Terra Founder Discusses Plan to Tackle Anchor’s Declining Reserves as LUNA Tumbles 20%

Do Kwon, co-founder and chief executive officer of Terraform Labs, laid out a series of measures on Jan. 28 to tackle the issue of depleting reserves on Anchor, the lending and borrowing DeFi protocol built on the Terra blockchain.

Anchor pays around 20% interest on deposits of UST, the U.S. dollar-pegged stablecoin native to Terra. The rate, known as “anchor rate”, is fixed, and significantly higher compared to what other industry peers currently offer – anything between 0% to 8.5%, according to defirate.com.

The protocol is able to pay this high rate from interest charged on loans, liquidation fees and yield earned from borrowers’ collateral. But as crypto markets crashed, borrowers have been in short supply, and so Anchor has started to dip into its reserves – a form of savings account – in order to sustain its so-called “anchor rate”, built to become an industry benchmark.

According to Mirror Tracker, Anchor’s reserves have slumped 55% from $70 million on Dec. 29 to $31 million on Jan. 29. On the average, reserves have been falling by about $1.3 million per day over the past four weeks. With demand for new loans waning, users are worried that the Anchor Yield Reserve could be depleted within weeks in the absence of a cash injection.

LUNA, the native token of the Terra ecosystem, tanked more than 20% to $48 on Jan. 28, as effects of the Wonderland scandal rippled through the entire decentralized finance (Defi) industry, causing UST to momentarily lose its peg. At Press time, LUNA is down 4.3% at $50.47 over the previous 24 hours, and more than 51% off its all-time-high of $103.

“It’s impossible to predict what will be the final straw that causes people to flee UST, but I do think what has been going on over the last few days is causing some people to re-evaluate,” said crypto analyst Freddie Reynolds, in a tweet.

Kwon promises cash injection to boost reserves

Do Kwon, the CEO of Terraform Labs, the South Korean entity behind Anchor, noted how “deposits have gone up a lot and borrowing down”, but stressed this was not a cause for concern. Kwon said the reserve mechanism is working exactly as it should during bear markets, when demand for loans slows down – it maintains stability.

In the event that the “yield reserve depletes, Anchor will just operate like regular [Defi] money market,” stated Kwon, adding:

If we were to get to this hypothetical situation, Anchor will still offer the highest return [15% to 16%] on stablecoins. By far. It will be fine. In the meanwhile, I am resolved to find ways of subsidizing the yield reserve. Anchor is still in the growth phase, and maintaining the most attractive yield in DeFi stable will strengthen that growth and build up moats.

Terraform Labs injected around 70 million UST into the Anchor Yield Reserve in May last year amid a market-wide decline. At the time, UST dropped below its peg to the U.S.dollar to about $0.93, creating a lot of arbitrage opportunities. LUNA crashed as traders feared a collapse of the Terra ecosystem.

Long-term, Kwon plans to narrow the gap in between deposits and borrows by “adding more staking collateral”. Instead of forced bridging, he intends to deploy Anchor to users on other blockchains such as Avalanche, where “users want to borrow natively instead of having to bridge and set up new key management structures”.

“Goal is to drop LUNA dominance in anchor collateral under 40% by growing adoption of other assets – should grow utilization rate,” Kwon explained.

What is the Anchor Protocol?

Anchor is a savings protocol that pays depositors of the Terra stablecoin, UST, a fixed yield of roughly 20%. The deposits are lent out to borrowers, who lock proof-of-stake assets such as bonded luna (bLUNA) or bonded ethereum (bETH) as collateral. As borrowing demand rises, so do interest rates. Staked earnings from borrowers’ collateral are paid to lenders as yield.

Sometimes Anchor generates more money from returns on interest and collateral yield, and from liquidation fees, than is needed to pay depositors. It puts away the surplus into the Anchor Yield Reserve. Whenever there is not enough money from the revenue pool to pay depositors at the agreed “anchor rate”, Anchor taps the reserve.

However, there is no incentive for borrowers to get loans when markets are in decline. More people tend to move into stablecoins at such times, preferring instead to park their money into an interest-bearing savings product. Anchor needs that demand for both deposits and borrows move in tandem to prevent any imbalance between the two, as is currently the case.

As at Jan. 30, $5.09 billion was deposited into the Anchor savings account compared to over $1.28 billion borrowed, according to data from Anchor Protocol. That’s an imbalance of more than 290%. In addition, the ripple effects of the Wonderland scandal have spread across the Defi sector to include Abracadabra Money, one of the key sources of yield on Anchor.

The Daniele Sestagalli-founded lending protocol, which has driven up to 25% of demand for deposits on Anchor, according to reports, took a hit, as panicky liquidity providers withdrew more than $2 billion from pools that supported the MIM stablecoin, a key liquid token for farming in decentralized finance.

“The Abracadabra protocol allows users to deposit UST to borrow MIM and automatically exchange MIM for UST. The UST mechanism determines that the price of Luna is linked to the total amount of UST locked. So the problem of MIM poses a danger to Terra’s ecology,” said Chinese blogger known as Wu Blockchain.

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