Since the crashening, the UST Borrowed on Anchor fell nearly 80% peak-to-trough. While demand for borrow has since recovered, it has not outpaced the unabated growth in Deposits. As a result, utilization (the percentage of deposits lent to borrowers) remains stubbornly low in the mid-30s.
The resulting mix of assets (Borrow) and liabilities (Deposit) has pushed Anchor into a negative net interest margin. The yields on collateral, a function of LUNA price, and the interest from loans are not enough to cover the interest owed to depositors.
The deficit is being paid out of Anchor’s reserves, which have ~4 million UST at the time of writing and declining $13k per day. At current levels, there is no emergency with the reserve. However, the level of cash burn is sensitive to:
- the price of LUNA and;
- the utilization ratio
These two are positively correlated, given the reflexive nature of crypto asset prices and volumes. As the price of LUNA goes up, borrowers feel more comfortable taking risks and vice versa. As such, until some changes are implemented, the fate of Anchor’s reserve largely depends on the price of LUNA.
Consider the impact of a 20% drop in the price of LUNA to 4.88. Assuming the same utilization ratio, Anchor’s reserves would run out in 4 months. Conversely, if LUNA went up by 20% to 7.32 with the same utilization ratio, Anchor would generate $8k per day of cash flow. In all of these cases, I assume a 9.5% yield on bLuna collateral.
|Scenario||Price of LUNA||Utilization Ratio||Depositor APR||Daily Cashflow (burn)||Months until reserves reach 0|
This is an untenable position. The difference between 4 months to live and self-funding is a 20% swing in the price of a volatile asset. After discussing the issue, the Anchor community decided to wait until the Anchor reserves hit 3 million UST to take action. However, we’d like to put a plan in place in case we need it.
There are several long-term fixes for the root cause of these issues (more diverse collateral, more competitive borrower rates, and updated deposit interest rate model that adjusts for market shocks, etc.). A few are being rolled out now, like bETH. Others are still in the design phase, such as a new interest rate model. These improvements will take varying amounts of time to test, implement, measure, and optimize.
And the situation is dynamic. While we cannot predict the market’s vicissitudes, we can prepare. If reserves reach 3 million, Anchor will need more reserves to buy time for planned improvements to affect the system. This proposal is for the plan of execution if Anchor reserves reach 3 million UST.
If reserves reach 3 million UST, take some of the LUNA community pool that is earmarked for Ozone, burn it into UST, and use it to capitalize Anchor’s yield reserve.
ANC equity holders should take the first loss. However, keep in mind that:
- Anchor is a three-month-old protocol and thus inherently fragile. Confidence and liquidity in ANC are low relative to LUNA.
- Authorizing ANC is a one-way door that could provide more uncertainty around supply schedules and thus per token value.
- ANC tokens are the primary catalyst for bootstrapping borrow demand. Therefore, causing harm to its long-term value could have a deleterious impact on protocol bootstrapping.
You can read the thread on the Anchor forum where the community debated using ANC from the community pool here: Authorize use of emergency community funds if reserves run out. Note that in that thread, @ryanology045 says he is against the use of ANC or changing its emission schedule for the reasons above.
We can’t be certain how much Anchor might need. The price of LUNA will be the deciding factor. I think a reasonable estimate for the upper bound is about 7% of the 71.9 million LUNA in the community pool:
- Let’s say that the price of LUNA fell to 3.86, such that the protocol was at 50% LTV (the
Max) with current collateral.
- In this scenario, I estimate the protocol would burn $53k per day.
- Topping up reserves to give Anchor 12 months of runway would require ~7% of the community pool (~19 million UST at 3.86).
These are rough estimates meant to provide some context, not serve as a model for implementation. A reasonable course of action might be to add to Anchor’s reserves as the price of LUNA goes down. For example, if the price of LUNA were to go down 20% to 4.88, add 1.5% of the LUNA community pool (in UST) to Anchor’s reserves. More UST is added to give the Anchor community time to calibrate the system as the price goes down further.
The Anchor protocol is young, fragile, and under-capitalized for the current market environment. Authorizing the use of LUNA in the Terra community pool to top up Anchor’s reserves if necessary gives the team time to make planned improvements. Think of this as an insurance policy for what may be stormy waters ahead. Mr. Market is a capricious fellow and Anchor is at the mercy of his whims.
I recognize authorizing the use of the Terra community pool to backstop another protocol is a nontrivial request. However, the two communities’ interests are aligned in the matter. Furthermore, anchor is integral to driving UST adoption across the chasm.
I welcome everyone’s thoughts on the problem and proposed solution.