Review: Terra’s Anchor Protocol
The Revolution of Passive Income
Executive Summary
Anchor Protocol — built on top of the Terra Blockchain — aims to be the “gold standard for passive income” by establishing a stable savings rate across the typically highly volatile crypto and DeFi universe utilizing Proof-of-Stake block rewards. The protocol launched in mid-March 2021 with an initial working feature-set that allows users to earn a fixed 20% APY on their UST (the native Terra USD-pegged stablecoin) and to collateralize $LUNA to borrow UST incentivized by the distribution of the ANC governance token. The protocol achieved more than $700M in TVL one month after launch. In the future Anchor will also integrate other PoS assets such as DOT, ATOM, and SOL and its target is to have the Anchor savings protocol seamlessly integrated into multiple retail-facing savings and payment applications around the world.
The foundation: Terra blockchain
Anchor Protocol is built on top of the Terra blockchain which itself is Cosmos-based and has been launched in 2018 by Terraform Labs based in South Korea. Terra offers a highly scalable blockchain with native stable coin support that allows for programmable money and an open, decentralized financial infrastructure built on top of it. It supports a basket of fiat-pegged, seigniorage share-style stablecoins which are algorithmically stabilized by the native crypto asset, Luna.
The initial usage for Terra came from the highly popular payment app Chai in South Korea that utilizes Terra’s KRT stable coin (pegged to KRW) and allows for immediate settlement between buyer and seller. Chai has now more than 2 million users and catapulted Terra into the top 5 blockchains based on generated fees. The launch of the synthetic asset protocol Mirror Finance and now Anchor Protocol led to a surge for UST (Terra’s native USD-pegged stable coin) demand, which is now a top 5 stable coin in terms of market capitalization.
At this point in time, many different projects are built on top of Terra, not only from the official Terraform labs team but from many different participants around the world. This additional growth was partly driven by newly launched Terraform Capital, Terra’s own venture fund providing free access to launch capital for new networks and projects.
The team behind
Anchor Protocol has been developed by Terraform Labs, the company behind the Terra Blockchain which has been founded by its CEO Do Kwon. Do Kwon has been in the Forbes 30 under 30 Asia list (you can find his profile here) and started Anyfi, a wireless mesh network startup, before transitioning into crypto finance.
The Anchor Protocol has been written by Nicholas Platias, Head of Research at Terraform Labs, who before co-founded a machine-learning startup within the insurance industry, Eui Joon Lee, who also works for the Chung-Ang University as well as the C-Link Research team, and Marco Di Maggio, Professor at Harvard Business, Co-chair of the Leveraging Fintech Innovation to Grow and Compete program.
The challenges to be solved
The current macroeconomic situation has led to a deterioration of interest rates in the financial markets for both institutions and retail. This development was driven by the major economic crisis in the last decades (the burst of the dot-com bubble in 2000, the near-collapse of the financial markets in 2007–2008, and omnipresent market turmoil driven by the Covid-19 crisis in 2020 and 2021) and the monetary and fiscal politics in reaction to these. Right now, interest rates for bank deposits are near zero around the world or even negative in some countries for larger deposits (e.g. Switzerland’s Credit Suisse charges a negative interest rate of –0,75% for deposits higher than 2M Swiss Francs).
On the other hand, we have witnessed the rise of cryptocurrencies with the launch of Bitcoin in 2009, Ethereum in 2015, and thousands of other projects until today. This has led to the rise of Decentralised Finance (DeFi) which tries to offer a fully transparent and open alternative to the existing traditional financial ecosystem built on top of blockchain technology that does not rely on central intermediaries.
The DeFi ecosystem has re-built many traditional financial instruments such as borrowing & lending, decentralized exchanges, derivatives as well as hedge funds and has attracted more than $50B by April 2021. Since its first bloom in the “DeFi summer” of 2020, participants can earn a high yield of 20% and more (up to several hundreds of percent) on their capital based on current high borrowing demand, an early distribution of protocol tokens, and fee accrual towards protocol “shareholders”, often relying on some kind of leverage.
Additionally, this yield is often highly volatile, hardly predictable, and comes with high risk across several dimensions, making it unusable for many market participants like mainstream users and risk-averse institutional investors. This has already led to more and more projects in the ecosystem trying to provide some kind of “fixed interest” either through tranching, splitting deposits into collateral, and yield-bearing tokens or other means (e.g. BarnBridge, Saffron, Notional, Horizon, etc.).
Anchor Protocol’s mission is trying to solve these meta challenges by providing a stable and reliable high yield savings rate on deposits combined with high composability.
