RF Capital
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RF Capital

Anchor Protocol: Institutionally Viable?

RF Capital Alpha Score: 74

About Anchor

Anchor is a borrowing/lending protocol on the Terra blockchain in the Cosmos ecosystem. Individuals are able to take out loans in UST, the native Terra stablecoin from Anchor by collateralizing Luna (bLUNA) or Ethereum (bETH). The addition of ETH to collateralization options is new and has led to $5 billion in Total Value Locked in the protocol.

Staking

Individuals are incentivized to provide capital to Anchor due to their high yield savings protocol. Savers earn between 15–20% on their UST holdings and now can use other stables like DAI, USDC, USDT, and BUSD via their gateway Orion.Money. Utilizing Orion is not as optimal as Anchor since the average rate is 13.5% on those stablecoin competitors.

Insurance

As of recently, there are multiple insurance options to protect from UST peg destabilization or smart contract failure through Unslashed and Ozone Protocol. Unslashed is live and aims to offer their insurance at 4.5% annually of your ETH worth in the protocol. Ozone is a Terra native option that is a part of their Columbus-5 rollout with more details shortly as to rates and structure. Insurance was the final layer of protection needed to make this product viable for major players across financial sectors.

How it actually works

There are 4 major components to Anchor Protocol:

  • Bonded Assets — Tokenized representations of bonded PoS assets
  • Money Market — Handles lending and borrowing of Terra stablecoins, with borrows collateralized by bAssets
  • Liquidation Contract — Manages collateral liquidations of loans at risk of undercollateralization
  • Anchor Token Contracts — Handles ANC-related operations and Anchor governance

Bonded Assets

bAssets allow for LUNA or ETH tokens to be bonded then collateralized in order to gain further yield. The growth of these assets in Anchor adds to the Total Value Locked (TVL) in the protocol. Users can mint bAssets, burn them in order to claim their underlying asset, or claim bAsset rewards. At the moment LUNA and ETH can be used to mint their bonded counterparts that allows users to take out loans against their holdings and get roughly 30% APR as long as their loan does not get liquidated.

Money Market

The money market feature allows for the execution of various lending/borrowing applications on the protocol. Anchor is able to attain their deposit yield from the bAsset collateralized loans. Users are incentivized to take out these loans due to attractive borrowing incentives that were previously mentioned. This created a positive usage cycle from the subsidization incentivizing continuous stablecoin deposits, creating a lowering borrow rate, that in turn incentivizes more collateralized loans, therefore enabling more bAsset rewards to be collected.

Liquidation Contract

Quite possibly one of the most important aspects of the protocol revolves around the liquidation contract. Without it, there would be no profit for the protocol. Anchor is able to incentivize liquidators to observe and liquidate their loans with an LTV ratio above the allowed maximum. In the event of liquidation, the contract converts the collateral to Terra stablecoin which repays the loan. Anchor has an oracle contract that suffices as a price feed where conversions between Cw-20 token based assets and Terra stablecoins are executed.

Anchor Token Contracts

Anchor and Ozone for that matter are both controlled in a decentralized manner by their communities as a DAO or Decentralized Autonomous Organization. Anchor does not contain any admin keys to the network. Anchor Governance has sole authority over the protocol with votes being administered and executed by community members only. Community members are designated by holders of their native ANC token which is used to vote on new proposals. 1 ANC staked equals 1 vote.

Institutional Risk Factors:

While the actual products offered by Anchor are incredibly attractive to those in the institutional sector, there are a few questions that always come up when we are talking to others in the space. We would like to address a few of the main sticking points that we have come across.

The need for insurance layers

First and foremost, Anchor’s smart contracts have never been hacked or exploited for any amount of money to this point. They have had multiple contract audits from reputable firms reporting 0 serious bugs or threats to their system. That does not mean that it is not possible to be exploited as it has happened occasionally to other chains so it is important to incorporate insurance into our product.

This insurance covers three major issues: 1) Market Illiquidity, 2) Smart Contract Exploits, and 3) Destabilization of USD Peg

These issues have been a barrier for institutional adoption of this protocol but with the addition of Ozone, this is no longer a problem. Savers now will be covered in the event of:

  • aUST cannot claim UST tokens due to money market illiquidity
  • The loss is related to UST-US dollar peg, UST trading below $0.87 on CMC, Coingecko or other reputable sources
  • The loss on UST-US dollar peg results in a TWAP, based on market data extracted from reputable sources, below $0.87 in a two-week span at least
  • The loss is related to the Smart Contract Network
  • The loss occurred due to an unauthorised, malicious or criminal act aiming at exploiting covered smart contracts’ code vulnerabilities; and/or loss occurred due to errors or omissions in code implementation, or unavailability or failure to access or process these covered smart contracts
  • The loss occurred during the policy period

Is it centralized?

As previously mentioned, Anchor is controlled by a DAO and only answers to its community for direction of the protocol. Creators of Anchor were wise to create a feature that continues to decentralize the ownership of ANC tokens by giving them to LUNA stakers every single week. As the community of LUNA continues to grow, so does the spread of ANC tokens to new members in order to prevent a 51% attack to take ownership of their DAO.

Is it an Unregistered Security?

While the parent company of Anchor, Terraform Labs, exists in South Korea; purchasers of their token live in the United States which gives the SEC jurisdiction over them to some degree. They did have an ICO raise which is in the crosshairs of the SEC for most of the crypto space. This raise was not open to retail investors, only to US based institutions or accredited investors. A list of the major companies that invested in the Anchor ICO is below. Ethereum which also had a ICO raise was recently classified as not a security due to their high level of decentralization.

Ethereum has over 8,000 active node validators while Terra has over 300, their competitor Solana has only 200 in comparison. The main issue is that the SEC has not distinguished how many validators are required to be determined sufficiently decentralized and thus not a security.

The Bottom Line:

Anchor protocol has been one of the most attractive investment vehicles DeFi has to offer with its sleek UI, high return on stablecoins, and incentivized borrowing. Holding it back at the moment is the ire of SEC head Gary Gensler and uncertainty related to its status as a security. If Ethereum level decentralization is the marker to attain, they have fallen short as of now. That could absolutely not be the case as innovations like the Columbus-5 update allows for more validators on the network. With larger groups like Alameda Research, Pantera, and Galaxy Digital all placing their bets on Anchor, it seems that the future is strong for this fledgling protocol and incoming institutional partners.

About RF Capital

RF Capital is an alternative investment firm with a special focus in the underlying infrastructure of the blockchain space. Other areas of specialization include real estate, debt/equity markets, and OTC trading.

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Jared Gabaldon

Jared Gabaldon

Principal for R.F. Capital - Decentralized Finance Fund