How Anchor Protocol’s Yield Model Worked and Why It Failed
KEY TAKEAWAYS
- Anchor Protocol offered depositors a stable 19.5-20% APY on UST by redirecting staking rewards from borrowers’ collateral and interest payments.
- The yield reserve acted as a buffer to maintain fixed rates but depleted rapidly as deposits outpaced borrowings.
- Subsidies from TerraForm Labs and ANC token incentives artificially boosted the model, but they also led to token dilution and unsustainable imbalances.
- The protocol’s failure was intertwined with UST’s de-peg, triggered by mass withdrawals and design flaws in redemption processes.
- Analysts warned ahead of reserve exhaustion and Ponzi-like characteristics, highlighting the risks of high-yield promises without sufficient organic revenue.
, a well-known decentralised finance (DeFi) lending technology that promises steady, high rates on stablecoin deposits, was introduced in March 2021 as a component of the Terra blockchain ecosystem. By offering an annual percentage yield (APY) of roughly 19.5% to 20% on deposits in TerraUSD (UST), an algorithmic stablecoin pegged to the US dollar, it drew in billions of user dollars.
With analogies to traditional banking but far larger profits, this strategy positioned Anchor as a “savings account” for cryptocurrency consumers. But the protocol’s rapid expansion concealed inherent flaws, leading to its demise in May 2022 amid the broader collapse of the Terra ecosystem.
Based on , economic analysis, and post-mortem evaluations, this article examines the workings of Anchor’s yield model, the factors driving its imbalance, and the factors leading to its ultimate demise.
The Anchor’s Yield Model’s Fundamental Mechanisms
Similar to a money market, Anchor Protocol facilitated lending and borrowing to give depositors a steady yield shielded from market fluctuations. Its core was a mechanism that turned the unpredictable staking rewards of blockchains into steady income for UST holders.
Making a Deposit and Getting Paid
The aTerra (aUST) tokens users received as a receipt for depositing UST into Anchor’s “Earn” feature accumulated interest over time. To preserve stability, the protocol used subsidies to maintain a constantly adjusted of about 20%.
Retail and institutional depositors were drawn to this rate since it was significantly higher than that of ordinary savings accounts. Deposits reached $9 billion by the beginning of 2022 and $13.3 billion by the middle of the year, representing 75–80% of UST’s circulation. The model’s promise of low-risk, high-reward savings with returns paid immediately in UST was what made it appealing.
Collateral and Borrowing Requirements
Users placed security in the form of bonded assets (bAssets) on the borrowing side, like staked ETH (bETH) or bLUNA (a tokenized version of staked LUNA). Even when used as collateral, these assets and staking derivatives continued to produce PoS benefits. With an APR of roughly 10–13%, UST loans were available to borrowers with a loan-to-value (LTV) ratio up to 60%.
Anchor gave its governance token, ANC, to borrowers in order to encourage borrowing and maintain system equilibrium. This frequently produced a net positive yield for the borrowers, effectively compensating them for borrowing during certain times.
Although the goal of this mechanism was to boost demand for loans, borrowings consistently fell short of deposits, reaching a peak of $2.5–3 billion compared to far larger deposit pools.
Sources of Income and Production of Yield
The two main sources of income for Anchor are from borrowers and staking rewards from collateralised assets. For example, bETH provided 4.6% from ETH networks, whereas bLUNA yielded approximately 8–9.5% from Terra’s PoS staking. Borrowers lost these benefits, which were transferred to depositors.
Although ANC incentives mitigated the effective rate, borrower interest added another layer and occasionally made the net borrow cost negative. The pool also received a 1% fee on liquidations (where the value of the collateral fell below certain levels).
Theoretically, this produced a self-sustaining cycle: high yields drew deposits, which financed loans and produced profits from interest and staking.
The Mechanism of Yield Reserve
Anchor used a yield reserve as a buffer to maintain the intended APY despite varying revenue. Surpluses from higher income than payout commitments were placed in the reserve, and the reserve covered the shortfall. TerraForm Labs (TFL) was the original viewder of the reserve, which was then strengthened by injections, including $450 million from the Guard (LFG) in February 2022.
As a result, Anchor provided the “anchor” of stability by mitigating cyclical fluctuations in PoS yields and borrowing demand. 10% of net income (later than subsidies) was used to purchase back ANC tokens, thereby increasing the value of the governance token.
Elements That Lead to Unsustainability and Unbalance
The is structurally unstable from the beginning, despite its creative design. Because of the alluring fixed yield, deposits increased rapidly, while borrowing demand lagged, creating a long-lasting funding shortfall.