How Anchor works
The core principle of Anchor is to provide a stable savings rate that can compete a traditional savings account and does not rely on leverage and reduces risk as much as possible. In order to achieve this, Anchor aggregates Proof-of-Stake (POS) block rewards from different PoS assets (right now only Terra’s LUNA) to derive an average return rate on top of a lending rate from Anchor’s own money market. The respective collateralized assets are bonded as so-called bAssets on Anchor (staked through Anchor) so that the protocol earns the rewards itself and can redistribute them to lenders.
The chosen assets for the future are Solana’s SOL, Polkadot’s DOT and Cosmos’ ATOM making Anchor in the future a multi-collateral system where borrowers can open loans against multiple assets.
The typical accumulated block rewards generate between 6 and 12% APY. These block rewards are then used to subsidize the lending rates on Anchor’s own money market so that the actual lending rate equals the anticipated Anchor Savings Rate which is currently fixed at 20%. This 20% is derived from the current on-chain yield of LUNA which is approximately 12%. (As the loan-to-value ratio (LVR) is 50% this rate is backed by two times the 12% block rewards in yearly returns). Later, the Anchor Savings Rate will be set by governance depending on the yield from bLUNA and other PoS assets that will be added to the protocol. The collateral also acts as insurance for the lender’s deposits.
So all lenders get a guaranteed lending rate which currently equals 20% whereas borrowers are exposed to a floating borrowing rate.
The protocol has built-in incentives mechanics to stabilize the ratio between lenders and borrowers. For example, if the actual lending rate is below the anticipated Anchor Savings Rate, the lender’s share of the PoS rewards is increased and vice versa. This adjustment happens on a block-by-block basis.
In order for this to work in times of market turmoil, the underlying bAsset collateral needs to be liquidated when loans become undercollateralized (e.g. if the price of LUNA falls) as common in all lending protocols.
Let us now summarize the different roles taking part in Anchor:
Depositor/Lender: He/she lends UST (later also other Terra-based stable coins) to Anchor via a lending pool. The depositor receives Anchor tokens (e.g. aUST) in exchange that can be claimed for the collateral + interest and subsidies at withdrawal.
Borrower: He/she create a loan based on bAssets (initially only bLUNA) to borrow a stablecoin (UST). The borrower has to monitor the LTV (loan-to-value) ratio in order to not get liquidated and earns ANC tokens as a reward during the first 4 years of the protocol.
Liquidator: He/she monitors risky loans and triggers a liquidation (purchase the liquidated collateral in exchange for UST) if the LTV ratio is beyond the set maximum. This process will most likely be changed in the future to automate it as explained in the respective chapter.
There is also the role of the ANC liquidity provider for the AMM-based ANC-UST pair and the oracle feeder which is currently provided by Anchor itself but will probably be outsourced later to a third-party oracle (e.g. Chainlink or Band).
The first weeks in retrospect
Anchor protocol launched on March 17th, 2021 after being originally announced in summer 2020 (you can read the original announcement here). This launch happened during a raging bull market and after the high usage of the Terra blockchain through Chai but also through Mirror Finance which launched a few weeks before was recognized by the market and led to a steep price increase for the native LUNA token.
Also for Anchor, the Terra team planned an airdrop just as they did for Mirror Finance, distributing 50M ANC tokens to LUNA stakers during the genesis event. This equaled 1/3 of the initial token distribution, as 100M went into the community fund.
All of this led to great excitement and anticipation towards the project. Thousands joined the official Discord and Telegram channels within a few days and it was no surprise that many would try to get hold of the token early.
In fact, the start of trading at Terraswap.io, Terra Station, and Anchor’s web3.0 platform itself had to be postponed because of DDoS attacks against Terra Station’s public nodes happened and bots tried to get hold of ANC tokens before the public.
The starting price of ANC was defined as $0.05 but quickly rose to about $4 before topping at $8 two days later. Therefore, for a short amount of time, Anchor’s fully diluted market cap reached $8 billion.
The launch of Anchor was also covered broadly across crypto-related media and the protocol saw a continuous inflow of funds (LUNA converted to bLUNA, deposited UST) and borrowing of UST. As of today, the protocol reached more than $700M TVL consisting of $500M in bLUNA collateral and $200M of UST deposited as well as $170M UST borrowed.
The promised 20% APY for UST deposits could be guaranteed all of the time but we have to be aware the borrowing of UST (currently costing 35% APR) is incentivized by the distribution of ANC tokens leading to a net positive borrow APY of above 60%.
Anchor — which is still in a “bootstrap mode” — was able to “survive” its first small test on April 18th when we saw a large drawdown in crypto markets with many digital assets losing 20% to 30% of their market value. Both UST kept its peg to the US dollar and Anchor continuously paid 20% APY on UST deposits — although this event cannot be compared to a black swan event that happened in March 2020 where the market lost more than 50% of its valuation.
