An Anchor Protocol update - What happens if the yield reserve goes to zero in 75 days?
Welcome to this newsletter where I break down DeFi and crypto in an easy way. We’re now 21,042 subscribers strong!
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Anchor Protocol
Anchor Protocol is the cornerstone of Terra.
At the moment there is $18.6b locked in Anchor. Out of that 18.6, $12b $UST is deposited into Anchor Earn to get the 19.5% APY.
Terra is having momentum and the market cap of $UST has been steadily increasing for the last 1 year.
In one year the $UST mcap has increased by 10x from $1.6b to $16.3b.
Why is it increasing so rapidly?
Because of Anchor and the 19.5% APY. Nowhere else can you get a stablecoin with the stability of Anchor.
The concept is easy: deposit $UST, get paid in $UST.
No lock-up.
But how sustainable is this model?
Let's look at Anchor Protocol's balance sheet.
Anchor has to pay 19.5% APY on the $12b deposited -->
Expenses: $2.34b per year ($12b x 0.195)
But what about the income?
How does Anchor Protocol earn money?
Anchor earns money in 2 ways:
1. Staking rewards
2)Â Borrowing of money
The APR for both staking and borrowing is variable, but at the moment the staking rewards for $LUNA is 6.9% and for $ETH it's 4%.
The borrowing APR is 12.6%.
To borrow money on Anchor, the user has to provide collateral.
The collateral is in form of bonded $LUNA, bonded $ETH, and staked $AVAX.
Now we can calculate Anchor's income:
1. Staking rewards
Right now there's $6.5b provided as collateral:
$4.85b bLUNA x 0.069 = $334M
$1.67b bETH x 0.04 = $66.8M
The income from staked AVAX is pt. so low that I won't include that.
Borrowing of money
$3.2b borrowed $UST x 0.1264 = $404M
Now let's look at Anchor's balance sheet.
Anchor Protocol Balance Sheet
Income:
-Staking rewards: $400.8M
-Borrowing: $404M
=Total: $804.8M
Expenses:
-Anchor deposit: $2.34b
Balance: $2.34b - $804.8M = -$1,53b
The protocol is paying out $1.53b more than they can cover at the moment.
You might already think: "How can this be sustainable?"
It isn't. And Anchor themselves also know that.
The real market rate would be approx. 6.7% APY ($804.8M/$12B)
The only reason why the interest rate is still 19.5% (and not 6.7%) is because of the yield reserve.
Yield Reserve
The yield reserve was originally made to fight tough market conditions so that people could get the stable 19.5% APY no matter what happened in the market.
The yield reserve was established in the summer of 2021 and topped up with $70M.
The thought behind it was that in good times the yield reserve would refill because income > expenses.
The yield reserve lasted until February 2022 and was topped up with approx. $500M from LFG (Luna Foundation Guard).
Terraform Labs and the Luna Foundation Guard sit on billions of dollars worth of both $UST and $LUNA.
Anchor was developed by Terraform Labs.
When the yield reserve runs low, Terraform labs donates $UST to LFG who then uses that $UST to replenish the reserves.
Now, why would they do that?
Simple explanation.
Refill of yield reserve --> increased $UST mcap --> increased $LUNA price --> more interest for Terra --> more money into the ecosystem.
A positive flywheel.
Also, look what LFG council Remi wrote:
He said that the current APY would last for 2 years.
But only one week later there was a proposal to adjust the APY with a dynamic interest rate.
The Anchor rates will drop 1.5% per month until the yield reserve starts to increase.
See the consequences in the below tweet:
Most likely we'll see 18% APY from the 1st of May and 16.5% from June 1st. But the rate won't go lower than 15% unless the yield reserve goes to 0.
If it goes to 0, then we would have market rates (6.7%)
You can keep track of the yield reserve here:Â mirrortracker.info/anchor
The question that now remains is why would Anchor keep the rate between 15 - 19.5% when 6.7% is the sustainable APY?
Answer: Marketing
The purpose of the high rate is to attract people to use $UST.
And as we know: $UST mcap up = $LUNA price up.
What is the future for Anchor Protocol?
At the current rate Anchor's yield reserve is going down by 19.5 - 6.7 = 12.8%
At the moment Anchor is paying has to pay out $1.53b per year from the yield reserve (because they're only able to pay $804.8M from their income).
The Problem
The yield reserve is only $363M, and it's decreasing by approx. $4M per day.
If the rate was 19.5% the reserve would sustain for 3 more months.
An 18% rate from May 1st and a 16.5% rate from June 1st will help, but at the same time, the mcap of $UST is growing.
In the last 90 days, the mcap of $UST has gone up from $10b to $16.3b.
What if it increases to $22-25M in the coming 3 months?
Not very unlikely in my opinion.
Somewhere between 60-80 days left for the yield reserve seems like the most likely scenario.
Will the yield reserve be topped up again?
As Remi hinted, they could cover a 19.5% APY for 2 years with what they have in the LFG wallet.
And why wouldn't they keep the show going on?
It's in their best interest to sustain Anchor so that more people will use $UST.
Is it possible to make Anchor sustainable without a top-up?
If you asked me 3 months ago I would say yes. Now, I'm not so sure anymore. $UST is growing too fast.
Even with a doubling of the $LUNA price (increased collateral value) for Anchor, it wouldn't be possible with such a high APY.
The dynamic interest rate is a step in the right direction, but it's not enough.
Anchor V2 and more bAssets will also help, but I think a usecase for the $ANC-token in Anchor Protocol would be the best to preserve the yield reserve longer.
Eg. if you want 19.5% interest you have to have X amount of $ANC in your wallet. If you don't have it, you get 10% APY.
Let's see.
Anchor is constantly innovating.
I'm bullish on their future.
I've written several threads about Terra.
Here is a good intro if you want to understand the relationship between $LUNA and $UST and how the ecosystem works:
That was it!
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See you next week.