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Is the anchor protocol (terra/luna network) legit?

Hey folks,

first things first. I’m fairly new to the crypto scene as well as to reddit as a network to have a discussion on. So please excuse my clumsy choice of words, if I’m using wrong terms in the following.

I recently stumbled over the anchor protocol of the terra network, which offers various ways to invest money. Even so I’m very impressed with the project’s idea, the names of the team and the amount of people already involved, I still have some doubts about how safe it is, to put my money there.

So as one of various options to stake your money (I will only talk about this one for now), the anchor protocol claims to guarantee 20 APR on the amount of UST that is being deposited. This sound like a crazy good deal regarding the APRs you would currently receive at a bank (at least here in Germany) which would be around 0.5 to 1.0 APR. So the question that springs to mind is, how is that even possible? Are there any catches?

So I tried to do a little digging (reddit, YouTube, google etc.). Sadly, none of what I found truly explained where the value was created in order to guarantee this 20 APR. Most of the posts took the 20% as good given or explained it with oversimplified examples that would just relocate the question about the creation of value to another part of the example.

To be fair, I was overstrained reading the white papers, since I m not familiar with IT-terms, as I never got in touch with programming too much. So maybe everything is laid out there and I’m just too stupid to understand it.

Anyhow, the little bit if research I did today as well as the examples posted gave me the impression that the 20 APR is only working as long as the network is growing and we are moving in a bulls market. As I said before, I don’t want to imply anything here, I just really hope, someone can give me a little deeply insight to understand the system.

So here is the given example that supposedly explains, how 20 APR can be maintained:

First of all, its presumed that stacked UST can generate a yield of 10-12 APR (even tho I have no idea if that is realistic, I just assume its true since I see how stacking generates value by verifying transactions)

1. Leo deposits 100 $, expects 20 APR = 20 $ for the year
2. Bob wants to borrow 100 $, so he puts down 300 $ dollar as collateral in order to take Leo’s 100 $ as a loan
3. the anchor protocol stakes Bob#s 300 $ collateral to gain 30 $ ( 10 APR on 300 $)
4. From this staking earning (30 $), 20 $ go into Leo’s pocket for providing the 100 $ loan, the other 10 $ go into some type of pool of the network

So why would you lock up 300 $ as collateral in order to borrow 100 $. Why not work with 100 $ of the 300 $ of your own in the first place? Since the collateral deposited is locked in stacking, you don’t get the 100 $ on top of your 300 $ to work with but instead.

Since this doesn’t make sense, I tried to figure out why people would loan from the depositors of UST. So apparently if you post bLuna as collateral, you get rewarded with anchor token with insane APR up to 250% (the YouTube video was from march this year). On top of that, you can loan money as states in the example before in order to add it to the collateral value already put down, leading to a bigger amount rewarded with the 250 APR.

to amplify the example before:

5. Bob gets 250 APR in anchor tokens for his 300 $ put down in collateral.

6. He also get 250 APR on the 100 $ loaned from Leo. Therefore he does not mind to pay 30% interest on the 100 $ loaned (10% stacking reward on the 300 $ put down as collateral) since he is still making good profit with 220 APR on the loaned money.

This leads to the next and even more urgent question. Are these 250% legit?

Apparently the APR on the collateral value is flexibel, depending on the amount of collateral value as well as the demand for it.

So right now the value of an anchor token sits at around 2.1 dollars. If the prices stays the same, even with more and more value being put down as collateral, the APR in put down collateral value will dip but not go anywhere near 30 APR in the foreseeable future. If demand for the anchor token goes up, the APR might even rise. So for those scenarios, system keeps going.

Question is: What happens if the value of anchor token goes down? Since the generated anchor token reward is self compounding and therefor put down as collateral value right away in order to general more anchor token, the “value” never really leaves the eco-system of the terra-network. I see the temptation of just putting all the profit right back in the collateral value, since 250% is simply too good to not throw all spare money you have at it.

But what happens if people actually started to cash out? I assume the price of anchor token would drop due to a drop in demand, the APR for collateral value would drop, therefore more people would get out, the value of anchor would drop even more, collateral loaned will be liquidated which all will eventually lead to a downward spiral.

It looks like the whole thing could go south pretty quickly, once rolling.

So this leads me to the final question where I want to leave it for now and see if anyone has some more information on this topic.

What is the actual value of anchor and how stable is its value?

Since its supposed to carry interest at 250 APR, is there any more value to it, other than being automatically reinvested as collateral value in order to general even more anchor? It seem that other the staking for interest you can also stake anchor tokens in order to participate in votes of the terra network community.

So this does not quite cut it for me in order to put my money here. The vote option aside. I don’t see any value in anchor other than that it might be stacked in order to get more value. The whole system stops working, once the price of anchor drops and people cash out. Everyone not fast enough will lose money or even get liquidated. Since we’re in a bull market and the “auto compounding” is very convenient, I don’t see this happening anytime soon, but I guess it will eventually happen.

I don’t know if I’m making any mistakes here, if I’m giving in to any misconception or if everyone else is just blinded by the $$-signs. As I said before. The network and community itself seems so vivid that I really want to participate. But at the same time, most communication stops at a rather superficial level while everything for the team itself is the hard to understand with any IT-background.

Edit: typos

What do you think?

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3 Comments

  1. You got the basics of it right, although you missed out on one thing. The 20% rate is made up of two main sources:

    1. Staking yield on collateral (currently around 10%)

    2. Borrow interest, paid on the loan amount (currently 17.3%)

    So to modify your scenario:

    1. Leo deposits $100, expecting $20

    2. Bob wants to borrow $100, he has to put down *at least* $200 dollars of collateral in order to take Leo’s $100 as a loan. Realistically though, you don’t want to set your borrow limit at 50% of your collateral in case the price of Luna drops and you get liquidated (your collateral is seized and sold to repay the loan). The safe rate is around 30-35% to account for price fluctuations in Luna. Using a borrow limit of 33%, Bob puts down $300 worth of LUNA to borrow $100 UST.

