Most DeFi lending and saving protocols (like compound and AAVE) can only offer flexible interest rates that are solely determined by the market needs. However, Anchor Protocol designs a whole new system that can stabilize the interest rate at approximately 20%.

To beat an old crypto saying that says, “If you do not know where the interest comes from, you are the interest.” And to avoid being the interest, I decided to dig up the rabbit hole for Anchor Protocol. Here is what I found about this delicate system.

TL;DR

In a TL; DR version, Anchor Protocol uses the following rule to guarantee the interest rate:

1. The collateral for the Protocol is bToken. Anchor Protocol uses the bToken’s PoS reward rate to set up an Anchor Rate (benchmark interest rate).

2. The bToken reward is the key tool for adjusting the interest rate. When the actual saving rate is higher than Anchor Rate, the interest goes to the borrower. Whereas, if the actual saving rate is lower than Anchor Rate, the interest goes to the lender.

3. The PoS reward of bToken is calculated in $UST, and captures the bull market of $luna and $ETH. That is the key reason for the high saving yield.

4. **Anchor Protocol uses $ANC mining to adjust the borrower behavior. **When the borrowing interest goes up, it decreases the $ANC mining to inhibit the borrowing needs, and vice versa.

5. Anchor Protocol uses protocol fees to buy back $ANC token and redistributes it to maintain sustainable development.

Some Pointers to Note:

• $UST is the USD pledged stable coin in Terra system;

• bToken represent staking token of PoS blockchain and generating PoS reward by itself, powered by Lido;

• Anchor Protocol doesn’t provide $ANC mining to the depositor.

The Secret Weapon: bToken and PoS blockchain

Compared to the traditional saving & lending protocols, Anchor Protocol has three significant differences:

1. Yield focus: the whole Anchor Protocol archives the Anchor Interest and stabilizes it. The Anchor Interest is set by PoS reward interest and decided by the DAO.

2. Yield source: mostly, the interest comes from PoS reward while traditional saving protocol relies on borrowing market.

3. Collateral: Anchor Protocol supports bToken only while traditional saving protocol only accepts large market cap token.

Anchor Protocol has a setup Anchor Rate and the whole design is to make the interest pledge to the Anchor Rate. Currently, the Anchor Rate is 20% and the real interest rate is around 19.5%. To achieve that, Anchor Protocol uses several ways to regulate the borrower and lender behavior.\

The secret weapon: bToken. The bToken is a series of liquid-staked assets powered by Lido. $bLuna represents the staked $luna token in Lido nodes.
When borrowers deposit bToken as a collector, they accumulate block value.

Anchor Protocol will collect those accumulated values and convert them into $UST, then redistribute them. Those rewards are then distributed to the $UST depositor and account for most of the yields. When the yield meets the target line (Anchor Rate) the rest of the interest will be distributed to the borrowers.

In the bull market, this design captures most of the price increases of both $luna and $ETH. However, here comes the question, why would the borrower give up those interests and pay over 20% APY interest to lend out $UST?

Mechanism: Dynamic game and adjustment

Now we are talking about the second weapon of Anchor Protocol — using dynamic liquid mining to adjust the borrower behavior.

The borrowing and saving rate depends on funds utilization. The more people borrow, the higher the rate, and vice versa. So how did Anchor Protocol lure people accept this high-interest rate? Very simple, by — decreasing the actual rate. The real rate for borrowing from Anchor Protocol is -0.93% by the time of writing this article.

Anchor Protocol uses two ways to adjust the real borrowing rate and incentives to the borrowers.First, Anchor Protocol will distribute the excess PoS reward to borrowers, which decreases the borrowing rate. If you look at the upper picture, the borrowing APR is 16.14% while the saving APR is 19.5%.

Second, the Anchor Protocol uses liquid mining to reward and adjust borrowers' behavior. Unlike other protocols, liquid mining is only for borrowers in the Anchor Protocol. If the real yield > Anchor rate, $ANC incentives to borrowers drop by 15% every week to inhibit needs. Otherwise, when real yield < Anchor Rate, the incentives to borrowers increase by 50% every week.

Last, liquid mining will create a huge selling pressure of $ANC token. Whereas a drop in $ANC price increases the real borrowing rate and reduces demand. Therefore, Anchor Protocol implements $ANC buyback and redistributes the protocol fees.

However, there is a potential risk in the high and stable yield in Anchor Protocol, which I will discuss in the next part.

