Anchor Protocol: The Demand Engine of Terra
The Anchor Protocol is a Bank Savings Account on Steroids
In this post, we will talk about:
The Anchor Protocol on Terra
How Anchor Protocol Connects Lenders & Borrower
Economic systems heavily rely on credit for growth. Through lending and borrowing, participants are able to use “IOUs” to synthetically create capital and funnel it to the most productive parts of the system. In the traditional world, financial institutions have the responsibility of acting as the middlemen of credit. If you look around, you will find a very high correlation between trust in the financial system and overall strength of the economy in any part of the world.
This is both good and bad news for crypto. Existence of middlemen means you can disrupt it through decentralization. That is a massive opportunity to make money, create impact, and all the other good things that come with it. The downside is that creating new economic systems requires you to build a good lending and borrowing process that people are willing to trust. Credit systems are ultimately going to be what makes one ecosystem stickier than another.
For Terra, Anchor’s lending and borrowing protocol currently represents the glue. Through an abysmally high APY, Anchor is able to incentivize users to lock up their Terra UST coins. This generates more demand for UST, reduces the overall circulating supply, and pushes up price of Terra’s governance token LUNA. This creates a cycle where more and more users are willing to onboard the ecosystem and stay in it for long periods of time.
How Does Anchor Protocol Work?
The Anchor Protocol acts as a money market fund between borrowers and lenders. Since the entire protocol runs on the Terra ecosystem, UST is the asset in which transactions are settled.
The lender here is the holder of UST who wants to earn yield on it by locking it up. On the other hand, the borrower wants to borrow the UST but they must provide some sort of stakeable asset as collateral for the loan. BLuna, or Bonded Luna, is the most commonly used collateral for loans on Anchor.
The bonded assets are staked by the protocol and liquidated over time to pay yield to the lenders. Although the staking yields vary, the protocol has decided to pay out a stable yield. Today, this yield is close to 20%. Yes, it sounds too good to be true, but it is in-fact real.
Anchor also has its own native token for the protocol, called Anchor Token (ANC). ANC introduces a new set of incentives for both lenders and borrowers where they can vote on governance issues by staking the token. The more ANC you hold, the more of a say you have in what the future of the protocol should look like.
Beyond that, ANC holders also receive some staking yield from the protocol itself. This creates a correlation between price of the ANC token and TVL (Total-Value-Locked) on Anchor, aligning the two together. As the protocol itself becomes more successful and gains users, the price of the token should also increase proportionally with it.
As of today, about 19 billion UST is locked up in the Anchor Protocol with a total yield reserve of ~264 million. Without a doubt, it is driving major demand to the Terra ecosystem. About 76% of all the TVL on the entire ecosystem comes just from this one protocol. This has led some people to worry that the same thing that caused the in-flow of users could result in its doom.
Anchor is expected to cut the yield rate and decrease reserves by $4 million per day. This will result in a massive redemption of Terra, which could potentially put downward pressure on the Luna token’s price. If that does end up being the case, other protocols will have to come in and make up for the excess supply in the market.
UST recently became the third most popular stablecoin in crypto, taking the spot from BUSD. The Anchor Protocol has been one of the biggest catalysts behind Terra’s demand growth and Luna’s price appreciation. Even if yields come down from where it is today, it will still continue to be significantly higher than what most banks are willing to give.
In my view, Anchor is going to be one of the most interesting case studies of how protocols can jumpstart entire ecosystems. Even if Anchor is gone, Terra will owe a lot of its success to this one project.
Coming Up Next
Our newsletter will be focusing on more Terra ecosystem projects including Mirror, Astroport Finance, Mars Protocol, and Vertex Protocol.