The anchor protocol offers an annual percentage return of 20%. Is it sustainable?

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  • Anchor, a DeFi lending protocol, made headlines this week for its 20% return on the UST stablecoin.
  • The high payout has raised questions about the source of his returns and his sustainability.
  • Crypto analysts see Anchor possibly reducing its payout while finding more sustainable borrowing demand.

As the broader crypto market stagnates on the prospect of rising interest rates, high inflation, and geopolitical uncertainties, a decentralized lending protocol has caught the eye of investors for offering a annual percentage return above normal by almost 20%.

Anchor protocol (ANC), a decentralized lending application based on the Earth blockchain (LUNA), currently pays depositors of TerraUSD (UST), the native dollar-pegged stablecoin of terra, a fixed 19.57% annual percentage return.

Depositors are able to earn such a high APY or “anchor rate” because deposited stablecoins are pooled and loaned to borrowers to accrue interest. In order to borrow UST, borrowers must also deposit staked tokens, including staked LUNA and staked ETH, as collateral, which earns staking rewards.

When interest earned and staking rewards combined aren’t enough to keep the peg rate close to 20%, the protocol draws from its return reserve to make up the difference between winnings and payouts.

The UST filing process in Anchor is simple. Investors should first download Terra Station, the terra blockchain wallet, before heading to the Anchor Protocol WebApp. There they can connect wallets and deposit as many USTs as they want into the protocol, transaction fees deducted.

The 20% yield compares favorably to the 0.04% interest rate for the average savings account in the United States. Of course, decentralized finance revenues are subject to security and regulatory risks without the assurance provided by the Federal Deposit Insurance Corporation.

Still, investors flocked to the Anchor Protocol for the 20% yield, driving up the CNA token and LUNA token 112.6% and 57.2%, respectively, over the past month, according to data from CoinGecko.

Unsustainable high yields

Beneath the almost “too good to be true” high yields, there is “an inherent imbalance,” according to Martin Gaspar, research analyst at crypto exchange CrossTower.

In his view, since Anchor distributes ANC token rewards to borrowers to incentivize loan origination, some of the borrowing is done by users who want to take advantage of the low borrowing rate plus token rewards. As the rewards dwindle and eventually run out, these borrowers are likely to repay their loans. This leads to less collateral posted by borrowers and therefore less revenue to meet the 20% return promised to depositors.

The system could be manipulated as some savvy users “simply take out a UST loan at an APR of almost 2.5% and then deposit that UST into Anchor to earn 20%,” he noted.

“The point is there is inherently an imbalance, there is far more demand for 20% depositor returns than there is borrower demand for UST right now,” wrote Gaspar in a recent research note. “Without the ANC incentives, there would not be enough borrowers, and therefore enough collateral deposited to pay 20%. Thus, returns paid to depositors would have to be significantly reduced to be sustainable.”

Indeed, to respond to unsustainable high yields, the protocol has exhausted its yield reserve, which has shrunk to around $6.56 million as of Feb. 13 nearly $70 million in December 2021.

Short term rescue vs long term solution

In February, the Luna Foundation Guard, a non-profit organization launched to grow the terra ecosystem, agreed to recapitalize the Anchor Yield Reserve with UST 450 million in response to a governance proposal.

Gaspar views the $450 million injection as a marketing move, as high returns are likely to attract more users to the terra ecosystem. Additionally, he buys more time from Anchor to develop and release his new borrowing model v2.

The new borrowing model “prioritizes cross-chain deployments and facilitates the onboarding of new collateral assets, which should organically drive borrowing demand,” Genesis Trading analysts wrote in a note. March 8 customer.

Although the $450 million extends the reserve for another 47 weeks, it is still a short-term solution.

“It’s very doubtful that Anchor can sustain its ultra-high rates, so I ultimately see this solution as just a time saver in hopes that use cases for UST proliferate further,” Gaspar said in the post. note.

To improve the long-term sustainability of the protocol, researchers and venture capitalists have proposed moving the fixed APY to a more flexible rate or reducing the payout to deposits exceeding 10,000 UST, according to the defiant.

For now, the anchor rate of almost 20% remains, but it is unlikely to last long.

“Over the next year, we could see the anchor rate decrease at least once, ANC adopt new tokenomics that will make it more value-creating, and anchor the launch of native deployments on avalanche and solana“, Genesis analysts wrote in the note.

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