A brief analysis of the working mechanism of the DeFi Anchor Protocol

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Terra’s stock synthetic asset project Mirror Protocol is one of the most popular projects on the market recently. Another product Anchor Protocol developed by this team is also worthy of attention.

Written by: LeftOfCenter

At present, the interest rate calculation method of most DeFi lending agreements on the market is based on the algorithm of supply and demand to determine the lending rate. Specifically, the interest rate paid or earned by the lender and the borrower in the lending agreement is a function of the “fund utilization rate”, which will lead to large changes in interest rates and is very sensitive to market cycles. The direct consequence is to discourage people who have never participated in centralized finance in the past, which is not conducive to the large-scale adoption of DeFi.

To this end, Anchor Protocol has proposed a new type of deposit interest calculation model that can provide a stable borrowing interest rate. So, what exactly is Anchor Protocol? What is the realization principle? How stable is the Anchor Protocol, which is known as a fixed interest rate agreement?

In this model, the interest rate calculation method is no longer based on the “fund utilization rate”, but is highly correlated with the price trend of ETH. In the assumption of the model, once the price of ETH increases, the demand for long positions in the market will increase, and stable currency borrowing will increase accordingly. If the price of ETH falls, the demand for leverage in the market decreases, and the ETH debt position is liquidated, stable currency borrowings will decrease.

What is Anchor Protocol?

Anchor Protocol hopes to become the reference interest rate or the savings version of Stripe for the entire blockchain market, and hopes to provide stable interest rate gains for cryptocurrency holders to promote the mainstream adoption of DeFi.

Anchor Protocol is created based on the stablecoin project Terra Money. It is a new type of savings protocol that aims to balance interest rates by coordinating block rewards from multiple different PoS consensus blockchains, and ultimately achieve a stable yield of storage interest rates.

Implementation principle

So, how does Anchor Protocol achieve stable interest rate gains for crypto depositors?

In the Anchor Protocol system, there is a currency market, which is actually a Terra stable currency UST asset pool, and depositors deposit UST in this pool to obtain stable UST interest rate income. The lender can mortgage the basic asset tokens of various PoS consensus blockchain protocols, lend the Terra stable currency UST, and pay the borrowing interest denominated in Terra stable currency UST. At this time, the system will determine the lending rate based on the algorithm of supply and demand.

Since the market supply and demand relationship is fluctuating, and the changes are even greater in the cryptocurrency market, it is impossible to maintain a stable interest rate in this way. So, how does Anchor Protocol achieve stable storage interest rate gains?

In fact, the interest income of depositors consists of two parts. One is the borrowing interest denominated in stable currency UST paid by the borrower. The interest rate is based on the dynamic changes of market supply and demand and is therefore unstable. In order to maintain stability, Anchor Protocol Another source of income is introduced into the system, that is, the block reward earned by the encrypted assets mortgaged by the lender, and the reward income is dynamically adjusted to the borrower and lender to achieve the anchor rate (Anchor Rate).

The Anchor Protocol wants to converge the deposit interest rate of depositors to a relatively stable value, which is called the anchor rate. The goal of the Anchor Protocol is to bring the deposit rate infinitely close to the anchor rate.

In fact, when the lender mortgages encrypted assets in the currency market and lends the stable currency UST, Anchor Protocol will generate the asset bAsset. bAsset represents the tokens owned by the pledger of various PoS assets. Like basic assets, bAsset is also The holder provides block rewards. But unlike most mortgaged assets, bAssets can be transferred and replaced, which means that bAsset will have greater liquidity.

In order to maintain stable storage interest rate gains, Anchor Protocol will automatically distribute the block rewards earned by mortgage assets bAsset to borrowers and lenders, and dynamically adjust the distribution ratio of the two based on the current interest rate changes, so as to stabilize the deposit interest rate to Infinitely close to the Anchor Rate.

For example, assuming that the current deposit interest rate is lower than the anchor interest rate, at this time, Anchor Protocol will automatically adjust the distribution ratio of block rewards and distribute more income streams to depositors. On the contrary, if the deposit interest rate exceeds the anchor interest rate, Anchor Protocol will distribute more block rewards to the borrower, thereby reducing the deposit interest rate.

In short, when the deposit rate is lower than the anchor rate, the block reward will be more distributed to depositors. On the contrary, when the deposit interest rate exceeds the interest rate, the yield will be more distributed to borrowers to reduce the contribution of the block reward to the deposit interest rate.

How stable is it?

So, can this realization method provide a more stable interest rate?

The Anchor Protocol wants to converge the deposit interest rate of depositors to a relatively stable value, which is called the anchor rate.

In fact, the income of the anchor interest rate comes from the block reward rate of multiple blockchains, and its goal is to reflect the income source more favored by the market. The advantage of this model is that as the market’s preference for reward accumulation tokens changes, the composition of collateral assets supported by Anchor Protocol will also change.

This means that the composition of the mortgage assets that determine the anchor interest rate is dynamically changing, and the anchor interest rate is always linked to the agreement with the highest reward yield currently on the market.

The anchor interest rate generated by this model will be much more stable than an agreement linked to any single source of income or a package of multiple fixed returns.

Reference link

https://twitter.com/tansawit/status/1357693218909868032

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