The Anchor Protocol
This isn’t in any way shape or form financial advice… Bla bla bla… I’m not a financial advisor… Bla bla bla… Do your own research… Bla bla bla… Consult your financial adivsor… Bla bla bla…
There it is, after months of waiting, the Holy Grail of money markets has arrived and I have to say, it blew my simple ape mind in an unprecedented manner.
Why? Well Anchor allows anybody to:
- Earn 20% APR on UST deposits. In case you don’t already know, UST is one of Terra’s stablecoins and is pegged to the US dollar.
- Borrow up to 50% of your LUNA’s dollar value in USTs by providing bLUNA (there will be other POS bAssets in the future) as collateral and get paid more than 260% APR for doing so. Yeah you get paid to borrow. Yes you read correctly.
- Earn yield by becoming a liquidity provider in the ANC-UST pool which at the current time results in 285% APR and 730% APY if you compound your interests on a daily basis.
- Earn transaction fees coming from the use of the Anchor Protcol by staking ANC which also allows you to take part in governance.
The purpose of this article is to break down these different mechanisms and to provide a step by step guide.
It can seem overwhelming at first but it is actually simple.
It’s important to take the time to read and practice. It’s better to use relatively small amounts to play around with Anchor and all the pieces are going to come naturally together.
“Knowledge is a treasure but practice is the key to it.” Lao Tzu
To access Terra a Terra wallet is obviously needed. Create one on Terra Station (or download the desktop version on Terra’s website) or simply connect a ledger wallet to it.
Terra Station’s chrome extension to which we will log in using our wallet.
Ok let’s dive into it now!
I. Lenders: earn 20% APY on UST deposits
The way this works is pretty straightforward, lenders deposit UST in order to allow other market participants to borrow these.
In compensation, lenders earn yield.
Why 20%?
The Anchor Protocol only allows liquid staking derivatives from major PoS blockchains to be used as collateral. The derivatives in question are bonded assets (bAssets) which are basically tokenized forms of bonded (staked) assets.
These generate cash flow unlike Bitcoin or stablecoins. Hence the surprisingly high yield for lenders. It doesn’t come out of nowhere.
For now, the only whitelisted asset allowed to be used as collateral is bLUNA (LUNA which at the time of writing, yields 11% APR).
Currently, the maximum LTV (Loan To Value) ratio is 50%.
If someone wants to borrow 1000$, they have to deposit 2000$ worth of bLUNA.
Instead of earning 11% on 1000$ which would make 110$, lenders earn 11% on 2000$ which makes 220$.
So they’re basically lending out 1000$ and getting paid 220$ giving them a 22% annual interest rate.
However in this precise scenario, the yield is above the target rate of 20% APR. So the excess rewards are stored in a UST denominated “yield reserve.”
This reserve is used to compensate lenders at times when the lending APR falls below its 20% target, to make sure the target rate is reached despite the slowdown in demand for loans.
So to sum it up, the real yield will not exceed/fall below 20%. No excess rewards but no lower yields either.
The APY is set by the Anchor rate which targets a stable 20% annual yield.
Anchor is no exception in the sense that supply and demand can make the APY deviate from its target at times.
When there is too much UST supply (lenders) vs demand (borrowers) the APY will fall below the target rate. The Anchor protocol will then moreover incentivize borrowers to borrow by allowing them to earn higher yields with their loans.
The opposite is true, when there is not enough UST supply vs demand the APY will rise above the target rate. The Anchor protocol will then lower the incentives for borrowers to borrow by lowering the yields they earn with their loans.
Let’s now take a look at what Anchor looks like from the lender’s perspective.
Needless to say that for each transaction you initiate, there are fees. So it’s important to pay attention to fees, even if they aren’t high.
- Go to the “Earn” section of Anchor.
- On the right hand side: the current APY, its past data and the interests earned over several time frames.
- In the upper part of the left hand side is the “Total deposit” section where total UST deposits are shown. This is the section in which we deposit/withdraw UST.
- In the lower part of the left hand side is the transaction history.
2. Select the amount of UST to deposit and click on proceed.
Note: You’ll notice that the UST you have deposited will show up as aUST in your wallet.
Depositors receive newly minted Anchor Terra tokens (aTerra) in exchange for their deposit. aTerra tokens represent a depositor’s share in the UST pool and can later be redeemed to claim the initial UST deposit, along with accrued interest.
II. Borrowers: get paid to borrow
In order for lenders to earn yield, they need solvent borrowers.
To make sure of that, in order to borrow from lenders of the Anchor Protocol, collateral is deposited to not only guarantee that the borrow won’t run away with the money but also to be sure he/she will be able to pay it back with interests even if the borrowed amount is lost or that the markets enters a corrective phase or even crash.
Metrics to understand:
- Collateral value: The UST value of the deposited collateral.
- LTV (Loan To Value): The amount of UST borrowed relative to collateral value.
- Max LTV: The maximum amount of UST it is possible to borrow relative to collateral value.
The current Max LTV is 50%, meaning for each borrowed UST there is 2 UST worth of collateral required.
This is a default parameter but can evolve over time if ANC holders were to vote to change it. - The Risk Ratio: Determines the risk of our position.
If the Risk Ratio exceeds 1, liquidation is due.
Formula: Borrowed amount/Borrow limit.
Note: Risk Ratios less than or equal to 0.8 are considered as safe.
This is also a default parameter and can be changed with a governance proposal. - Liquidation: Positions that have a Risk Ratio over 1 are subject to liquidation.
Positions with a desposited collateral value inferior to 500 UST are totally liquidated.
Positions with a deposited collateral value superior to 500 UST are partially liquidated until their Risk Ratio goes under 0.8 (the safe Risk Ratio).
Example:
Collateral value = 1000$.
Max LTV = 1000*0.5 = 500$
- Borrow 400$; LTV = 0.4; Risk Ratio = 400/500 = 0.8
Underlying asset of the bAsset used as collateral goes up by 20%.
New collateral value = 1200$
New LTV: 400/1200 = 0.3
New Risk Ratio: 400/(1200*0.5) = 0.66
We can do nothing, borrow more or withdraw part of the bAssets used as collateral. - Borrow 400$; LTV = 0.4; Risk Ratio = 400/500 = 0.8
Underlying asset of the bAsset used as collateral goes down by 20%.
New collateral value = 800$
New LTV: 400/800 = 0.5
New Risk Ratio: 400/(800*0.5) = 1
Risk of liquidation if price drops any further.
Either repay totally/partially our loan, close totally/partially the position or add more collateral to increase collateral value and so to decrease risk ratio.
This is why 0.8 is considered as being a safe Risk Ratio.
I suggest to have an even lower Risk Ratio. - Borrow 500$; LTV = 0.5; Risk Ratio = 500/500 = 1
Underlying asset of the bAsset used as collateral goes down by 10%.
New collateral value = 900$
New LTV: 500/900 = 0.55
New Risk Ratio: 500/(900*0.5) = 1.11
Our collateral has been partially liquidated (well before 1.11) until our risk ratio goes under 0.8, since our collateral value is over 500 UST.
Why borrow?
Like said earlier, except for the fact that market participants sometimes need loans, borrowers are paid... to borrow.
When going in the “Borrow” section of Anchor’s app, you’ll notice the Net APR which is the difference between “Borrow APR” (interests paid by the borrower) and “Distribution APR” (interests paid to the borrower).
Borrowers are paid in ANC tokens.
If you prefer to have your interests in the form of dollars, you can simply trade ANC for UST (cough… and deposit that UST to earn yield… cough).
More on the ANC later.
Interests percieved exceed interests paid by over 8x in this case.
There is a multitude of things to do with the borrowed UST:
- Deposit through “Earn” earning 20% APY thus reducing even more interests paid.
- Lever up a position by using the UST to buy more of an already held asset.
- Provide liquidity in ANC-UST or in other pools through the Mirror Protocol.
- Buy more ANC.
- Use the loan to take profit without selling the underlying asset.
Think about it, as the price of the asset used as collateral increases, your LTV decreases…
Let’s go through the process of borrowing.
- The first required thing to have is a bAsset. Two options:
Go to the “Bond” section of Anchor under the “Mint” tab.
Select the amount of LUNA to bond.
Select a validator to stake LUNA and click “mint”.
Terra Station extension will require to submit the transaction.