Risks: The unsustainable of bullmarket

Anchor Protocol is a really smart design. However, there are a few critical risks we need to be aware of. The risks I refer to here are not about the contract and ideally will not interfere with the safety of deposits.

Most of the yield is coming from the PoS reward, and those rewards are calculated by $UST, therefore, most of the yields come from the price raise of $luna and $ETH. When the market goes down, the high yield will be unsustainable. This also applied when the $ANC price drops.

Another issue is that the bToken represents the custody and staked tokens managed by Lido. All PoS nodes have the potential risks of being hacked or slashed, and when that happens, it will cause a chain reaction and cause massive liquidation.

Finally, the collateral is limited to $bLuna and $bETH.  This means that the system lacks the ability to resist the black swan from the borrowers' side. However, I am optimistic that the Anchor Protocol will add more collateral in the future.

In a nutshell, the 20% interest return is not sustainable in the bear market. Last but not least, all smart contracts have risks. DeFi is not 100% safe (it can be influenced by a third-party service like the slashed).

This article is originally published in The Microcosm Idea by Runchen. If you like this article, you could subscribe to my bi-weekly update by email.

Another article you might be interested in:

The AAVE team is proposing a more decentralized and interoperable lending protocol AAVE V3 into the market. AAVE V3 is enabled for cross-chain interoperability and will become the new era of cross-chain-as-service (CaaS).

Check out the full article here: https://www.themicrocosmidea.net/new-era-of-cross-chain-as-service-caas-learning-from-aave-v3/

During V3, the team is proposing a more decentralized and more interoperable lending protocol. In this new protocol, AAVE V3 is enabled for cross-chain interoperability by its new feature called portal and prepare for open to all kinds of assets.

More importantly, for the Defi community, AAVE V3 is pointing to a new era where the application is eating infrastructure. In the next shifting, giant applications (like AAVE) do not belong to any ecosystem, they’re interoperable and cross-chain.

AAVE V3: build-in interoperability

In this V3 upgrade, AAVE introduced serval new features including high-efficiency mode (eMode), cross-chain interoperability (portal), and new risk management parameters.

I would like to have a brief introduction about what’s new in AAVE and save more paragraphs for my statement in the next part. For details upgrade, please refer to AAVE’s forum. Link: https://governance.aave.com/t/introducing-aave-v3/6035

The innovation of AAVE V3 is mostly prepared for the multi-chain universe and a more open lending protocol. I will explain both of them in this article.

For the multi-chain universe, AAVE V3 introduces two new features: Portal and High-Efficiency Mode (eMode).

1. Portal. Portal allows a user to move their assets seamlessly by burning a token on the A-chain (e.g. Ethereum) and minting a new token in B-chain (e.g. Avalanche). In the past, users must redeem the assets in one chain and use the cross-chain bridge to transfer the token, they deposit again.

2. e-Mode: Users can utilize e-Mode to optimize their capital efficiency in correlative assets (such as WBTC, renBTC, tBTC, and pBTC). When a user is borrowed in a correlative category with a collateral factor of greater than 95%, the liquidation penalty is only 1%. This function isn't yet multi-chain compatible, but I am confident that it will be in the future.

We all know that the same assets can have different yields in different chains. AAVE itself is a good example, the supply rate of USDC can be different in multi chains.

The AVAVE V3 is a powerful instrument for cross-chain arbitrageurs. As a result, we may anticipate lower interest and borrowing costs in different chains with the introduction of Portal and eMode.

V3 is also trying to solve another question of lending protocol — how to enable more assets. Currently, AAVE (and most lending protocols) only support carefully selected assets to avoid the potential risks.

But in this new product, AAVE V3 is preparing to support more assets. Firstly, V3 introduces “isolation mode” where the risks of one asset are isolated and will not impact the overall. Then V3 proposed a new connect called “Assist Listing Admins” which allows the government to grant the specific entity to implement new assets without the on-chain vote.

The Ethereum community is currently the main source of AAVE, therefore the DAO is more difficult to comprehend than to accept novel assets on another chain. However, during V3, a new risk management system and representative democracy are prepared to embrace additional innovative assets.

Cross-chain-as-service (CaaS)

More importantly, the core value of this upgrade, I called it “cross-chain-as-service (CasS)”. In the past few years, when we are talking about AAVE, we are talking about the biggest lending protocol in Ethereum.

But in the next few years, when we are talking about AAVE, it will be the giant application building on top of the blockchain. As for which blockchain, that wouldn’t be important anymore.