But what could be noticed was that liquidations did not happen consistently across the collateralized debt positions on Anchor which would be necessary for the long-term safety of the protocol and the user’s funds. The reason for this seems partly to be the not yet automated handling of liquidations, which has now been addressed by Harpoon Protocol. You can read more about this topic here (community forum proposal).
Farming opportunities on Anchor
Anchor Protocol offers multiple farming opportunities for DeFi yield farmers.
The obvious one is to provide UST and earn 20% fixed yield on it. For more people with higher risk tolerance, LUNA can be bonded as bLUNA in order to borrow UST (currently to a max value equalling 50% of the value of the bonded LUNA). This borrowing is incentivized by a distribution of ANC, currently leading to a positive net APR of 66% (101% ANC distribution APR — 35% borrow APR). The borrowed UST can then be used to farm on other protocols for additional APY (e.g. providing liquidity on Mirror Protocol).
one can also add liquidity to the AMM-based ANC/UST pool which is also incentivized by ANC distribution and currently nets 97% APR.
Last but not least, ANC can be staked for governance rights, offering 5% APR. Rewards are in this case automatically re-staked.
The following diagram summarizes the different farming opportunities in the Terra ecosystem:
Risks
Anchor shares many of the risks of all other DeFi protocols but also some additional ones specific to protocols utilizing stablecoins and collateralized debt positions. This is not necessarily a complete list of all risks, so please always do your own research before using this or any other DeFi protocol.
- Smart contract risk: Errors or exploits leading to a loss of funds because of protocol errors or malicious actors.
- Layered risk: The composability in DeFi could lead to a multiplication of risks as several protocols work together or are built on top of each other. Therefore a bad event in one of those could lead to a negative chain reaction and affect all other protocols too.
- Other software risks: Malicious attacks such as hacks, DDoS attacks or similar could lead to a temporary unavailability of the service or even data loss.
- Market risk: A black swan event could lead to either a massive price fall for LUNA (leading to mass-liquidations as the value of the provided collateral goes down too) or ANC (suddenly the borrow APR could become negative as the borrow APR for UST becomes higher than the ANC distribution APR). Also, UST could lose its peg, leading to unforeseen consequences to the whole Terra ecosystem. This again could lead to a liquidity crisis based on a “bank run” as participants want to retrieve their funds.
- Liquidation risk: If the value of one’s collateral falls below a certain threshold compared to one’s debt (loan-to-value ratio; LTV) the collateral will be fully or partly (depending on the total value) liquidated to ensure the stability and collateralization of the protocol. Therefore the LTV should always be monitored.
- Economic incentive risk: Network participants could be encouraged to act in bad favor or against the design of the protocol. This could lead to borrows not providing enough collateral for the protocol to pay out the promised yield. Also, incentives to provide collateral and borrow on other platforms could be higher so that no one is interested in borrowing on Anchor anymore, especially once the incentives stopped.
- Regulatory risk: New country-specific regulations could affect the protocol in negative ways, e.g. restrict its usage of Terra’s algorithmic stablecoins (UST) or the access for certain countries.
Investors backing the project
For every bigger project, it is important to understand who is backing it, not only financially but also to drive adoption and provide constructive feedback. Anchor has the luxury of being an offspring of Terra Labs, which already has long-term relationships with notable investors since its launch in 2018 like Polychain Capital, Arrington XRP Capital Binance Labs, Huobi, and many others. You can read more about the initial $32M seed round announcement here.
Some of these investors, like Michael Arrington’s XRP Capital, invested in every single official Terra project and therefore also backed Anchor — which is a very positive sign.
But also new investors joined this project, leading to a list of backers that reads like the who-is-who of blockchain and DeFi investments, including heavyweights like Alameda Research, Delphi Digital, Naval Ravikant, Pantera Capital, Jumptrading, and many others.
It is important to understand, that these investors do not only bring capital but can help the project building and driving adoption. For example, P2PValidator for example stands behind Lido Finance a core staking primitive in Anchor, Everstake and CertusOne are building interchain bridges for the Anchor rate and both Delphi and IDEA will organize hackathons to foster new ideas on top of Anchor.
Anchor took advantage of making their announcement during DeFi summer in 2020 and launching their product during a crypto bull market and therefore in a time where lots of venture funds were seeking investment opportunities. The Terra team was also able to convince investors based on an experienced team, proven technology in form of the Terra blockchain as well as a successful launch of the “sister project” Mirror Finance.
