Anchor Protocol- A DeFi Savings Account

By DMoneyCanada | Free Lunch | 7 Dec 2021


This past weekend was pretty rough for the Crypto markets, with Bitcoin dropping to as low as $42k before bouncing back, potentially over the Fed’s likely decision to increase tapering and raise interest rates next year. For many, myself included, it’s never easy to stomach the feeling of seeing your investments go down overnight. This is why I believe it’s always important to diversify your investments and have cash on the sidelines.

Luckily, DeFi has introduced new ways of doing exactly that. There are ways to earn a guaranteed return without having to take on the risk of speculating on cryptocurrency prices. Today, I will be discussing one of these opportunities, Anchor, which I believe is the easiest and lowest risk free lunch in DeFi. As always, this is not financial advice, please do your own research.

Anchor Protocol

Imagine earning 20% a year on your cash without doing any work. Seems like a dream for those of us who are used to getting 0.05% interest from our banks, but in reality, this is already happening in DeFi today.

Anchor, a savings protocol on the Terra blockchain which launched in March of this year has been offering anyone who deposits UST a 20% return per year. UST, also known as the Terra US Dollar, is simply a stablecoin which tracks the US Dollar (UST is always equal to $1 USD). Anchor pays out this 20% yield in UST and compounds automatically, meaning a deposit of $100 will truly be $120 after a year.

For context, unlike stablecoins such as USDC which maintains their US Dollar peg by actually backing it with U.S. dollar-denominated assets, UST is an algorithmic stablecoin where the peg of $1USD is maintained by the use of another token, LUNA. In practice, whenever the demand for UST increases, LUNA tokens are burned (destroyed) to stabilize UST’s price and vice versa. This is the main idea behind the Terra Luna project, which is trying to become the leader of decentralized stablecoin payments in DeFi.

How does Anchor offer a 20% APY?

 

To offer a 20% APY for depositors, we need to look at how Anchor actually generates revenue from its borrowers. Just like most DeFi lending protocols, for someone to borrow on Anchor, they must first deposit a collateral (either Ethereum or LUNA) on Anchor. When borrowers cannot pay back their UST loan, Anchor will liquidate their ETH or LUNA holdings to compensate. For Anchor, this also means they can take these collateralized assets and earn staking rewards in the meantime, bringing in revenue to pay depositors, which are currently around 5% for Ethereum and 8% for LUNA.

The other revenue source for Anchor is simply in the interest rate it charges borrowers (which is currently 22.01% to borrow UST). But why would anyone borrow at such a high rate given you can borrow more cheaply elsewhere at only 1-2%? The reason is the ANC token incentive Anchor offers. Currently, and as planned for the next four years, Anchor is rewarding borrowers with ANC tokens. These tokens represents governance of the Anchor protocol and could easily be exchanged for UST.

Based on today’s value, the ANC reward is showed by the “Distribution APR of 23.04%” above. This simply means you get back a return of 23.04% paid out in ANC tokens. If you deduct the borrowing rate from this ANC reward, a borrower today is actually getting paid 1.02% (Net APR) to borrow UST on Anchor. This is the reason why Anchor is able to sustain the 20% interest rate as people are borrowing at an interest rate of 22.01%. Of course, it will be interesting to see how Anchor plays out once the ANC rewards ends in a few years, but for the foreseeable future, Anchor’s earn rate should continue to be between 19.5%-20.5%.

Potential Risks

Participating in DeFi is never without risks. For one, there will always be Smart Contract Risks. In the case that something happens to Anchor, you aren’t guaranteed your deposit unlike with banks which are FDIC or CDIC insured.

There are also risks with regards to the stability of UST. Since UST is not backed by actual assets, when there is a strong selloff in LUNA or a massive redemption of UST, UST could lose its $1 peg. We saw this back in May when UST dropped to $0.85 USD because of a wider crypto market crash. Although UST recovered and has been stable ever since, who’s to say this will never happen again. Luckily, if you are concerned about these risks, there are ways to mitigate this by buying insurance (see below).

Overall, given the size of Anchor today which is now close to $8 billion in TVL (total value locked in Anchor), I’m more than comfortable in parking some cash with Anchor for a free lunch even without insurance, as long as it’s not my entire life savings.

If you found this helpful, feel free to check out https://myfreelunch.substack.com/!


How to Earn on Anchor

  1. Get the Terra Station Wallet Extension on Chrome and create a new wallet

     

  2. Transfer UST into your Terra Station Wallet. For Canadians, here are the two easiest ways to get UST:

    1. Buy LUNA directly through Crypto.com, withdraw LUNA to Terra Station Wallet, and then swap LUNA for UST

    2. Buy UST directly through Newton, withdraw UST directly to Terra Station Wallet

       

  3. Go to Anchor and connect your wallet in the top right corner

     

  4. Navigate to Earn tab and deposit your UST to start earning!

 

If you found this helpful, feel free to check out https://myfreelunch.substack.com/!

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