Can Anchor Maintain Its 19.5% Interest Rate?
NOTE: Anchor Protocol is no longer live following the depeg of UST in May 2022. Adaptations are being made to accommodate this change.
If you’ve heard of Anchor, you are probably aware that Anchor’s Earn is paying 19.5% APY on deposited stablecoins. It may seem unrealistic that a coin pegged 1:1 with the US dollar could earn such a high interest rate, so let’s dive into how this is achieved.
To set the record straight, Anchor’s 19.5% APY is not permanent and is subject to change based on ANC governance and the amount of UST stored in Anchor’s reserve fund. In fact, there is a proposition to change this fixed rate to a dynamic rate, which if implemented, will likely pull the 19.5% rate down.
EDIT: the Anchor Dynamic Earn Rate has passed. Read more about this in Anchor’s Dynamic Earn Rate Explained.
Why offer this impressive rate?
Terra’s Anchor was created by Terraform Labs to increase the adoption of UST. The target rate of 19.5% acts almost as a promotional rate to grow the use of UST, and therefore boost the value for Terra’s native asset, Luna. As UST becomes widely adopted, the value of Luna should rise as a result.
How do stablecoins hold their peg?
Using UST as our example stablecoin, the price of UST is held 1:1 to the US Dollar algorithmically through minting and burning mechanics. Users burn Luna to mint their stablecoin (Terra) and users burn their Terra to mint Luna. Thanks to simple supply and demand characteristics, the user is incentivised to hold the peg 1:1 through arbitrage opportunities whenever the price is slightly off peg. There are no physical dollars involved in this process.
NOTE: UST is the largest stablecoin but not the only one. Other stablecoins hold their peg using the same token mechanics. Some of these stablecoins include TerraUST, TerraCNY, TerraJPY, TerraGBP, TerraKRW, TerraEUR, and TerraSDR.
How can Anchor afford to pay out a 19.5% rate?
The 19.5% APY was implemented to incentivise adoption of UST and therefore drive value to Luna. The yield is derived from the borrow interest, staking yields from bAssets, liquidation fees, ANC borrow rewards, and the Anchor Yield Reserve Fund. Let’s summarise.
Borrow Interest
This is the rate borrowers pay for the privilege of borrowing UST. At the time of writing this, the borrow rate is -12.5%. See “Net APR” below to see the real rate after collecting ANC borrowing rewards.
Staking Yields
This is the rate that the deposited bAssets are earning and provided to Anchor. At the time of writing this, staking Luna earns +6.1% APR (source as of March 8th, 2022).
Liquidation Fees
This is a 1% fee that is taken whenever a user’s collateral falls below the borrowing limit. When some collateral is sold to repay part of the loan, this is known as a liquidation. The 1% is taken from the amount liquidated and not the total value. The fees taken from liquidations are sent to Anchor’s Yield Reserve Fund (defined below).
ANC Borrow Rewards
There is a reward given to borrowers for using the platform. At the time of writing this, the reward rate is +14.5% APY paid in ANC tokens.
The Net APR is the cost of borrowing plus the ANC token reward. At the time of writing, this is a positive number at 2% (-12.5% borrow cost plus 14.5% ANC rewards). This means borrowers are being paid to borrow.
Anchor Yield Reserve Fund
Anchor’s Yield Reserve Fund is designed to provide balance and adoption incentives that can be changed through governance votes from ANC stakers. When revenues from borrowing interest and staking yields are lower than the target rate (currently 19.5%), the yield reserve is used to top up the difference. When staking yields and borrow interest are higher than the target rate, then the surplus goes into the yield reserve.
Can Anchor’s Earn Afford To Pay 19.5% APY?
So, with all of these defined, let’s do some maths to see how this all works with today’s given rates as well as deposit and borrow values. Anchor’s Earn is paying out 19.5% APY; borrow interest is 12.5% APR; staking yields on Luna is 6.1% APY; and the ANC borrow reward is 14.5% APY. Then there is $2.4b in borrowed UST and $9.2b in deposited UST.
If the borrowed amount was equal to the loans provided, then the maths would be simple. Anchor’s cost is 19.5% and the revenues would be staking yield plus borrow interest equal to 18.6%. Then the yield reserve fund would be responsible for topping up the remaining 0.9% difference (at today’s rates would be ~$227k UST per day).
But since there is far more deposited UST than borrowed UST, the reserve fund is being drained at a much faster rate.
19.5% paid on $9.2b UST = $1,794,000,000 UST
18.6% earned on $2.4b UST = $ 446,400,000 UST
There is an imbalance that is resulting in a reserve drain of $1,347,600,000 per year, or ~$3,692,000 per day. With the current yield reserve sitting at $455.5m, this means at the current rates, the reserve will be drained entirely in just over 123 days, or ~4 months.
NOTE: The ANC borrow reward is a separate mechanism and is not taken into account here as the rewards are paid in ANC and therefore does not add any revenue or expense to the Anchor yield reserve.
For the 19.5% APY paid to depositors to maintain longer than 4 months (*without further donations to the yield reserve fund), Anchor needs more UST to be borrowed, and soon. This is why the net APR on borrowed UST is positive as Anchor incentivises borrowing to help balance everything out.
So, how do we address this problem? One answer is to use bAssets to take out UST loans, and then use the loans in various yield farming strategies. That’s what we do at Neptune Finance.
Read our next post How Neptune Finance Can Help Solve Anchor’s Problem to understand how we address the problem and drive value back to both the user and the Terra ecosystem.