A $1.8 billion gap resulted from the combined income of staking (averaging 9.5% on bLUNA and 4.6% on bETH at 47% average LTV) and 10.45% borrow APR on $3 billion, which only covered roughly $700 million of the $13.3 billion in deposits that were needed for annual payouts, which required $2.5 billion.
The yield reserve was depleted at daily rates of $2.88–4 million due to this negative spread, in which depositor payouts outpaced revenues.
The difficulty was made worse by the ANC emissions’ dependence on borrowing, which led to token dilution and pressure on ANC holders to trade. The pro-cyclical aspect of the business, according to analysts, flourished in bull markets (such as LUNA’s 750% return in 2021) but suffered in turbulence as borrowers shunned leverage.
The issue was momentarily concealed by subsidies, such as a $70 million injection in July 2021 and the larger bailout in February 2022, but they hastened depletion later than the infusion. Without additional action, the reserve was expected to run out by March 2022.
This was addressed by proposals such as dynamic rate changes (a 1.5% monthly reduction begining in May 2022), but they were not enough to achieve equilibrium, which was predicted to be between 3 and 4.7% APY.
Additionally, Anchor prioritised UST stability within the Terra ecosystem by resisting market forces with its fixed deposit rate. Reducing rates risked de-pegging UST and triggering outflows, skewing incentives between ANC stakeholders and LUNA holders (who depend on Anchor for peg maintenance), since 9 billion of the 14 billion UST had been deposited in Anchor.
The Failure and Wider Collapse
When Anchor saw net withdrawals of $11.9 billion between May 7 and May 13, 2022, during UST’s de-peg from $1, the model’s flaws became apparent. Retail customers followed the ahead withdrawal of larger participants, which exacerbated a “death spiral.”
UST’s algorithmic peg relied on LUNA’s arbitrage; however, this mechanism was disrupted by LUNA’s hyperinflation (95% supply dilution), redemption costs (which increased to 60% during high volumes), and oracle pricing discrepancies (up to 70% from platforms).
The majority were sold on platforms like , where transactions increased to $2–4 billion every day, with only $4.9 billion being redeemed on-chain. Because of the reserve’s subsidisation of Anchor’s high yields, UST demand was artificially inflated, making the ecosystem vulnerable to shocks.
Mass exits were caused by a decline in confidence, as borrowing fell and reserves ran out. The disaster highlighted the dangers of unsubsidised, high-yield promises in DeFi, wiping out $40 billion in market value.
Professional Evaluations and Cautions
Concerns regarding were first voiced by analysts. According to Bloomberg, Terra’s 20% returns raise “sustainability concern,” comparing it to a Ponzi scheme in which “even Bernie Madoff didn’t consistently offer 20%.” According to a January 2022 Cointelegraph warning, “Anchor protocol’s reserves head towards depletion due to lack of borrowing demand.”
Following the collapse, economic evaluations highlighted design faults that prevented arbitrage and cemented the peg’s break, such as redemption concerns and volatility amplification.
Although Anchor transformed PoS yields into steady interest, researchers found that its reliance on subsidies and ecosystem incentives made it unsustainable in the long run.
FAQs
What was Anchor Protocol’s primary function?
Anchor Protocol served as a DeFi lending platform on the Terra blockchain, allowing users to deposit UST for high yields and borrow against staked assets.
How did Anchor generate yields for depositors?
Yields came from staking rewards on borrowers’ collateral (such as bLUNA and bETH) and from interest charged on UST loans, supplemented by a yield reserve during shortfalls.
Why was the 20% APY considered unsustainable?
Deposits grew quicker than borrowings, creating a revenue shortfall that relied on depleting subsidies, leading to an estimated equilibrium rate of only 3-4.7%.
What role did Anchor play in Terra’s collapse?
Anchor held up to 80% of UST supply, and its high yields inflated demand; withdrawals from the protocol accelerated UST’s de-peg and the death spiral.
Were there ahead warnings about Anchor’s model?
Yes, analysts, including those from Bloomberg and Cointelegraph, highlighted sustainability concerns and reserve-depletion risks as ahead as January 2022.
References
- : Anchor Protocol and the Curious Case of Staking Fees as “Stable” Interest
- Neptune Finance. “Anchor Protocol’s Point of Stability.” Medium, August 16, 2021.
- : “Anchor Protocol’s Unsustainable 20% Yield.”
- : Anchor Protocol (II): Too large to Thrive.”