Blockchain will be just like the traditional Internet, it’s not important if it’s building on AWS or Google Cloud, it’s also not important if your mobile carrier is EE or O3. More significantly, it's the app you select from your phone that matters.

The wind at night moisturizes things in silence, according to Chinese folklore. When the blockchain goes quiet means that the infrastructure is finally ready for the ecosystem.

AAVE is not the only application that uses multi-chain-as-service (MasS), it’s a trend in the whole blockchain world. Defi protocols are migrating across chains, wallets are multi-chain supported. Some game-changer, like Zecrey, are building the aggregator of layer 2, where the user doesn’t need to understand what is Layer 2.

2021 is the year of Defi and the year of a public blockchain. But 2022, multi-chain-as-service will be accustomed. At that moment, every blockchain must establish its place (particularly for those EVM side-chain), or else it will just be an app's add-on.

Application is thriving

Uniswap V3 has introduced five months ago (March 2021). With several new features, it is now more flexible and efficient than ever before. Thousands of words are insufficient to describe the changes; the team dubbed them "the most adaptable and efficient AMM ever created."

However, after the criticism comes, Uniswap V3 is difficult to understand. In the previous version, anyone could simply offer liquidity in Uniswap; however, in V3, it's a learned skill. It has become a competition among professional players.

But don't be concerned; you'll find loads of applications extending Uniswap V3 and attempting to address its issues soon. A new initiative called Themis, for example, can provide further liquidity for the NFT on Uniswap V3. And I'm sure that some of Defi's structure products are diminishing the barrier too.

We'll probably be talking about the ecosystem in years to come, not Ethereum or Solana. We're discussing an ecosystem comprised of enormous apps.

That giant application (like AAVE and Uniswap) will become the new layer 1 while the new Defi and metaverse application can plugin and access their service.

It's time to make a change.

In short, the metaverse is an entirely new media format--one that is likely to consume everybody’s free time, much the same way that social media has.

Every time a new technology emerges, it re-shuffles the cards and changes the game. Similarly, those who do not adapt to this new reality will be left behind.

For the large tech giants, the metaverse is not merely a possible future outcome; it is a requirement for their survival.

Especially for Facebook, the metaverse will unlock a whole new experience of virtual social worlds where users transact and utilize NFTs to confer social currency and wealth, rather than luxury handbags or sneakers. Instead of their real-world hobbies, they will gather in the metaverse to discuss their hobbies there. But Facebook, is based on a real life social network, which is why they are starting to panic.

The greatest of Facebook’s attributes is its ability to evolve and adapt quickly-- like how they acquired both WhatsApp and Instagram before they achieved peak popularity. But this time, Facebook cannot just buy a metaverse to survive, so it has to build its own.

I predict that the metaverse is where everyone will interact in the coming years. It will consume everything just like TikTok has.

Metaverses are made up of three components: infrastructure, economy and contents. For most of us, we can understand the metaverse as the sum of its contents.

Let me take TikTok as an example to explain this how the contents will be the substance of the metaverse:

In the case of TikTok, Infrastructure meant the platform, the 4G / 5G cellular and mobile devices that enable the ability for short videos to be shared from person to person. And, also these devices included high-resolution cameras. These become the indispensable INFRASTRUCTURE which enabled the new TikTok paradigm

An economy needs a system, a circle to share value. In TikTok’s economic system, it’s quite easy: user/consumers spend their attention and watch advertisements. Advertisers pay for the attention, creators benefit from the advertising spend, so TikTok is a fully operational and self-sustaining economy. More users = more advertisers = more creators and then the flywheel keeps spinning.

So, what lures the end-user? The answer is content; every short video either you like or dislike, either because it’s funny or inscrutably weird forms the basis of content. And that content is what is attracting and retaining users.

It’s important that every metaverse industry player understands from the user standpoint that the metaverse is all about content. It is a world where content is shared, in a global open competitive market. And that content and its quality is the most important thing.

The metaverse is a game-changer, just like TikTok. In TikTok, most of the older giants failed to compete; they were too slow to embrace the new media format. This will also happen in the metaverse.

My parting advice is both for the people inside and outside this industry. The metaverse will create prosperity for content creators, and it will definitelyshuffle the cards and incubate new opportunities. The big question is exactly how this change will occur and what it will look like.

But what I am absolutely certain of is that it will dramatically change the market.

Special thanks to Janine Yorio from Republic Realm.