Note: To burn bLUNA and unbond LUNA, simply follow the steps under the “burn” tab.
With the normal burn it is necessary to wait 21 days to be able to claim the LUNA which corresponds to the unbonding period. This allows to claim as much LUNA as burned bLUNA.
With the instant burn, it’s possible to claim LUNA right away.
bLUNA will be swapped for it on Terraswap (Terra’s decentralised exchange) but there will be fees to pay and possibly slippage meaning the quantity of LUNA recieved might be inferior to the quantity of bLUNA burned.
2. Provide bAssets as collateral.
Go to the “Borrow” section. At the bottom of the page is located “Collateral list” in which available bAssets are shown as well as the possibility to provide or withdraw them.
Click on provide and select the amount of bAssets to deposit.
Collateral value and borrow limit are now updated.
3. Click on “Borrow” to initiate a loan.
Select the amount of UST to borrow. Play around with the LTV gauge to see how much UST will be lent for x% LTV.
Note that LTV under 35% is considered as safe.
Once that is done the “Borrow” section will be updated.
4. Rewards are claimed in the “Rewards” Govern section.
Click on “Claim all rewards” or “…” corresponding to the “UST Borrow”” and “claim.”
5. Repaying the loan and the interests to exit the loan position.
It’s basically the same steps but reversed. We can repay the whole amount or just a part of it.
III. Provide liquidity in the ANC-UST pool
For those that are not aware, cryptocurrencies have given birth a new type of market making mechanism, the AMM (Automatic Market Maker).
Liquidity providers are given the possibility to deposit an equal quantity (in USD value) of two assets in a smart contract. The purpose of this is to allow other market participants to buy or sell those assets, experiencing very small slippage if not any.
In return, liquidity providers are compensated for this. They will earn X% APR or APY if returns are compounded by adding earned rewards to the pool (claim ANC rewards, sell half for UST and add both assets to the pool).
The APR/APY will change depending of the volatility of the provided assets. The more moves are aggressive (whether it’s up or down), the more the APR/APY rises and conversly.
If price rises, so will the value of the pooled assets and conversly.
The quantity of pooled assets will change. If price rises it means people are buying from us, so we will have less ANC and more UST.
This leads to “impermanent loss.” It’s called like that because prices fluctuate. They go up and eventually come down. So the losses being made compared to a hodl strategy will eventually be erased as price comes back to the price at which we started providing liquidity.
In the meanwhile, liquidity providers are paid their interests every hour. So by the time price goes back to our LP entry, we will likely be in profit.
The main risk associated with providing liquidity is providing an asset that could go to zero, in which case all losses become permanent as it means the market is dead.
Luckily, the tokens of the Terra ecosystem are robust, have actual use cases and are the pieces of the puzzle allowing Terra to thrive.
As you know, Terra is used in real world. We’re very far from what happened on other ecosystems and are not at risk of severe devaluation or worse, rug pulls.
Let’s take an example. The numbers used here are for the sake of simplicity to understand the mechanism of liquidity pools.
Assume ANC is worth 1$ and we have 100 ANC.
We provide liquidity.
Pooled assets quantity: 50 ANC + 50 UST; Pool value: 100$
- ANC goes to 1.1$.
Pooled assets quantity: 45 ANC + 55 UST; Pool value = 49.5$ + 55$ = 104.5$; 4.5% profit.
If we had held on to 100 ANC, the total value of our assets would be 110$; 10% profit.
The 6.5% difference is the impermanent loss. - ANC goes to 0.9$.
Pooled assets quantity: 55 ANC + 45 UST; Pool value = 49.5$ + 45$ = 94.5$; 6.5% loss.
If we had held on to 100 ANC, the total value of our assets would be 90$; 10% loss.
In this case, you actually lose less than with a hodl strategy, but you still end up losing, for now.
What really matters here is the time that ANC takes to make that move.
If it takes two weeks, obviously interests are not going to compensate losses in the short term or if ANC enters a long trend.
If it takes a year, interests could make up for the impermanent loss.
Though losses are diminished compared to a hold strategy, passed a certain percentage drop losses accelerate drastically. I encourage to do all the necessary calculations before providing liquidity.