    3. Anchor Protocol stakes Bob’s Luna for 10%. The staking yield remains consistent so long as there are transactions on Terra-Luna. Given the size of Chai, a payments app that uses the Terra blockchain and has over 2% of South Korea’s population as customers, I imagine that there will always be an influx of transaction fees.

    4. Bob pays an additional 17.3% which accrues to his loan amount (his loan amount grows over time). This yield is also transferred over to the depositor Leo.

    5. The remaining yield ends up in a yield reserve, which aims to smooth out the interest rate in times of low capital utilization (less borrowers, therefore less interest). Until very recently, this yield reserve was draining down until Terraform Labs announced a one off cash infusion to sustain current interest rates until more types of collateral (like bETH) can be added. Further reading on this announcement [here](https://agora.terra.money/t/bolstering-anchors-sustainability/1516).

    As for Bob:

    1. The 250% APR is called the distribution APR, and it is on the value of Bob’s loan ($100), not his collateral ($300). This APR rapidly drops as capital utilization goes up and more borrowers enter (it is currently at 84.65%). When capital utilization is low, the system recalibrates by increasing emission of ANC tokens to borrowers in order to increase the number of borrowers. This high apr that you see is therefore deceptive, it only exists for a short time before borrowers will quickly move in to take advantage of it. Since the apr is denominated in ANC tokens, it is affected by how often you compound. If you compound every day, the apr is likely to be accurate. If you compound every week, the tokens might have either dropped or rose in value. The distribution APR does not take into account the latter scenario, as it has no way of knowing the price of ANC tokens in the future.

    Some clarifications:

    1. You cannot take out a loan against ANC tokens as collateral. You are correct in that if ANC were both the token put down as collateral and the token that’s being given out as rewards, it might cause a death spiral. Most farm tokens face a similar fate, as they have no diversity in use cases. Even this being not the case, there is an active debate ongoing on the Terra forums on the fact that ANC actually has very little use besides staking, governance, and rewards, thus causing the steady sell pressure (as people sell their rewarded ANC tokens continuously). However LUNA, which is the collateral being used, has many use cases that are market independent (the Chai example referenced above). If you want to research on the stability of borrowing with LUNA as collateral, look into LUNA use cases and consider whether they are diverse enough to ensure that LUNA doesn’t simply go to zero tomorrow.

    2. You can look into the collapse of Iron Finance as a case study of what can go wrong. I won’t expound upon it here, but Do Kwon (founder of Terraform Labs) made a comment in this [thread](https://twitter.com/d0h0k1/status/1405742211396882434).

    So why would a borrower borrow at all?

    1. Holding cryptocurrencies in a wallet earns no interest. If I want to hold LUNA or ETH for the long term, I could borrow against it and use that UST for whatever reason I wanted. I could deposit it back into Anchor Protocol, I could leverage my risky assets to buy more risky assets. Finance is about transference of risk. The key here is that borrowers engage in risky crypto related activities (trading, yield farming), and transfer some of that value back to the depositors who do not want to learn or engage in that risk. Since crypto is so lucrative in general, the apr even for depositors is quite high.

    Now, a few caveats:

    1. Yes, Anchor Protocol is extremely new (launched 4 months ago) and is being tested in the real world, like almost everything in defi. One can argue that in a bear market scenario this apr is not sustainable, and this is technically what happened for the last month or so. As the markets crashed and traders became risk off instead of risk on, the borrow amount dropped dramatically and Anchor Protocol was draining its yield reserve quickly. There’s no way of knowing if this apr is guaranteed to continue. Regardless, I am optimistic that new changes (read announcement above) may work to solve some of its issues. The introduction of bETH as collateral will mean that holders of ETH have a new way to generate yield and participate in the Terra Ecosystem. A proposal to increase the borrow limit to 60% is currently being voted on, and if it passes, it will increase capital utilization as users can now borrow more against their collateral safely. Even if apr drops to zero, your deposited funds will still be there and you can withdraw it, but I think Anchor Protocol users would vote to drop the apr if it is unsustainable, so it is highly unlikely it will go to zero.

    2. Lastly, all protocols initially start out as ponzi schemes. Most protocols have some sort of reward distribution system to reward early participation. This is because of the network effect, in other words the chicken and egg problem. Reddit is the best example of this. You need users for a forum to be useful, but how can a forum gain users if it is not useful (doesn’t have users)? Therefore reward distribution or liquidity mining programs are a way to bootstrap users until the protocol is big enough that it is self sustaining.

    So to list out risks:

    1. Smart Contract Risk (if the smart contract has bugs)

    2. Stablecoin Risk (if UST depegs from its dollar value)

    3. Price Action Risk (if LUNA goes to zero)

    4. Black Swan Risk (the possibility of a completely unpredictable event, usually you have insurance to cover this)

    Does this cover your questions?

  2. There is no such thing as guaranteed APRs in DeFi – they’re all variable APYs. Meaning they will go up and down over time as more or fewer people interact with the protocol and the value of governance tokens go up or down.

    Anchor doesn’t promise 20% APR, they’re promising a variable APY.

  3. TFL – Terra form Labs is going to refill the Anchor reserve with 50 Million dollar, which is enough to pay roughly for 1,5 years the 20% APY.

    They expect that there will be enough demand after this time, so the ecosystem can work on it’s own.

    I am using it (see my last posts) – it’s awesome and here are my method and the risks involved:

    [Click my like a little link](https://www.youtube.com/channel/UCZny4hW5XPvuIGtgJWbOgrQ)

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