Anchor’s Dynamic Earn Rate Explained
NOTE: Anchor Protocol is no longer live following the depeg of UST in May 2022. Adaptations are being made to accommodate this change.
The Anchor Earn rate has been steadily paying out ~20% APY on UST deposits for just over a year (happy belated 1st birthday, Anchor!)
It’s hard to believe that a stablecoin deposit could yield ~20% APY and maintain that rate for over a year. Since Neptune Vaults are built using the backend of Anchor, we shared an article explaining the growing imbalance of new deposits to new borrows in Can Anchor Maintain Its 19.5% Interest Rate?
In that post we determined the following:
“There is an imbalance that is resulting in a reserve drain of $1,347,600,000 per year, or ~$3,692,000 per day. With the current yield reserve sitting at $455.5m, this means at the current rates, the reserve will be drained entirely in just over 123 days, or ~4 months.” (source)
Now the jig is up and Anchor is making strides to change from a fixed target Earn rate at 19.5%, to a dynamic rate that will fluctuate based on withdrawals and deposits in the Yield Reserve. This is far more sustainable and creates a gradual drawdown, rather than one that continues to accelerate as new deposits exceed new borrows.
The dynamic rate is modeled as a simple equation based on an increase or decrease to the Yield Reserve
The percentage change in Anchor’s deposit rate will increase or decrease to a maximum of 1.5%, or 150 basis points, per month. If the Yield Reserve goes up, the deposit rate will increase 1.5%. If the Yield Reserve goes down, the deposit rate will decrease by 1.5%.
So given the current Yield Reserve is steadily decreasing and the current deposit rate is 19.5% APY, then for the following month, the rate would be 18% (19.5% - 1.5%).
18% would be the new Anchor Earn rate for the next month and if the Yield Reserve continued to decrease in that month, then it would decrease by another 1.5% to 16.5% for the following month.
This is great for adding a sustainability mechanic to the reserve fund, but ultimately, this still results in the Yield Reserve being drained because the reserve is draining by over 25% per month! A 1.5% change each month does little to prevent the reserve from draining.
Although it’s a step in the right direction, this will not be enough to stop the Yield Reserve from hitting zero. To prevent a full drain on the reserve, we must expect one of two things, or both:
- Anchor has a plan to obtain a large amount of borrows
- The Yield Reserve will receive another injection of capital
So, what is needed to prevent the Yield Reserve from draining?
We expect that attracting more borrows on Anchor has been a goal from the beginning. We are not sure whether new borrows will ever outpace new deposits with the Earn rate near 20% APY. The ratio of deposits to borrows is currently 4.12, up +0.29 from the time of writing our previous article only two weeks ago when the ratio was 3.83. If we consider a ratio close to 1.25 as balanced, then the current deposit-to-borrow ratio is moving in the wrong direction very quickly.
So, if attracting enough borrows to balance out the deposit-to-borrow ratio is unfeasible in the short term, then there is only one solution left.
We expect the Luna Foundation Guard (LFG) to, yet again, bail out the Yield Reserve.
With poll 20 locking in a dynamic earn rate, it would be reasonable to assume that the Luna Foundation Guard (LFG) is going to buy more time by injecting additional capital into the reserve and allow the 1.5% monthly change to gradually pull the rate down to a more reasonable level. If we assume the deposit-to-borrow ratio remains constant, then we can expect a ~$400 million donation from LFG to keep the reserve from running dry over the next year and perhaps indefinitely.
These assumptions are made because, with an extra ~400 million, this provides enough time for the rate to drop to levels close to 6% within one year and, if the deposit-to-borrow ratio remained stable, it would find a lower bound to its equilibrium somewhere between 6% and 7.5%.
On its way down, it is expected that the ratio of new deposits to borrows would decrease, thus reducing the strain on the yield reserve.
Additionally, as UST and other Terra stablecoins gain traction and are used with other protocols, it will increase the market size for UST borrows, and therefore help balance out the deposit-to-borrow ratio and further reduce the strain on the yield reserve. This could be amplified by the addition of new collateral types such as adding sAVAX to Terra.
Between these two mechanisms we can roughly calculate that ~$400 million added to the Yield Reserve could prevent the reserve from going to zero and allow for a gradual drawdown of 1.5% each month until equilibrium is reached.
If the deposit-to-borrow ratio approaches 1.25 before the earn rate drops to 6%, then we can expect the earn rate to remain higher than 6%. This is all assuming that the deposit-to-borrow ratio remains the same or goes lower. If the ratio continues in its lopsided direction despite a lower anchor earn rate, then the expected donation from LFG would have to increase.
What is the end goal for the Luna Foundation Guard and Anchor Protocol?
The introduction of Anchor’s 20% earn rate on UST deposits was to increase the adoption of UST. Given that we are above $17b in total locked value (TLV) compared to ~$100 million just one year ago, it is safe to say it was successful.
Anchor now needs more borrows, preferably from sources that use leverage, such as How Neptune Finance Can Help Solve Anchor’s Problem, and more adoption for UST.
The more that UST is adopted outside of Anchor, the more stable the UST economy will become, and consequently, we will see the price of Luna continue to rise as a result.
What does this all mean for the price of Luna? Read our next article —The Demand for UST & Luna Part 1: Macroeconomic Principles.
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