Deep Dive on Anchor Protocol: DeFi’s USD Savings Account. Where Does The 20% APY Come From and How Sustainable is it?

Just to be transparent, 8 months ago I deposited 10,000 UST into Anchor Protocol and have been earning about $162.5 (about 19.5% APY) in passive income every month since.

[screenshot of my earn page](

Here were my expected earnings on 10,000 UST per year, month, week, and day.

* $1950 per year
* $162.5 per month
* $40.625 per week
* $5.8035 per day

So, yesterday I made a post on r/cc about defi and was really surprised by the number of people on this sub that had no idea what Anchor was and there seems to be a lot of misinformation regarding the risks and calling it a scam. I’m currently banned from there lol. So I thought I should do a deep dive on one of the most largest protocols in DeFi on here.

Anchor Protocol is the cornerstone of Terra. At the moment there is about $19 Billion locked in Anchor. Out of that 19, $13b $UST is deposited into Anchor Earn to get the 19.5% APY. Terra has been gaining 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 $18.1B, and has become the 3rd largest stablecoin by overtaking BUSD. A pretty cool milestone for a decentralized algorithmic stablecoin imo 🙂 So, how and why is it increasing so rapidly? Honestly, because of Anchor and the 19.5% APY. Nowhere else can you get a stablecoin with the stable yeild of Anchor.

**The concept is easy: deposit $UST, get paid in $UST. No lock-up. No other token exposure.**

Sounds too good to be true right? How sustainable is this model and the 19.5% APY? The truth is complicated and I will come back to the sustainability at the end of the post, but the tl;dr is that it depends on something called the LFG yield reserve which is depleting. More on that later.

# Risks

Let’s talk about the risks first. Such a high APR seems too good to be true risk free right? Why doesn’t everyone just park their money in Anchor? Here are the risks that you need to be aware of:

***- Smart contract risk:***

When you deposit money into Anchor Protocol, you’re putting your money in a smart contract. Smart contracts may be vulnerable to cyber-attack and technology failures. It’s therefore very important to check if the contract is audited. Anchor is audited by many reputable firms so we’re good there.

***- De-peg risk:***

$UST is a alghorithmic stablecoin. $1 UST represents $1 fiat USD. 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 last year on May 19th when $UST dropped to $0.85. So why did $UST drop from $1 to $0.85? Remember, May 19th 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. $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. $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. 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 is very unlikely, because the Terra team has improved the peg algorithm stability since the May crash to prepare for new bear markets and has also started accumulating a massive $10 Billion dollar BTC treasure chest to stabilise the UST peg. In the September crash and most recent January crash $UST was the most stable coin of them all.

# Sustainability

So how sustainable is this legendary 19.5% APY? Let’s look at Anchor Protocol’s balance sheet: Anchor has to pay 19.5% APY on the $12b deposited. So, expenses: $2.34b per year ($12b x 0.195) But what about the income? How does it earn money?

**Anchor earns money in 2 ways:**

*- Staking rewards*

*- 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:**

– 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 and ATOM rn is pretty 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.:**

Income:
-Staking rewards: $400.8M
-Borrowing: $404M
=Total: $804.8M

Expenses:
-Anchor deposit: $2.34 billion
Balance: $2.34b – $804.8M = $1.53 billion

The protocol is paying out $1.53b more than they can cover at the moment. How can they do that? 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. 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. Refill of yield reserve –> increased $UST mcap –> increased $LUNA price –> more interest for Terra –> more money into the ecosystem. A positive flywheel. The question that now remains is why would Anchor keep the rate between 15 – 19.5% when 6.7% is the true sustainable APY (which is still better than a bank)??? 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

So how to solve this problem of unsustainable yield and depleting reserves? Recently 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. So, 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% as long as the yield reserve exists. You can keep track of the yield reserve here: [mirrortracker.info/anchor](

So 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. At 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 Terraform Labs hinted on Twitter, 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 difficult 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, and I think ANC token $ANC-token in Anchor Protocol could 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.

The protocol has been very lucrative for me and was one of my first introductions to the wonderful world of DeFi. The Anchor team is great and is constantly innovating (they added staked ATOM collateral recently and will add SOL soon, this should increase true yield) so I stay bullish on the future of the protocol.

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13 thoughts on “Deep Dive on Anchor Protocol: DeFi’s USD Savings Account. Where Does The 20% APY Come From and How Sustainable is it?”

  1. It isn’t sustainable. I’m rooting for Luna, but look at the borrow curve. A substantial growth of the borrow curve would indicate adoption, in my opinion.

    I think people are only in it for the 20%. After that is over with, what stops people from chasing the next highest APY/APR?

    Reply
  2. I don’t know why people concern themselves with the sustainability of the payout rate when most other LPs and even CeFi deposits are variable rates anyway. Usually high yields are only available for days or weeks if you’re lucky.

    If they lower the yield in a gradual way then the capital flight can be controlled in a way that is unlike a bank run.

    Reply
  3. >we enter a bear market and the top coin $LUNA drops 50% in value

    if we enter bear market, demand for stable coins (USDT USDC UST) increases. UST minting Burns more Luna and possibly increases Luna price.

    This is a pointless hypothetical because no one can predict the effects of bear market on UST-Luna tokenomics.

    Agreed with the last point about de-pegging being unlikely but possible.

    >$UST is growing too fast. Even with a doubling of the $LUNA price

    This seemed like a fair point and it seemed concerning at first based on how you framed it so I looked up the marketcap of UST and marketcap of LUNA. Currently UST is over collateralized. Do you have any response to that?

    Reply
  4. The yield reserve can be replenished at any time, just as it has before when it got low. But yes, decreasing the apy will increase longevity. It was never a permanent apy. Anyways avoid r/cc its just of cancerous idiots.

    Reply
  5. thx mate, pretty interesting story hope one day I’ll get one similar to yours; I’m starting right now on cryptos and NFTs so I’m digging into new projects like quint and studying old cryptos (BTC, ETH, etc..) so I’m doing my best to shine in the future

    Reply
  6. Watching this thing implode is going to be something. I’ve still yet to meet anyone that has convinced me this is NOT a ponzi. When it collapses, it’ll go extremely fast.

    Demand is going to plummet soon when the rates crash. When that happens, UST is at real risk of a de-peg downward spiral.

    Reply

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