An upstart stablecoin issuer out of South Korea is making a run at MakerDAO’s DAI, the fourth-largest cryptocurrency in this category.

Terraform Labs just launched Anchor, a long-awaited protocol for lending and saving that the Seoul-based firm expects to drive enough demand for its stablecoin, TerraUSD (UST), to top DAI’s circulation. Like DAI, UST maintains its peg to the U.S. dollar in a decentralized manner, but at $1 billion, its market capitalization is only about a third of its rival’s. 

To enhance the stablcoin’s allure, Anchor aims to offer returns that outperform other decentralized finance (DeFi) offerings with a combination of sheer yield and predictability. It’s all driven by validation rewards (the equivalent of freshly minted bitcoin awarded to that currency’s miners) from Terra’s own blockchain, and will eventually pool such rewards from other chains. 

If Anchor gains traction, it could represent a significant DeFi play that ultimately does not run on the Ethereum blockchain, which basically has a monopoly on that piece of the industry. 

“By tapping into a diversified set of staking yields you’re able to produce yields that are highly stable and attractive,” Do Kwon, a cofounder of Terraform Labs, said in an interview.

Read more: Proof-of-Stake Chains Team Up to Prove DeFi Is Bigger Than Ethereum

Since its debut in late 2020, UST has already surpassed the Paxos Standard (PAX) and the Gemini Dollar (GUSD), both of which are backed by fiat currency held in real-world banks and subject to intervention by their issuers. 

But DAI remains the top stablecoin for users who prefer a cryptocurrency that can’t be blocked or frozen by a central authority and generally holds its value, with a $2.8 billion market cap.

“If you let Anchor do its run for a couple months, I think we should be there,” Kwon predicted.

“When the market takes a downturn, a lot of those highly volatile crypto assets will be sold off for UST and then staked in Anchor for a savings account,” says Do Kwon, a cofounder of Terraform Labs
(Terraform Labs, modified by CoinDesk)

What is Anchor?

Think of Anchor like the savings account your parents set up for you as a kid, but without the anemic returns typical of U.S. bank savings accounts today.

It’s no secret that, over the last year or so, returns in DeFi have been strong to the point of somewhat unbelievable. Still, even on the most mainstream offerings, such as the money market Compound, returns can fluctuate from one week to the next.

Returns for depositing DAI on Compound have ranged from 3% to 12% roughly since the new year. Returns for supplying USDC have ranged from 3% to 14%.

Anchor advertises a 20% return on deposits made in UST, though it’s unclear yet what kind of guarantee is made there. 

On the lending side, Anchor will accept as collateral only staked tokens that earn returns. Starting with bLUNA (the token that represents the staked version of the Terra blockchain’s LUNA governance token), a user can borrow half of the value of their staked LUNA.

On certain newer blockchains, the entities that validate transactions stake, or pledge, assets as a way of guaranteeing the quality of their work. This allows the blockchain to use less energy (a hot-button issue of late), but it remains secure because if the stakers are found to validate badly, their assets can be taken or slashed. Each of these blockchains has a native coin that’s used for staking. On Terra, that’s LUNA; on Cosmos it is ATOM, etc.

So a user could stake $200 worth of LUNA to the network, then pledge that much in bLUNA as collateral to borrow $100 from Anchor. While the loan is active, Anchor will earn staking rewards on all $200 worth of bLUNA plus the interest on the loan. The combination of staking rewards and interest should enable Anchor to pay out a higher return to its depositors. 

A token that represents a stake, such as bLUNA, is in effect a derivative. Anchor will soon accept as collateral such derivatives for other base layer protocols’ native tokens, such as polkadot (DOT), solana (SOL), staked-Ethereum (stETH) and cosmos (ATOM).

“In the world of blockchains there isn’t any source or yield that you’re going to get that’s more stable than what the base layer is going to give you,” Kwon said. “If we’re going to define a new monetary policy from these blockchains I think it’s going to come from that base layer and that is the staking yield.”

Luna stakers and borrowers in the Anchor ecosystem will get the additional benefit of liquidity mining. They will receive Anchor’s governance token, ANC. 

How does TerraUSD stay at $1 without a central authority?

UST is held stable to its peg with the greenback under a seigniorage system. Terra also has stablecoins pegged to track currencies the South Korean won and Mongolian tugrug, along with the International Monetary Fund’s Special Drawing Rights (SDRs).

The supply of each of the stablecoins is regulated by the governance token, LUNA. When demand for UST gets too high, new UST gets issued and it can be purchased for $1 in LUNA. This allows arbitrageurs to buy the UST at a discount to the market price and sell the UST immediately at a profit.

If demand weakens for UST, LUNA will be released to the market and exchanged for UST, to be burned.

Validators on the Terra network have to stake LUNA (which creates bLUNA). These validators are rewarded by collaboratively serving as oracles for the price of the dollar in LUNA. Validators also earn small fees on transactions in UST.

The overall design is fairly similar to that of Basis, the Silicon Valley-backed stablecoin that ultimately closed down, citing regulatory issues, and returned all the funds invested.

UST can be found on Solana and Ethereum, but it is native to its own Terra blockchain, which runs on the Tendermint consensus model. Part of the Cosmos ecosystem of blockchains, Terra will eventually move to be interoperable with other Tendermint-based chains sometime after the Inter Blockchain Communication (IBC) protocol is enabled.

The big vision

Terra’s stablecoins were created as a way for e-commerce giants in Southeast Asia to escape credit card fees. Its payments app, Chai, hit two million users late last year.

Mobile-first payments have been huge in China. Kwon saw the potential but realized another facet was needed: a way to make saving money really worthwhile. That’s worked well for Alipay’s money market offering, for example.

Terra raised a fresh $25 million in January on the strength of its product offerings.

Anchor makes the third leg of the stool for UST demand. After Chai, Terraform Labs built Mirror, a marketplace for synthetic U.S. equities, which currently has 1.25 billion UST staked on it. It’s a way to bet on the prices of Apple, Tesla and the like without buying the actual stocks.

Anchor will first be offered on CoinList, a platform mainly for token issuance, but the product is designed to be integrated into other applications, just as the Unicorn startup Stripe has made fiat payments easy to add on desktop and mobile applications. With the Anchor software development kit (SDK), the product can be added to exchanges, wallets and other parts of the crypto market infrastructure.

“When the market takes a downturn, a lot of those highly volatile crypto assets will be sold off for UST and then staked in Anchor for a savings account,” Kwon said.