The savings account has sunk, and without an anchor, your savings will slowly drift away.
Interest rates, which is how much the banks are paying you for borrowing your money, have fallen down a whopping 99% since 1985. The inflation rate, which tracks how more expensive everything is getting, is only going higher.
This means that the value of your money floats away when you leave it in the bank.
The Anchor Protocol, a savings account powered by crypto, fixes this.
What does Anchor do for your savings?
Anchor is a savings protocol for your dollars powered by the Terra blockchain. Currently, it promises a near 20% interest for its depositors.
How does it work? Think of it as a hybrid between banks and pawnshops.
Savers store their dollars into the app, which then lends the same to borrowers who surrender their property to secure the debt. Borrowers then pay the protocol interest over time until the debt is paid back. When the debt is paid back, their property is returned to them.
But because it’s built on the blockchain, several differences make it more profitable for everyone involved. The differences are as follows:
The deposits in anchor are “stable coins”
Collateral put up is a “productive asset”
Incentives for borrowers
Different risks
I hope to illustrate how Anchor can afford to pay depositors such a great interest rate by going through these differences.
Stable coins and programable banking activities
Stable coins are cryptocurrencies whose values are tied to real-world currencies like the US dollar.
What is deposited in Anchor is the stable coin Terra-USD (UST) which maintains its value to the dollar through an algorithm and well-thought-out economic incentives. You can learn more about that in this video.
One UST should always equal one US dollar. So while you are exchanging your dollars for a cryptocurrency, you do so with much less price volatility compared to other assets in the space.
Using UST is advantageous to savers in the protocol because it allows the borrowing and lending to be done by the program instead of real people. In addition, Terra’s blockchain allows for banking to be automated, reducing operation costs.
Since it is automated, there is no need to pay for rent for a building or wages for a large staff. This allows a large chunk of the program's revenue to return value to lenders.
Currently, borrowers are charged a 15% yearly interest rate on their loans. And because its code controls the borrowing and lending in the application, the program can automatically rebalance the cost of loans based on demand and supply.
When there are more borrowers than deposits, the program increases the interest rate to make borrowing more expensive. Conversely, when more borrowers would be more profitable, the program can decrease its interest rate to make borrowing more affordable.
But how secure are the loans? And how can the program pay depositors near 20% despite charging borrowers only 15%?
Over-collateralized loans and productive digital assets
Loans granted by Anchor must be over-collateralized by the borrower. Currently, all loans from the protocol must be backed by at least two times their value. This means that every dollar lent out must be backed by at least two dollars worth of assets.
What assets are used to secure the loan? Borrowers have to surrender cryptocurrencies that can be staked in return for rewards.
In a blockchain that utilizes Proof-of-Stake(PoS), coins are delegated to validators in a network and accrue rewards whenever a new block is created. Examples of these are types of currencies are ETH, SOL, and LUNA.
You can think of these assets like land and transaction fees on a network like rent.
Whenever an application is built on top of the network, people who use it pay transaction fees to the network’s validators. The validators need to be delegated your coins to receive these fees, and delegators get a share of those fees for doing so.
Hence, coins on a chain secured by PoS are productive assets that earn yield.
Borrowers provide these productive assets to secure their loans. The program then stakes these assets to receive its rewards. These rewards are then exchanged for UST and paid out to depositors.
As a parallel example, it’s sort of like giving possession of your land to a creditor in order to secure a debt. The creditor can lease it out and collect rent while waiting for you to pay back your loan.
Currently, LUNA is the only available digital asset that can be used as collateral in Anchor. Its current yield from staking is around 10%.
The protocol requires the borrower at least double the amount LUNA equivalent to every dollar borrowed. This allows the protocol to earn about 20% on every dollar borrowed by putting surrendered collateral to good use.
The interest paid isn’t magic. It’s math.
But it does seem like borrowers are getting the short-end of the stick whenever they take loans. They also run the risk of liquidation, which is when the protocol automatically sells their collateral if it falls below the required loan-to-value ratio of 50%.
So why would anyone want to take a loan?
Incentives and risks for borrowers
The way I see it, there are currently two kinds of borrowers: the speculator and the farmer.
To illustrate the incentives of a speculator, suppose Clarissa holds LUNA.
She thinks that the value of LUNA will be worth way more in the future, so she refuses to sell the asset. Unfortunately, she’s short on cash for this month’s bills since her check won’t come in till the end of the week.
To pay her bills without having to sell her coins, Clarissa can use her LUNA as collateral for a loan in the meantime. Then, when she gets paid a few days later, she can settle her outstanding debt and get back her LUNA. Because she speculates that LUNA will increase in value, she is incentivized to borrow against her coins in times where she requires more cash.
Farmers, on the other hand, borrow money from the protocol in order to receive rewards in doing so. Anchor rewards borrowers a variable but generous average percentage yield (APY) for borrowing. This means that borrowers are paid in Anchor’s own governance token, ANC, for participating in the protocol.
At times, the APY for borrowing is so large that borrowers effectively get paid to borrow. While this won’t last forever, since ANC has a finite supply, clever individuals are incentivized to borrow in order to farm ANC.
Risks for depositors
It would be irresponsible to say that this protocol does not have any risk for its depositors. Like all financial vehicles, there are several that you should be aware of. Here are two of what I consider the biggest risks with using Anchor.
#1 Smart contract risk
Smart contract risks are bugs in the code that may cause hacks or exploits in the future. While hundreds of hours have been spent by Anchor’s developers to ensure the protocol is free from bugs, there’s always the possibility of a major problem that is not yet known. These problems are the unknown risks that a user takes on in every smart contract.
I can’t say what those problems might be because problems that are not yet known are “unknown risks” by definition. Fortunately, smart contract risk can be insured against through products offered by Nexus Mutual.
#2 Risk of UST losing its peg against the dollar
UST is an algorithmic stable coin not backed by real dollars. While I personally believe that the incentives around its design will allow it to maintain its peg, there have been instances where it has been valued above and below the dollar.
UST loss 5% against the dollar during the recent May crash but regained its peg a few days later. Insurance providers like Unslashed Finance can insure against this risk.
How to get started
Saving your savings can be done directly on Anchor or through the use of third-party applications that integrates the Anchor protocol.
#1 Directly using Anchor
You can purchase LUNA from centralized exchanges like Binance, Crypto.com, and KuCoin. You can then transfer this to a Terra wallet created through the network’s browser extension or desktop application.
LUNA can then be swapped for UST. If you prefer it, UST can also be purchased directly via KuCoin. These will be used to fund your deposit.
You can access the website and its application through this link.
Once there, press the “connect wallet” button on the top right, and the rest is fairly straightforward. If this is your first time interacting with a decentralized application, please note that every action on the protocol will be charged a small transaction fee.
#2 Third-party applications
Anchor’s attractive yields can easily be integrated into third-party applications. If you aren’t comfortable jumping into decentralized finance yourself, services like Yotta might be more suitable for you.
Just download the application, fill up its KYC, and you’re good to go with them. Please note that the yield they offer is only 8%, which is significantly higher than the average savings account but is also quite less than the yield offered directly by Anchor.
More third-party applications like Yotta are coming in the future. Here are some to look out for:
