The reserves of Terra-based lending and borrowing protocol Anchor, which offers a supposedly industry-beating benchmark deposit rate of around 20%, are sliding fast as a result of the crypto market crash.
Data provided by Terra.Engineer shows reserves have slumped by half to 35 million UST – that's Terra's native U.S. dollar-pegged stablecoin – in four weeks. It works out to an average decline of about 1.25 million UST per day. The crypto community is worried that the reserves will be drained in three weeks or so in the absence of corrective measures.
"The Anchor Yield Reserve was created as a buffer to maintain the 20% interest stability," pseudonymous market expert and Anchor user Duo Nine, who operates the Twitter handle @DU09BTC, told CoinDesk. "However, this reserve has been running a deficit for weeks due to more deposits than borrowers on Anchor Protocol. At this rate, it will hit zero in 20 days."
LUNA, Terra’s native token, dropped below the $50 mark on Friday and is down over 17% over the past 24 hours. It was recently trading at $49.31.
While most decentralized finance (DeFi) platforms allow demand-supply forces to determine lending and borrowing rates, Anchor offers an almost fixed 20% annualized percentage yield (APY) to users depositing UST. The so-called "anchor rate" is set by holders of Anchor's governance token, ANC. At press time, other industry heavyweights were offering lending rates of less than 10%, according to data source defirate.com.
The project finances the super-high deposit rate from three income sources: interest charged to borrowers, staking rewards earned from borrowers' collateral – such as liquid staking proof-of-stake assets from major blockchains like bonded luna (bLUNA) or bonded ether (bETH) – and liquidation fees. Luna is the native token of Terra's blockchain, while ether (ETH) powers the Ethereum blockchain.
If the realized yield from the three income sources is greater than the anchor rate, the excess amount is kept aside as the UST-denominated Anchor Yield Reserve. The protocol taps into the reserve when the realized yield is less than the anchor rate, ensuring depositors are paid as promised.
The structure makes the platform's reserve vulnerable to market crashes and the resulting imbalance between demand for loans and supply of deposits. During bearish periods, traders are less likely to borrow UST to seek higher returns elsewhere, leading to a decline in loan demand. They are also more likely to supply UST tokens in a bid to make a relatively stable return, pushing deposits higher.
That's what seems to have happened since December, forcing the platform to persistently tap the reserve, as tweeted by Do Kwon, co-founder of Terraform Labs, the decentralized financial payment network behind Anchor.
Data from Anchor Protocol show total deposits stood at 5.71 billion UST at press time, while the amount borrowed was 1.37 billion UST. That's a loan demand shortage of over 300%. The yield reserve was 34.13 million UST, and the anchor rate was 19.88%.
The situation perhaps indicates that fixed rates are unsustainable over the long run and yields are better determined by free interaction of demand and supply forces.
"The fixed yield of around 20% may not be sustainable," Duo Nine said. "With the protocol facing a deficit, it needs fresh money in the form of increased loan demand to keep the anchor rate at 20%."
Founder downplays concerns
Terraform Labs' Kwon is trying to soothe concerns about a depletion in reserves, saying the mechanism was created precisely to ensure stability during market downturns. Early today, Kwon assured crypto followers on Twitter that the protocol would function as a regular DeFi money market if the much-feared scenario of reserves dropping to zero occurred.
"If we were to get to this hypothetical situation, Anchor will *still* offer the highest return on stablecoins. By far. It will be fine," Kwon tweeted.
It remains to be seen what corrective measures are implemented. Terraform Labs provided a cash injection of 70 million UST following the crypto crash of May-June 2021, which punctured the broader market bull run.
"The deployment is a one-off solution that will prevent the need for future intervention, allocating a significant runway for the protocol to introduce self-sustainable mechanics even during periods of low borrowing demand," Terra Research Forum's blog post Bolstering Anchor's Sustainability published in July said.
Experts say a cash injection could be a temporary solution. It will, after all, have little impact on loan demand.
"A capital injection will prolong the health of the system, but generally, they need to either reduce the deposit rate or increase the utility for ANC token, so it's not viewed as a farming coin," Hassan Bassiri, vice president of portfolio management at Arca, a digital asset management firm, said
Borrowers providing collateral are given ANC tokens proportional to the amount borrowed.
"ANC is also used as incentives to bootstrap borrow demand and initial deposit rate stability. The protocol distributes ANC tokens every block to stablecoin borrowers, proportional to the amount borrowed," the official explainer says.
An ANC token with increased utility might bring loan demand and greater income for the protocol, alleviating the pressure on the reserve. Kwon has assured that he is resolved to finding ways to subsidize the yield reserve.
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