The presale investor price for ANC has been $0.1 per token, which has been a great opportunity for any seed investor as an initial market cap of above $100M was to be expected and indeed, the initial ANC price ranged around $5 since its launch with a current market cap of +$250M and a fully diluted valuation of close to $5B. The original listing price on Terraswap has been $0.05 per token. Investors are bound to a 6-month cliff and a 12 month vesting period thereafter.
Utility, tokenomics & valuation of Anchor’s ANC token
The ANC token is a typical DeFi governance token, granting holders the right to participate in governance polls. Even more importantly for potential investors might be the fact that ANC is designed to capture a portion of Anchor’s yield and in fact, is promised to scale linearly with the number of assets under management in the Anchor protocol.
ANC will capture fees from the protocol itself (part of the rewards from bAssets, excess yield and a part of liquidation fees will all be used to buy back ANC from the market) and through governance (governance polls that have failed to reach the required quorum are redistributed to ANC stakers as staking rewards).
The total supply of ANC will be 1'000'000'000 which will be distributed across 4 years based on the following distribution schedule:
Therefore, the final token distribution will look like this:
Finally, let’s look at the price development of ANC since its launch on March 17th, 2021:
We can compare this current valuation to other known lending platforms to have a better reference model. For this, I compared the market caps and TVL as well as the corresponding ratios of Aave, Compound, Alpha Finance, Cream, Hard Protocol, and Anchor.
The future
Essential for Anchor’s future is the widespread adoption of Terra’s stablecoins and especially UST as well as the utilization and integration of the Anchor Savings Rate by other platforms.
For UST, this means additional listings on centralized exchanges (it is still not available on Binance, Coinbase, or FTX), and its usage in top DeFi applications as collateral (of the main DeFi protocols, it is only available on Uniswap, Suhiswap, and Curve) as well as having it integrated as means of payment.
Regarding the adoption of the Anchor Savings Rate, there are countless opportunities for financial applications to utilize it as any deposit could be enriched by 20% APY fixed which is a clear value proposition to customers. Also, Anchor is very much focusing on this by providing its own developer portal, incentivizing development with Terraform Capital, and offering an SDK.
We can also see first live integrations with Oxis (crypto wallet) and Kash (digital banking application).
Anchor right now is the very first implementation of the protocol, focusing only on bLUNA as collateral. In the coming months, we will see the addition of bATOM (Cosmos), bDOT (Polkadot) & bSOL (Solana), and deeper integration with the corresponding communities and platforms.
If the value proposition of a stable savings rate is recognized by the corresponding token holders, and they are additionally valuing the exposure to UST by borrowing on their collateral, the total value locked (TVL) on Anchor would rise accordingly and therefore also the value accrued by ANC.
We can also witness that Anchor is already working on improving the core mechanics of its protocol such as liquidation (mentioned above) or insurance. Especially the latter could make it attractive to be used by institutions to earn a yield on (temporary) idle funds.
In order to judge the long-term viability of Anchor, it is recommended to closely track both the market capitalization and utility of UST (or other Terra stablecoins in the future) as well as the volume of assets under management (and its growth) in Anchor protocol which in the future has to be driven by capital outside the Terra ecosystem. Critical will also be if Anchor can generate enough growth in a highly competitive lending market especially once incentives dry off, as current borrowing rates of 30%+ will not be viable then.
The good and the bad
To conclude this review, let’s summarize the current key strengths and weaknesses of the protocol in a few bullet points:
Strengths:
- High-yield stable savings rate
- Incentivized borrowing for yield farmers
- Proven and scalable underlying technology (Terra, Cosmos)
- Potential to accrue value from other blockchain’s PoS assets
- Potential to be integrated into non-crypto savings accounts
- Strong backing by high-profile investors
Weaknesses:
- Dependence on the adoption of Terra stablecoins
- High competition in the DeFi lending market
- Not as risk-free as marketed
- Concept not yet battle-tested by black swan event
- Highly incentivized during the first years, not yet clear if the concept works in practice without those
Links
To dive even deeper into Anchor, I recommend the following sources:
Anchor Website: https://anchorprotocol.com/
Anchor Whitepaper: https://anchorprotocol.com/docs/anchor-v1.1.pdf
Arrington XRP Capital’s research article on Anchor: http://arringtonxrpcapital.com/wp-content/uploads/2021/03/aXRPc_resurrecting_the_saver_walking_tall_with_anchor.pdf
Delphi Digital’s research article on Anchor: https://www.delphidigital.io/reports/anchoring-the-market-to-a-new-reference-rate/
Anchor Tutorial by Chorus One: https://medium.com/chorus-one/opportunity-of-the-month-anchor-protocol-yield-farming-using-liquid-staking-derivatives-98134be9fe62
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
Some members of Qi Capital own or farm ANC, LUNA, and other Terra-related digital assets. 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.
