Will the upcoming Anchor Protocol cause LUNA’s short-term liquidity shortage?

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One view is that the launch of Anchor may trigger a liquidity shortage in LUNA, and in the long run, it will help break the reflexive cycle of bear markets.

Written by: LeftOfCenter

Anchor Protocol, a fixed-rate agreement based on the stablecoin project Terra Money, will be launched at 4pm Beijing time on March 17, 2021. Before going live, Terra Money founder Do Kwon announced via Twitter that Anchor Protocol has just completed a $20 million round of financing, and many important venture capitalists in the crypto industry have participated in the investment.

This long list of investors is the envy of many start-up projects, including Hashed, Galaxy Digital, Pantera Capital, AngelList founder Naval Ravikant, Delphi Digital, Dragonfly Capital, Jump Trading, Alameda Research and more.

In addition, Anchor Protocol also stated that it will publicly sell its governance token “ANC” on the Terraswap, Terra Station and Anchor web pages at a lower price than early investors. According Do Kwon’s statement , ANC early investors to buy tokens for the price of 0.1 US dollars, 6-12 months linear unlocked, and the public sale price is only half of the former, to $ 0.05, and without Lock.

According to the token distribution plan, Anchor Protocol will airdrop 5% of the total supply of ANC tokens to LUNA pledgers-this will not only have a significant impact on the ANC token itself, but also have a significant impact on LUNA.

One of the investors of Anchor Protocol, Delphi Digital, a well-known research institution, conducted research on the economic model of ANC tokens and pointed out:

  • In the short term, the ANC token incentive mechanism will increase the number of LUNA pledges. In addition, up to 20% of the annualized return of UST will also lead to an increase in market demand for UST, which will cause a short-term shortage of LUNA.

  • In the long run, by providing the algorithmic stable currency UST with the risk-free interest rate of cryptocurrencies, Anchor will help break the reflexive cycle that appears in the bear market cycle.

What is Anchor Protocol?

Lianwen once wrote an article ” A Brief Analysis of the Working Mechanism of the DeFi Fixed Deposit Rate Agreement Anchor Protocol “, which introduced the basic principles of the Anchor Protocol.

As shown in the article, Anchor Protocol’s product positioning is to become the reference interest rate or savings version of Stripe for the entire blockchain market, and hopes to provide stable interest rate benefits 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.

The core mechanism of Anchor is to use a money market structure to connect depositors and borrowers. However, contrary to most current currency markets in the crypto industry (such as Aave and Compound), Anchor’s architecture is specifically designed for depositors to provide them with more stable interest rates. In order to achieve this goal, Anchor consists of multiple different components.

Depositors: From the perspective of depositors, the Anchor experience is very simple. The Anchor platform provides stablecoin depositors on the Terra platform with a fixed interest rate called the Anchor interest rate. Initially, the interest rate is set at 20%, which can be adjusted in the future based on governance. For depositors, the attractiveness of this product is obvious. Contrary to the current volatility prevailing in cryptocurrencies, Anchor will become one of the main platforms for predictable passive income.

Borrower: One of the most important design decisions regarding the Anchor currency market is that the agreement only supports blockchain pledged asset derivatives that are consensus on mainstream PoS as collateral assets. The reason is that, as assets that naturally generate income, the rewards generated by these blockchains are more stable and powerful, which can ensure that the Anchor interest rate of depositors is maintained at a certain level.

In the Anchor system, the borrower deposits the pledged derivatives of each blockchain (called bAssets in Anchor) as collateral, and sacrifices the pledge income of the deposited assets in exchange for lending capacity (subsidy interest rate may be 0) and Anchor tokens (ANC) Award. The pledge income generated by these token assets can in turn be used to subsidize the accrued interest of Anchor depositors. Initially, Anchor only accepted bLUNA (representing pledged LUNA tokens) as collateral. Later, it will expand to accept more pledged asset derivatives of mainstream PoS blockchains, including Ethereum, Polkadot, Cosmos and Solana.

Stability mechanism: However, for the above system to work properly, a certain balance must be maintained between depositors and borrowers. Otherwise, two unfavorable situations may arise. The first and most important unfavorable situation is that the pledge income generated by bAssets in the platform is not enough to cover the depositor’s anchor rate, which is the accrued interest. Another situation is that there are too many borrowers on the platform, which means that the borrowers have to pay a higher premium than the service fee. In order to alleviate the possibility of these situations, Anchor introduces a stabilization mechanism, which works as follows:

If the pledge yield (the pledge income generated by the borrower’s mortgage assets) is higher than the target yield (the interest that must be paid to the saver), the following two things will happen:

  1. Part of the excess income will be stored in the “Profit Reserve” at UST
  2. Reduce the borrower’s ANC rewards by 10% per epoch every week

If the pledge income is lower than the target rate of return, two things will happen:

  1. Take out the desired amount from the “Profit Reserve” for replenishment;
  2. Increase the ANC incentives for borrowers, and double every epoch every week until the actual rate of return converges to the target rate of return.

What is the purpose of ANC tokens?

According to the document published by Anchor Protocol, ANC tokens are mainly used for two purposes in the Anchor ecosystem:
Governance: ANC pledgers can use token voting to change relevant parameters in the system (including Anchor interest rates), and can control the community fund pool (accounting for 27.8% of the total ANC supply).

Obtaining repurchase income: Part of the income generated by the pledge of the Anchor platform will be used to purchase ANC tokens on Terraswap, and then distributed to ANC pledgers. This will increase the buying pressure of ANC tokens.

