20% Fixed Returns on Your Savings!! But Can We Do Better Than That?

Hi there!

Interest in the Terra ecosystem seems to be blowing up of late, particularly in Anchor Protocol, a savings protocol that claims to offer a stable interest rate of 20% on your deposits!

In this guide, I’ll briefly introduce the Terra ecosystem and Anchor Protocol, as well as share different strategies (low risk and high risk) that you can implement to maximise your gains!

*Disclaimer: All material presented here is not meant to be financial advice. Please do your own due diligence before investing in anything.

**To LUNAtics: Sorry for the alpha leak lol

Terra Ecosystem

There are 2 main cryptocurrencies residing in the Terra ecosystem. LUNA is Terra’s native token, while UST is Terra’s non-collateralised, algorithmic stablecoin that achieves its peg through market-efficient arbitrageurs. UST is fully decentralized and interoperable with other Tendermint-based blockchains built using the Cosmos SDK that enforces the standardized Inter Blockchain Communication (IBC) protocol.

In layman’s terms, UST is a stablecoin with no fiat backing and can be used across other blockchains. UST aims to be pegged to 1USD by burning/minting $1 worth of LUNA to mint/burn 1 UST.

If there is demand for UST and the price of UST exceeds 1USD, arbitrageurs can burn $1 worth of LUNA to mint 1 UST, which can be sold at the open market for a profit.

Conversely, if demand for UST falls and the price of UST falls below 1USD, arbitrageurs can buy UST at the open market and profit by minting $1 worth of LUNA.

In even more layman’s terms, this just implies that if demand for UST increases, the supply of LUNA falls, potentially pushing the price of LUNA up. But if demand for UST decreases, the supply of LUNA expands and pressures the price of LUNA down.

Anchor Protocol

Anchor is a platform that allows savings and borrowings, much like a bank.

For UST deposits, the interest rate aims to be fixed at around 20%.

Borrowing UST incurs an interest rate of 15% as of today, but Anchor is distributing ANC rewards for borrowers to incentivise borrowing, and the distribution rate of ANC is 110%. As such, you’re currently being paid 110% - 15% = 95% to borrow UST on Anchor.

There are 3 main strategies to yield farm on Anchor.

Option A – Lower Risk

This is pretty obvious. All you gotta do is simply deposit UST on Anchor. But first, you’ll need to download the TerraStation wallet here. Once you’re done, there are 2 main ways to fund your wallet with UST.

Method 1: Open an account with a crypto exchange that supports UST (Kucoin, Bittrex, Bitfinex). Fund your account by transferring your existing crypto holdings and swap them for UST. Transfer UST to TerraStation Wallet.

Method 2: If you have Binance, buy LUNA on Binance and withdraw to TerraStation Wallet. Go to https://app.terraswap.io/#Swap to swap LUNA to UST.

Once you have UST, under the Earn tab, deposit your UST to enjoy 20% APY!!

Option B – Higher Risk

For this strategy, we shall play both sides of the Anchor protocol.

To borrow on Anchor, you’ll need collateral in the form of bonded Luna (bLuna) tokens. Go to https://app.terraswap.io/#Swap to swap your LUNA to bLUNA. Provide bLUNA as collateral under the Borrow tab.

For the sake of depositor’s principal protection, over-collateralization is practised. So, given an amount of collateral, you are only allowed to borrow up to 50% worth of UST.

To give some leeway in the fluctuation of prices, Anchor deems 35% loan-to-value (LTV) a safe amount, but as a kiasu Singaporean, I shall keep my LTV ratio to 25%.

Hypothetically, this means that with collateral of 10k, I’m only borrowing 2.5k, and I will only be liquidated if my collateral goes under 5k.

Once you’ve borrowed the UST, you can then deposit under the Earn tab and accrue a 20% interest comfortably.

If you do the math and assume a 25% LTV, you’ll end up with an annual yield of 26.25%. It’s not that much higher than Option A, but that’s because my 25% LTV is rather conservative. If you choose to borrow more, your rewards will increase accordingly.

In addition, Option A is a stablecoin play, whereas Option B gives your portfolio exposure to LUNA and ANC tokens. If you’re bullish on LUNA and ANC and willing to take some risk, Option B would be a great choice.

Option C – Higher Risk

This option is a more complex play for pure Terra/LUNA bulls out there. For those who have farmed on AAVE before, I’m sure this will be familiar to you.

Essentially, this strategy applies ‘recursive’ thinking to amplify your gains. The gist is as such:

With the following assumptions in play: 10k capital with LTV of 25%, a simple Geometric Progression calculation should result in an annual interest of $2833, which works out to a yield of 28.3%.

Using this method multiplies your portfolio’s exposure to LUNA token. By means of yet another GP calculation, your portfolio would theoretically have a $13.3k exposure to LUNA on the back of a $10k investment.

As such, this method is more suited for LUNA bulls out there as they will stand to gain more if LUNA rises. Conversely, if LUNA were to fall, you would have to fork out more money to repay your loans.

Personal Strategy

After evaluating these options, I have decided to implement Option B as I am bullish on LUNA and willing to take on a little more risk.

I have decided not to opt for the recursive method simply because it’s too mafan to keep borrowing and providing collateral. For those who were previously using this method on AAVE like me, there are some differences to take note of:

1. Terra's transaction fee is higher compared to Polygon's dirt-cheap fees

2. On AAVE, I deposited and borrowed the same token, which meant that I wouldn’t be liquidated because if my collateral falls, my borrowed amount would fall accordingly / if my borrowed amount rises in value, my collateral will rise accordingly. The liquidation threshold was also much higher and I was borrowing over 50% of my collateral each time

3. On AAVE, yield-earning deposits act as collateral, but that’s not the case on Anchor. My bLUNA that acts as collateral is unable to earn yield, so effectively I’ll only be able to play one side of the equation

Due to the reasons above, I’ve decided to keep it simple and go for Option B.

Moving Forward

Many have wondered how Anchor can sustain such a high yield on the deposit interest rates.

Besides funding these payouts with the interest Anchor earns from lending, Anchor primarily earns on the borrowers’ collateral because bonded assets can in fact generate cashflow!

For eg, before taking out a loan, a borrower has to stake bLUNA as collateral and the system is able to delegate the bLUNA to earn delegation rewards. The current staking yield of 8% serves as revenue for Anchor.

Consider this hypothetical scenario:

Alice has 2000 UST and deposits it in Anchor, expecting an annual return of $400 (20% of 2000).

Bob wishes to borrow 2000 UST and assuming the worst-case scenario where Bob is a chad degen, he aims for the maximum 50% LTV by only providing the minimum collateral of 4k worth of bLUNA.

Anchor is able to delegate the 4k worth of bLUNA, earning $320 (8% of 4k) in the process. Anchor is also earning $300 (15% of 2k) on Bob’s borrowed amount. This revenue of $620 far exceeds Alice’s interest of $400.

I hope this example is able to help you better understand the sustainability of the Anchor protocol, but that’s not all!

There are tons of new proposals on Anchor such as a possible increase to 60% max LTV and the acceptance of other bonded assets like bETH, bDOT, bSOL and bATOM as collateral.

These upcoming developments will affect your investment strategy, but more importantly, this will cement the long-term prospects of Anchor.

If you share my conviction in the whole Terra ecosystem (it’s much more than just Anchor!), I hope the strategies in this guide can help you with your yield farming process!

Cheers :)