The kind of innovation Decentralized Finance (DeFi) has brought to the table with its financial products has been nothing short of amazing. Not only has it been great in terms of quality but also in terms of quantity—with more products hitting the market every single day.
But in all of its greatness, DeFi has failed to provide us with a safe and simple savings product—one that can fit the needs of the masses. Since most of the assets in the crypto domain suffer from price volatility, staking any asset is something most people aren’t comfortable with.
Then there’s the fact that even stable coins aren’t all that stable. During the pandemic, DAI rose to $1.50 even though it was supposed to mimic the US Dollar. Now, you might wonder why that would be a problem. It is a problem since the interest rates would fluctuate too. If they don’t, you would end up having to pay considerably more than what you borrowed.
Imagine borrowing 10,000 DAI thinking you’re borrowing $10,000 but then having to pay back $15,000 just because DAI was trading at $1.50 when it was time for you to repay your loan.
This makes most crypto assets unsuitable for household savings products and that is what Anchor aims to fight. So, without further ado, let’s get right into what Anchor is!
What is the Anchor Protocol?
The Anchor protocol is a savings protocol built on the Terra blockchain. The protocol offers users a stable coin savings product that is capable of providing a stable interest rate to the depositors.
New DeFi applications have been launching day after day to cover a wide range of use cases, including collateralized lending (a great example for which would be Compound), decentralized exchanges (Uniswap is the first that comes to mind for this), and prediction markets (like the renowned platform Augur).
But despite the meteoric rise, DeFi has failed to produce a savings product with mass appeal that is simple, convenient, and robust. And that is exactly where the Anchor protocol comes in with its principal-protected stable coin savings product.
How it does that is something we’ll discuss in detail later, but for now, all you need to know is that it uses the block rewards that accrue on the assets you provide them for borrowing the stablecoins.
What this means is that when you submit some assets in return for the stablecoins you’re borrowing, those assets don’t sit idle. Instead, the block rewards that are gained on those assets are used by the company to provide you with a stable interest rate.
This helps the protocol deliver the benchmark interest rates. DeFi is famous for using the yield of the most in-demand PoS blockchains. The team behind the Anchor protocol aims for it to become the gold standard for generating passive income on the blockchain.
The savings protocol allows for instant withdrawals done on your account, pays low-volatility interests to the depositors, and accepts Terra (LUNA). The last one is kind of obvious given the fact that the platform is built on the Terra blockchain. Nevertheless, it doesn’t hurt to know that.
How does the Anchor protocol generate yield?
The protocol lends deposits to borrowers who, as collateral (bAssets, which we’ll talk about pretty soon), give their liquid-staked Proof of Stake assets that they have from major blockchains.
Now, from this collateral, the protocol takes a variable fraction of the yield generated by the bAsset. This is then offered to the depositor as the interest, thus guaranteeing a stable interest rate. So your rate of interest is actually ensured through your own collateral that is worked on with the help of third-party arbitrageurs and liquidation contracts.
As you can see, it is a pretty good recipe for a savings product that can have a broad appeal. And that is exactly what the team was aiming at. It isn’t just a DeFi investment vehicle with a low-volatility yield. It is a system that empowers the average investor with a single, reliable return rate across all of the blockchains they have made their investments on.
And let’s face it, such a product is much needed. With so many staking products up in the market, each having its own terms and yields – DeFi is practically inaccessible to the average investor. This makes DeFi quite unappealing for them – and Anchor the best product.
What are bAssets on Anchor?
For delivering the interest rates Anchor promises, it uses bonded assets or bAssets in short. These assets are basically just tokens representing the ownership of staked Proof of Stake assets.
It is these assets that, much like they would if you held on to them, would pay you back block rewards. Or in this case, they would pay the block rewards to the platform holding them, which is Anchor.
The best part of bAssets is the fact that they’re fungible and you can transfer them – something that isn’t possible with the staked assets. So you can transfer them whenever you feel the need to with quite an ease.
What this means for you, as an investor, is that you can maintain the fungibility and liquidity of your staked assets. And at the same time, you would be able to earn block rewards from your assets.
Taking things to another level is the fact that bAssets can be generated on virtually any Proof of Stake blockchain that has the support for smart contracts.
There’s more to it but as an investor, it wouldn’t really matter to you. It is only if you’re a developer that you would be interested in the intricacies that make bAssets function the way they do. And for that, you can always head over to the website and go through their documents.
What is the Terra Money Market?
Terra money market is a Web Assembly (WASM) smart contract built on the Terra blockchain that allows for depositing and borrowing of Terra-based stable coins to happen. This money market makes up the core building block of the savings protocol Anchor is offering.
It is basically a pool of different Terra deposits that are earning interest from those who borrow from it. That is of course through the digital assets the borrowers put down as collateral against which they borrow Terra.
An algorithm determines the interest rate as a function of supply and demand, which is encoded using the pool’s utilization ratio. The utilization ratio is just a fancy way of talking about the fraction of Terra borrowed from the pool, just in case you were wondering.
Pretty straightforward, right? It’s just like locking up collateral in banks to get a loan. And just like the bank would do some calculations to decide how much loan you’re eligible for, the platform does the same. The platform determines your borrowing capacity with the help of the quality and amount of the collateral you have locked in.
Anchor comes up with a loan-to-value ratio (popularly called LTV by financial vehicles) for each collateral type. This ratio tells the platform how much of the asset’s value can actually contribute to your borrowing capacity.
The details for this too can be found on the website in case you wish to go through it. I personally find it too technical for my non-finance-oriented brain but those of you who are actually serious about taking a loan from Anchor should consider checking it out.
You would also find out—in great detail—how the platform calculates the rate of interest algorithmically and ensures that the interest rate stays stable in the documentation present on the website. I could get into the details about that out here, since I have quite an interest in mathematics, but most of you reading this are probably just scouting if the platform is any good. And I’m quite certain you won’t be into these details.
Nevertheless, if you are interested in knowing more, be sure to check the documentation present on the website. It would answer just about any question that would pop into your mind.
Before you go…
The Anchor protocol is bringing a much-needed stable savings solution to the DeFi space. And by the looks of it, they’re doing a pretty good job at it. Everything is well thought out and that is something you can see when you go through their whitepaper. Which is something I would highly recommend everyone to do before deciding to put any money into it.
Given the fact that the DeFi space is still growing and drawing more people in, this is perhaps the perfect time for such a solution to be introduced.
The team behind the Anchor protocol aims for it to become the gold standard for generating passive income on the blockchain. Whether it is able to achieve this aim or not is something time will tell. Until then, all we can do is keep an eye on the platform and see how it goes.