ANC token distribution strategy

The total supply of ANC tokens will be 1 billion, and the distribution method is as follows:

Will the upcoming Anchor Protocol cause LUNA's short-term liquidity shortage?

Will the upcoming Anchor Protocol cause LUNA's short-term liquidity shortage?

Will the upcoming Anchor Protocol cause LUNA's short-term liquidity shortage?

Regarding the distribution mechanism of ANC tokens, the following points are worth noting:

Airdrop: Similar to the Mirror distribution method, 50 million ANC tokens (5% of the total supply) will be airdropped to LUNA pledgers at Genesis.

LUNA pledge reward: A total of 100 million ANC tokens will be distributed to LUNA pledgers in the first two years after the agreement is launched.

Borrower incentives: 100 million ANC tokens are allocated every year to encourage borrowing. This means that 40% of the total supply is earmarked for this purpose to support the stabilization mechanism. It is worth noting that the amount of incentives will vary with the balance between depositors and borrowers.

ANC token liquidity provider: In the first year after the agreement is launched, 5% of the total token supply will be allocated to motivate the liquidity provider of the ANC/UST trading pair on Terraswap.

Community funds: 27.8% of the total supply of ANC is dedicated to community funds, which will provide a lot of resources for community management in the future.

What impact will Anchor have on LUNA?

Yan Liberman, the co-founder of Delphi Digital, a well-known research institution, analyzed the possible impact on the Terra ecosystem and LUNA tokens after the release of Anchor Protocol on his Twitter. It is important to point out that Delphi Digital is one of the investors of Anchor Protocol, but Yan Liberman’s point of view is worth studying.

Yan Liberman pointed out:

  • For Terra, the most interesting point is that new products created based on the Terra ecosystem will add value to LUNA tokens.

  • At least, this trend can be seen, namely 1) Anchor will lead to an increase in the market demand for LUNA tokens; 2) At the same time, it will promote an increase in the market demand for UST, which in turn will lead to a decrease in the supply of LUNA.

Why do you say that?

Anchor will distribute a total of 100 million ANC tokens to LUNA pledgers within 2 years, which is 10% of the total supply. All other things being equal, this will make LUNA tokens more valuable, because it means that LUNA’s mortgage income will increase.

In addition, the case also demonstrates a powerful narrative that, in the long run, projects launched on Terra can benefit LUNA pledgers through pledge rewards. It can be said that LUNA token has become a de facto pass-through token. As long as LUNA is pledged, it has the right to obtain native tokens based on other products built on Terra.

In addition, bLUNA is the only collateral asset initially supported by Anchor and can receive ANC rewards. bLUNA can only use LUNA to create and generate, which will cause speculators to buy LUNA on the market and deposit it in Anchor as collateral, which may lead to LUNA’s supply-side liquidity crisis.

Since 69% of LUNA’s total circulation is currently in pledge state, and it takes 3 weeks to unlock the pledge, this causes the LUNA liquidity crisis to be extremely obvious.

According to statistics from Yan Liberman, there are currently about 138 million LUNA on the market that can be used to mint bLUNA and used as Anchor’s mortgage assets. However, only a small portion (20% to 30%) of them can be purchased on exchanges. Taking into account the limited supply of LUNA and the expected demand growth trend, a supply-side liquidity crisis may occur in the next few weeks.

He also believes that the market demand for UST will also increase dramatically.

At present, USDC, DAI and USDT deposits worth more than 6.5 billion U.S. dollars on the Aave and Compound platforms range from 4 to 14% per annum. In contrast, after the launch of Anchor, the annualized UST savings on the platform is as high as 20%, which is extremely competitive. Considering that the market value of UST is about 1 billion U.S. dollars, even if it only occupies a low share of the current cryptocurrency savings market, it can generate a large amount of UST seigniorage revenue. Since all generated UST seigniorage is used to repurchase LUNA from the market and burn it, the growth of UST seigniorage revenue will be of high value to LUNA.

More importantly, Anchor can be expected in the future and may have an incremental market. Although Anchor is a cold start through the cryptocurrency audience, the future plan of Anchor is to merge into Terra’s e-commerce platform Chai and integrate with more financial technology companies. This means that once Anchor starts to attract more mainstream users, it will have a greater impact on LUNA than the initial stage of the project.

Anchor can also leverage LUNA for long. This will increase market demand for LUNA and UST at the same time. Specifically, users deposit bLUNA on the Anchor platform, lend UST, and repeat this operation many times to buy LUNA, which increases the demand for LUNA.

In addition, users can also deposit bLUNA and lend UST to other protocols in the Terra ecosystem. For example, using UST to mine on Mirror, which will increase the market demand for UST.

Break the reflexive cycle of negative feedback

More interestingly, Yan Liberman believes that Anchor can also alleviate the negative feedback reflexive cycle that may occur in the Terra ecosystem in the bear market.

He believes that since LUNA’s main role in the Terra ecosystem is to absorb the volatility of stablecoins, during an economic downturn, if the demand for stablecoins shrinks too fast, it will have an adverse effect on LUNA.

And this is where Anchor comes in. By providing depositors with a higher fixed interest rate, Anchor has the potential to attract a large amount of deposits during the economic downturn. As investors are eager to hold stable currency positions to seek hedging, the amount of deposits may be higher than during the bull market. As mentioned earlier, since the seigniorage revenue generated by UST will be used to repurchase LUNA tokens from the market and burn them, this additional demand for UST will alleviate the negative impact on the price of LUNA tokens. This means that Anchor has anti-cyclic characteristics and will become a key infrastructure in the Terra ecosystem.