Newsletter nr. 2: A deep dive into a DeFi protocol: how can you get a 19,5% annually interest rate without risk?
There are endless possibilities in DeFi
I've got a growing interest in crypto in the last 6 months as I mentioned in the previous newsletter.
In the start I only knew Bitcoin and that there were other coins (altcoins). I thought cryptocurrencies were something you bought/sold and that the use case stopped there.
When the bear market entered fully in May 2021 I started trading Ethereum as I saw a huge upside before the EIP-1559 launch on August 5th.
Holding Ethereum lead me to another path, I discovered NFT's in the Ethereum bull run in August 2021. For 2 weeks I almost did nothing besides buying/selling and monitoring the NFT-market on OpenSea and rarity.tools
I still love NFT's, but I found it to be too time-consuming and at the same time the gas fees on Ethereum simply were too high, so I continued to discover what was out there in the crypto world.
Anchor Protocol - how is a 19,5% APY possible on stablecoins?
Earlier on I've heard about people receiving 10-12% APY on stablecoins. In my mind that sounded awesome. If you're a hardcore crypto-dude reading this, remember I made my wealth in the stock market where 10% per year is what's expected long-term.
As I started to dig deeper into stablecoins I found Anchor Protocol which is a part of the Terra Ecosystem (the biggest coin per market cap is $LUNA). Anchor Protocol is a protocol that promises a stable savings rate between 19-20% per year on their own stablecoin $UST.
I read everything I could find about the Terra Ecosystem and talked to a lot of smart people on Twitter. I became very bullish on the whole ecosystem and especially on $LUNA and Anchor Protocol. As with all investments, there are risks. I will come back to them later in this newsletter.
I started with putting in $100 as a test, everything worked fine and I started putting in more and more. As of this writing, I have about $216,000 in Anchor Protocol.
Below I'll show you much I'll earn per year/month/week/day.
I don't know about you, but I think that's a pretty great passive income source. To receive the same dividends from stocks you would've needed at least 5x the capital ($1,000,000).
The ironic thing is that inside the crypto community no one thinks 19,5% APY is great. Someone earns this monthly on a regular basis for years, so why would they accept 19,5% for a full year?
Well, as I said I think it is a decent interest rate and my plan is to store money there in bear markets and in periods where I don't find big opportunities in the market. With that said, it's probably great to remind my readers that I have a trader mindset. Some like HODL'ing coins, but I prefer more "control" by taking calculated bets. Maybe I lose more money this way, but at least it gets me more of a feeling of having control.
How can Anchor Protocol offer 19,5%? My bank only offers me 0,1% per year...
Well, first of all, remember that banks don't want what's best for you. They want what's best for the banks. When you deposit a million dollars to a normal bank they will use your money to buy assets on which they earn higher interest rates than you're getting paid.
Although 20% APY appears too good to be true, it is real. Anchor protocol can generate at least 20-24% staking revenue on deposits.
This leads me to the tweet below:
After seeing Anchor Protocol and using it for a month I have serious trouble defending my reasoning to continue investing in the stock market. Why would I take on risk in the stock market when I could have "no risk" in a stablecoin in crypto?
Risks with using Anchor Protocol
But I have to be honest, there are some risks that you need to be aware of, so let's dig into them:
Smart contract risk: When you deposit money into Anchor Protocol, you're putting your money in a smart contract. Smart contracts are generally the most vulnerable points for cyber-attack and technology failures. It's therefore very important to check if the contract is audited. You can check it here. Let's wrap it up. Anchor is a protocol backed by Terra Luna. But what if the people behind Anchor Protocol one day just withdraw the money from Anchor and deletes all evidence? I'm not expecting this to happen, but there are frauds in DeFi, so keep it in the back of your mind.
De-peg risk: $UST is a alghoritmic stablecoin. $1 UST represents $1 fiat. This is described more below. But what if $UST loses its peg? Let’s say we enter a bear market and the top coin $LUNA drops 50% in value. How does the Terra ecosystem avoid that UST losing its peg? If $UST trades below $1 market makers would quickly trade any coin for $UST for a quick profit. This actually happened this year on May 19th for some hours when $UST dropped to $0,85 (see the picture below).
So why did $UST drop from $1 to $0,85? Remember, this was an absolute bearish day in the market. People who got afraid sold both normal coins and stablecoins to USD or Euro, many of them to never return to crypto ever again.
Wouldn't you buy something for $0,85 if you knew the real value was $1?
$UST hovered between $0,96 and $0,99 from May 20 to May 24, before climbing back to $1 25th of May. Comparatively, the USDC stablecoin fluctuated between $0.99 and $1 in that whole time period.
But what if it's different next time? "Normal" stablecoins are partly backed by the US dollar while $UST is algorithmically controlled.
$UST’s drop was in part driven by a sell-off in Terra’s native cryptocurrency $Luna, which plunged by as much as 80% to $4.18, the lowest since Feb 27. That’s because $UST relies on $Luna for its stability: The Terra protocol acts as a market maker, making sure that when the supply of $UST goes up, the $Luna supply goes down, and vice versa.
Users can swap $1 worth of $Luna for $1 $UST, and vice versa. The system is designed to handle $20 million of redemptions with a 2% spread. But the sharp price declines in LUNA, compounded by large amounts of liquidations on Terra’s lending protocol Anchor, drove redemptions from $Luna to $UST to exceed $80 million, forcing UST to trade at a discount.
To summarize: this can happen again, but I know the Terra team has improved the peg algorithm stability since the May crash to prepare for new bear markets.
In the September crash $UST was the most stable coin of them all (see tweet below):
And to just end this, you can buy insurance for both smart contract risk and peg risk on Anchor Protocol (see picture below). As of what I've heard this would cost you 2,5% APY per year, reducing your yield from 19,5% to an acceptable 17%.
How can I buy $UST?
You can buy $UST:
Directly on Anchor Protocol via Transak (expensive)
Directly on Kucoin, Coinbase, Uniswap or Terraswap
By buying $LUNA on most exchanges --> send it to Terra Wallet --> convert $LUNA to $UST
Conclusion
Overall, I think Anchor Protocol is great. I've tried to be as neutral as possible with listing the risks. However, there is no secret that I do believe in the Terra Ecosystem, so DYOR before you ape in with all your money.
On 30th September the Terra Ecosystem upgrades from Colombus 4 to Colombus 5 and there will be launched about 50 new dApps. The one dApp called Mars Protocol looks really promising.
Rumours says that you will be paid to borrow $UST by using your current $UST that you already have in Anchor Protocol. Let's say you have $100K in Anchor Protocol earning 19,5% APY. You use this $100K as collateral and borrow $50K more. Then you deposit this $50K as well. You now have an increased your 19,5% interest rate by 50% to approx. 30% APY. Getting paid to do that? That's yield upon yield!
/Route2FI