Providing liquidity allows us to do 3 things
- Earn interests when markets are neutral.
- Scale in a position when markets are approaching what we think is a bottom.
- Scale out of position when markets are approaching what we think is a top.
How to provide liquidity:
- Have UST on wallet and buy ANC so that quantity of ANC = quantity of UST in dollar terms.
To do this, go to “Trade ANC” in the “Govern” section of Anchor.
2. Then go to ANC-UST LP
3. In the “Pool” section and under the “Provide” tab, select how many ANC and UST to provide or click on the quantity next to “ANC balance” and “UST balance” (red rectangle) to make our lives easier if we want to pool everything we have, like the true apse we are.
Then click on “Add liquidity”.
Notice at the bottom “LP from Tx.” This gives the amount of LP tokens that recieved. LP tokens represent our share of the ANC-UST pool.
4. In the “Stake” section under the “Stake” tab, select the amount of LPs to deposit.
Then click on “Stake” at the bottom.
5. Just like for “Borrowing” rewards are claimed in the “Rewards” part of “Govern.”
Click on “Claim all rewards” or “…” corresponding to the ANC-UST Pool and click “claim.”
To exit a pool, go back to the ANC-UST section:
- Go under the “Stake” section under the tab “Unstake” to unstake LP tokens from the pool.
- Go under tge “Pool” section under the tab “withdraw” to convert the LP tokens back to ANC and UST.
IV. The ANC token
ANC is Anchor Protocol’s governance token. But not only, it also allows those who stake it to earn a part of the fees emanating from the use of the protocol’s different services.
What basically happens is that the fees (paid un UST) generated by the people using Anchor’s different services are swapped via Terraswap to buy ANC which is distributed to ANC stakers.
So in essence stakers remove ANC from the market and generate buy pressure for the token.
Currently staking doesn’t yield much. As the use of Anchor rises, so will it.
Yields will always remain lower than ones for providing liquidity but there is no risk of impermanent loss here.
Staking ≠ Providing liquidity.
About governance, anybody can create a proposal. At the bottom left of the “Governance” section, there is a “Create poll” button.
Please remember to go on the forums and discuss about a proposal before creating a poll. For people to vote, value must be created but most of all, it must be understood by all.
1000 ANC are to be deposited to submit a proposal.
If the proposal is passes, the ANC will be returned to the creator.
Failure to pass the quorum will have for consquence the distribution of the 1000 tokens to ANC stakers. So propose wisely.
If a proposal is already created, it will be shown under “Polls” at the bottom left of the “Govern” tab.
To vote for/against, ANC must be staked in “Gov Stake.” This can be done at any time, there is no waiting period to unstake. However once we vote, our ANC will not be withdrawable until the pole ends.
As for tokenomics, there will be a total of 1 billion tokens distributed over 4 years. Most of which will have been distributed after 2 years.
Inflation is often percieved as bad. However, it’s important to think in relative terms. A coin with no particular value will suffer greatly from inflation.
The effects of inflation aren’t the same for coins with a strong intrinsic (and extrinsic) value like it’s the case for ANC which generates cash flow, gives governance rights and that will generate even more value in the future.
Big names are invested in Anchor, and it’s not for a quick pump and dump scheme.
To conclude…
I’ve been waiting for the Anchor Protocol ever since I learned about Terra. And am very happy with it. Financial services have never been this good, fast and cheap.
TerraForm Labs came up with an ingenious new form of money markets where everybody wins.
Of course as always, we have to research, understand and planify our actions if we want to win but for who puts in the necessary work (and it’s really not that hard, no excuses allowed), the rewards will be massive over time.
The ANC token will face significant inflation within the first 2 years. Inflation is a bad thing if market participants sell. Some will.
The questions is, do you want to sell the governance token of what is going to become the biggest decentralized finance application in the world?
You’re the only one who can answer that question but you know… Not financial advice blablabla
One last point, the Anchor protocol, like all other DeFi (decentralized finance) protocols, is governed by smart contracts which can present risks (hack, bug, etc.).
The TerraForm Labs team are knowledgeable and have always gone out of their way to ensure that there are no issues with all their projects, so I don’t see why Anchor’s smart contracts would be an exception. However, it is always good to keep this in mind.
