Surely You’re Joking Anchor Protocol
By: Four Barbers Crypto
Tags: Financial Freedom, Anchor Protocol, Cryptocurrency, Tutorial, Terra

My bank offers sub-1% savings interest rate, 20% APY seems like a scam.

Yes! It is only natural that you think there is something fishy about 20% interest rate. In fact, it is actually important to have such attitude when doing your own research on cryptocurrency. Anchor protocol is a savings protocol that offers low-volatile yields on UST (Terra stablecoin) deposits, and once you understand the mechanism behind the protocol, you will see why the ludicrous 20% APY on savings is not only possible, but relatively safe and reliable.

Anchor Protocol UST Deposit (Savings) APY at 19.46%

Okay, what is Anchor Protocol and how does it work?

Anchor is a cryptocurrency money market. The protocol involves 4 main players; depositors, borrowers, liquidators and liquidity providers. For the purpose of this blog post, we will explore the dynamics between the depositors and borrowers (More details on Anchor Protocol documentation for those who want to dive in further) to explain how the protocol works. On Anchor Protocol, any individual can be either depositor or borrower (or both). In fact, many use Anchor Protocol as both depositors and borrowers at the same time.

Below is an example of Emma and Leo using Anchor Protocol to earn 20% APY on their savings.

Depositor

Emma deposits 100 UST in Anchor Protocol (Like one would at a bank to a savings account). Emma, by definition is now a depositor. She earns ~20% APY on his 100 UST savings paid out to her wallet live, as we speak. In about a year, her wallet will have accrued ~20 UST, totaling ~120 UST. Keep in mind the UST in Anchor Protocol (principle + interest) can be withdrawn at any time (You will have to pay some transaction fee)

Borrower

Now, let’s zoom out a little. By depositing 100 UST to Anchor Protocol, Emma has technically “lent out” her 100 UST and is now available for others who need to borrow. Leo thinks TSLA stock will perform well in the short-term and wants to borrow 100 UST to invest in Mirror Protocol (We will cover Mirror Protocol and delta-neutral interest accruing strategy in a future post). But we need to assure that Leo will be able to pay back his 100 UST loan. This is where LUNA, the native currency of Terra Ecosystem comes into play. Leo is holding some LUNA (400 UST worth of LUNA), but does not want to sell any of it, because he believe the price of LUNA will moon in the near future. So instead of selling 100 UST worth of LUNA to buy mTSLA on Mirror Protocol, he instead “provides” his 400 UST worth of LUNA to Anchor Protocol. Now his LUNA is “locked” in Anchor as a collateral (i.e. proof that he will be able to pay back the borrowed amount). Now with 400 UST worth of LUNA collateral locked in, he then borrows 100 UST. We call this borrowing at 25% Loan-to-Value (i.e. 100 UST / 400 UST = 25% LTV)

Anchor Protocol allows users to borrow at maximum 39.99% initial LTV, and will start liquidating (selling) collateral when LTV goes past 50% (Max LTV, don’t confuse with initial allowed LTV) to protect the players involved and the network as a whole. To read more about LTV and liquidation, please refer to Anchor Protocol Documentation

I get the player dynamics, but where does the 20% APY come from?

The beauty of this whole construct is that the collateral itself is an interest-bearing asset. LUNA is proof-of-stake cryptocurrency with ~10% yearly staking return. If Leo were to stake his 400 UST worth of LUNA on the Terra network, he would have earned ~40UST in a year (assuming the price of LUNA stayed the same). Therefore, by providing his LUNA to Anchor Protocol, his LUNA collateral can “do the work and pay” Emma, the depositor, for lending out her 100 UST.

LUNA staking return as calculated by Terra Station Wallet (Jul 7, 2021)

But you said yearly staking return of LUNA is ~10%?

Remember how Anchor Protocol’s Max LTV was set at 50%? In order to borrow 100 UST, Leo needs to provide at least two-times the borrowing amount (technically, you will need to provide 2.5x the borrowing amount due to recently changed maximum initial LTV of 40%, but let’s assuem 2x for the purpose of this discussion) We call this “over-collateralizing” by 200%. Now, with two-times the loan collateralized AND staked on the network (done through Anchor Protocol), we can “guarantee” a ~20% staking return and happily provide 20% to Emma, the depositor. (The excess yield goes to yield reserve, which in turn is used to buy ANC, the native token of Anchor Protocol, to distribute to ANC token holders, borrowers and liquidity providers)

What are some benefits for the borrowers?

