. This is to give you breathing room to pay back your loan in order to avoid liquidations.
- Make sure your funds are highly liquid. Some examples of illiquid strategies; Pylon Pools (UST is locked for x months), using aUST to mint mAssets (UST cannot be redeemable on the weekends for most mAssets),
- Make sure your funds are redeemable for a similar value. This means if you’re planning to buy LUNA with your borrowed UST, you better be sure it will go up in the short term.
Have a Backup Back-up Plan
While there are no specific ways to describe this lesson, this should be considered as a general rule of thumb. Having a backup plan to your backup plan allows you to create multiple safeguards before liquidations.
An example of setting multiple safeguards:
- Safeguard #1: Low LTV (ex: 20%)
- Safeguard #2: Keep borrowed funds liquid (ex: Anchor Earn)
- Safeguard #3: Have external capital ready to pay back loans (ex: selling ANC)
This becomes important as a significant amount of your portfolio is being used as collateral on Anchor.
Upcoming solutions
There are auto-repaying bots that allow you to maximize your borrowing while managing your LTV safely. This solution is great for those who want to maximize their ANC borrowing rewards, but it does require some technical knowledge to implement.
Other solutions coming in the future include Nexus Protocol that does this for you. This means anyone will be able to access these types of tools without having the technical know-how.
Conclusion
Borrowing from Anchor can be a lucrative way to yield farm but it comes with its risks. These include smart contract risk, but more notably; liquidation risk. Hopefully, this article can serve as a general framework on how to borrow safely on Anchor.
About Qi Capital
Qi Capital is a group of like-minded and experienced individuals from around the globe, sharing two common objectives: providing insights about crypto and DeFi, and proactively working with ambitious teams on the future of decentralized finance. Our core principle is to promote and foster individual creativity, growing not only as a group but also as creative thinkers and builders. To learn more about us, check out our website www.qicapital.org and our “Qi Podcast” via www.buzzsprout.com/1729379/ or engage with us on Twitter: @QiCapital.
Disclaimer
This statement is intended to disclose any conflict of interest and should not be misconstrued as a recommendation to purchase any token or participate in any farms. This content is for informational purposes only and you should not make decisions based solely on it. This is not investment advice. All market prices, data, and other information are not warranted as to completeness or accuracy, are based upon selected public market data, and reflect prevailing conditions and the author’s own views as of this date, all of which are accordingly subject to change without notice.
