- Anchor, a DeFi lending protocol, hit the headlines this week for its 20% yield on stablecoin UST.
- The high payout raised questions about the source of its yields and whether it is sustainable.
- Crypto analysts see Anchor lowering its payout eventually while finding more sustainable borrow demand.
As the broader crypto market stagnates amid the prospect of rising interest rates, high inflation, and geopolitical uncertainties, a decentralized lending protocol has caught the attention of investors for offering a higher-than-normal annual percentage yield of nearly 20%.
Anchor Protocol (ANC), a decentralized lending application built on the terra blockchain (LUNA), currently pays depositors of TerraUSD (UST), terra’s native dollar-pegged stablecoin, a fixed 19.57% annual percentage yield.
The depositors are able to earn such a high APY or “anchor rate” because the deposited stablecoins are pooled and lent out to borrowers to accrue interest. In order to borrow UST, borrowers must also post staked tokens, including staked LUNA and staked ETH, as collateral, which allows staking rewards to be earned.
When the earned interest and staking rewards combined are not enough to sustain the nearly 20% anchor rate, the protocol draws from its yield reserve to make up the difference between earnings and payouts.
The process of depositing UST into Anchor is straightforward. Investors first need to download Terra Station, the wallet for the terra blockchain, before heading to the WebApp of Anchor protocol. There, they can connect wallets and deposit however much UST they want into the protocol, with transaction fees deducted.
The 20% yield compares favorably to the 0.04% interest rate for the average savings account in the US. Though to be sure, the earnings in decentralized finance are subject to security and regulatory risks without the insurance provided by the Federal Deposit Insurance Corporation.
Still, investors have flocked to Anchor protocol for the 20% yield, driving up the ANC token and LUNA token 112.6% and 57.2%, respectively, in the past month, according to CoinGecko data.
Unsustainably high yields
Beneath the almost “too good to be true” high yields is “an inherent imbalance,” according to Martin Gaspar, a research analyst at the crypto exchange CrossTower.
In his view, because Anchor distributes ANC token rewards to borrowers to incentivize loan origination, part of the borrowing is done by users who wish to take advantage of the low borrowing rate plus token rewards. As the rewards shrink and run out eventually, these borrowers are likely to repay their loans. This leads to less staked collateral posted by borrowers and therefore fewer earnings to satisfy the 20% yield promised to depositors.
The system could be gamed as some savvy users “simply take out a UST loan at an APR of close to 2.5% and then deposit that UST back into Anchor to earn 20%,” he noted.
“The point is that there is inherently an imbalance, there is far more demand for the 20% yields from depositors than there is demand from borrowers for UST at the moment,” Gaspar wrote in a recent research note. “Without the ANC incentives, there would not be enough borrowers, and hence enough collateral posted to pay 20%. Thus, yields paid to depositors would need to be lowered dramatically to be sustainable.”
Indeed, to meet the unsustainable high yields, the protocol has been burning through its yield reserve, which shrank to about $6.56 million as of February 13 from nearly $70 million in December 2021.
Near-term rescue vs. long-term solution
In February, the Luna Foundation Guard, a non-profit launched to grow the terra ecosystem, agreed to recapitalize the Anchor yield reserve with 450 million UST in response to a governance proposal.
Gaspar views the $450 million injection as a marketing move because high yields are likely to bring more users to the terra ecosystem. In addition, it buys anchor more time to develop and release its new v2 borrow model.
The new borrowing model “prioritizes cross-chain deployments and makes it easier to onboard new collateral assets, which should organically drive borrowing demand,” analysts at Genesis Trading wrote in a March 8 client note.
While the $450 million extends the reserve by another 47 weeks, it remains a short-term solution.
“It’s very doubtful whether anchor can sustain its ultra-high rates, so I ultimately see this solution as simply buying time in hopes for UST use cases to further proliferate,” Gaspar said in the note.
To improve the long-term sustainability of the protocol, researchers and venture capitalists have proposed shifting 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 nearly 20% Anchor rate remains, but it is not likely to last long.
“Within the next year, we could see the anchor rate decrease at least once, ANC adopt new tokenomics that will make it more value-accretive, and anchor launch native deployments on avalanche and solana,” Genesis analysts wrote in the note.
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