Besides the above-outlined scenario of utilizing LUNA as collateral to borrow UST against, there are some direct APR related to borrowing as well. Currently, as we write this post, the borrowing APR is at staggering 124%! This is means you are earning as you borrow. This is possible because Anchor Protocol has 45% of their token designated for Borrower/LP Provider incentives, and borrowers are paid in ANC token for borrowing. However, collateralizing your LUNA token to borrow UST comes with the risk of potential liquidation in case of price dump (LTV going above 50%), so make sure to monitor your LTV and have some UST available in your wallet to pay back the loan in case the market tanks.

Borrow APR on Anchor Protocol (Jul 7, 2021)

Does Anchor Protocol accept other cryptocurrency as collateral?

Currently, LUNA is the only cryptocurrency that is supported by Anchor Protocol as collateral. However, the team has hinted that they are working on accepting other PoS cryptocurrencies such as ETH 2.0, SOL and ATOM. Keep in mind that the staking return rate are different for these assets, so Anchor Protocol will most likely have different Max LTV rate for different currencies (This is our guess) to ensure 20% APY.

I think I understand how Anchor Protocol works. How do I use it?

We’ll go through what Emma and Leo did in above example on the Anchor Protocol WebApp. We will start by borrowing, then use the borrowed UST to deposit for some extra APY boost.

This tutorial assumes that you have terra wallet set up, preferably on a hardware wallet such as Ledger, and 400 UST worth of LUNA loaded. The tutorial will work with any amount, but you will maximize transaction fee efficiency with larger amount.

Go to Anchor Protocol WebApp. In order to borrow, we need to deposit LUNA as collateral. We do that in the form of bLUNA (bonded LUNA). Let’s first mint our LUNA into equivalent amount of bLUNA by clicking on the “bond” tab. Under “Mint” option, enter the amount of LUNA to mint, in our case 64 LUNA at current price of 6.25UST. (Keep in mind that you need to have some UST in your wallet to pay for transaction fee) We need to pick a validator to mint our LUNA into bLUNA. Validator does not affect the APY so it’s okay to pick any of them. I like to pick different validator every time I mint LUNA for decentralization. (We will discuss more about choosing validator in a future post) Click “Mint” and Terra Station Wallet will pop up. Click on “Allow” to proceed. After paying a small fee in UST, we have successfully minted our LUNA into bLUNA. Now let’s provide collateral. Go to “Borrow” tab and click on “Provide” on the bottom of the page. Provide all the bLUNA we have minted on step 5, and proceed on the Terra Station Wallet pop up. (We are almost there!) Now click “Borrow” and enter 100 UST. You can see that LTV is automatically calculated for you. In our case, the meter should be hovering somewhere around 25%. Click on “Proceed”. You have successfully borrowed your first UST on Anchor Protocol. (To gauge the “safety” of your collateralized asset, remember that the liquidation starts at 50% LTV. This means that your assets are safe as long as the price doesn’t tank lower than 50% of current price. i.e. LUNA = 3.125UST with our example) At the time of writing, we are earning at 124% APR for borrowing! The borrow rewards will accrue on your wallet as ANC token. You can check them pile up live on “Govern” tab and claim them whenever you like. Now, lets deposit the borrowed UST for the added 20% APY. (yes, 20% is only extra) Go to “Earn” tab and click on “Deposit”. Enter 100 UST and click on “Proceed”. You have now deposited your borrowed UST and are earning ~20% APY on your 100UST.

Keep in mind that borrowing APR will fluctuate depending on the market condition to support a stable Anchor Rate. It can get pretty technical, but for those who are interested, Anchor Protocol defines the “conditions” as below.

If the real yield > the target yield THEN the ANC token incentives for borrowers drop by 15% per week. If the staking yield is < the target yield THEN the ANC token incentives for borrowers increase 50% per week.

The Terra community is very friendly and active. If you have any question on using Anchor Protocol (or really anything related to Terra ecosystem and beyond), make sure to reach out to the community through Official Telegram, Agora forum or Twitter.