Investments

How Does Anchor Protocol Work

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 6 minute read

In the field of decentralized finance (DeFi), Anchor Protocol pays a staggering 19.5% interest on deposits, while the majority of banks only provide savings accounts with less than 1% yearly interest. 

Even though more than $15 billion in deposits have joined the platform, Anchor has maintained this high-interest rate, making it appear too good to be true. Then again, how is this possible?

We looked into the specifics of the Anchor Protocol to learn more, and we’ll explain how it operates, why the return rate is still so high, what risks come with investing with Anchor, and what the future might hold for this cryptocurrency savings account.

Why the Anchor Protocol Works

Using the Terra blockchain and its TerraUSD (UST) stablecoin tokens, Anchor Protocol is a decentralized finance (DeFi) platform for borrowing and lending. Deposits of UST cryptocurrency earn an annual percentage rate (APY) of over 20%. 

When compared to other platforms, Anchor Protocol allows users to earn significantly greater interest rates on their stablecoin holdings.

To put it simply, Anchor is a platform that facilitates the lending and borrowing of UST stablecoins between users in exchange for interest payments. Those who have deposited UST coins receive interest, making you the “bank” for their cryptocurrency loans.

Since Anchor is a permissionless app, its features are controlled and updated automatically by means of smart contracts. Instantaneous loan approval with automatic interest payments.

Also like Anchor, there is no central governing body or board of directors making policy calls. Instead, token holders in the Anchor Protocol (ANC) can propose changes and vote on those proposed by the community.

In a nutshell, Anchor is a decentralized financial institution (DeFi) program that facilitates the automatic acquisition and repayment of bitcoin loans and deposits.

Principal Elements of Anchor Protocol

Earn (Savings Accounts)

Earn accounts, offered by Anchor Protocol, are well-known for allowing users to earn over 19.50% APY by depositing TerraUSD stablecoin (UST). Anchor is one of the most widely used platforms for crypto savings accounts in DeFi due to its high-interest rate, which is among the highest in the industry for deposits using stablecoins.

Borrow (Crypto Loans)

In order to borrow UST against their cryptocurrency holdings, users of the Anchor Protocol can do so by making a deposit of cryptocurrency. They can use their cryptocurrency as loan collateral while maintaining full ownership of their holdings (similar to a line of credit).

At present, ETH, ETH, ATOM, and AVL are the only four cryptocurrencies and one token (LUNA, the Terra network’s native token) that can be used as collateral for loans (AVAX). 

These currencies must be moved to a digital wallet, then deposited to the Anchor platform, and then converted via the Anchor bAsset tool in order to be used as collateral.

Staking ANC-UST

Staking is a more complex kind of interest earning on the Anchor Protocol platform, and it involves the locking up of tokens. To accomplish this, users will place a quantity of ANC and UST tokens into a liquidity pool on Anchor. Tokens facilitate trading and exchange on the platform while also serving as a kind of security for the network as a whole.

If you have AND or UST tokens in a digital wallet, you can deposit them by going to your wallet’s “Govern” section. To deposit tokens into ANC-UST LP, choose that option and enter the number you wish to deposit. The value of the tokens will be evenly split, as determined by the deposit form, which will calculate the amount of each token to be placed.

After making a crypto deposit, you will immediately be credited with an LP token with a value equivalent to your initial contribution. You can also earn ANC on the platform, which can be transferred to your virtual wallet.

Benefits of the Anchor Protocol

Users of the Terra platform can take benefit from high-interest rates on their cryptocurrency holdings thanks to Anchor Protocol. Here are a few of the ways that Anchor benefits cryptocurrency traders.

  • Interest Rates of (Nearly) 20% Per Annum. Presently, the best DeFi option is Anchor Protocol because of their over 20% APY rates on UST balance deposits. When compared to traditional bank savings accounts and even the best crypto savings accounts, this interest rate is sky-high. It’s a great rate even until it drops to 18% in May 2022.
  • Finance Your Cryptocurrency Acquisitions. It is possible to borrow against your crypto balance with Anchor if you need access to your crypto value without selling the underlying asset. Borrow UST stablecoins and keep your cryptocurrency secure on the exchange while you wait.
  • Decentralized (Governed by Committee) (Governed by Committee). The holders of ANC tokens, rather than a central board or organization, determine the direction of the Anchor Protocol network. The true decentralization of this governance mechanism is on display in the holders’ ability to vote on crucial protocol upgrades that may affect the development of Anchor.

Drawbacks of the Anchor Protocol

When seen over a longer period of time, Anchor Protocol’s claims may appear to be too good to be true. The current interest rates may seem attractive, but there are simply too many deposits and not enough borrowers or other revenue generators on the network to sustain them.

Given the high rates of interest on crypto-backed loans, it’s possible that Anchor won’t be a good long-term answer. 

Some of the drawbacks of the Anchor Protocol are as follows:

  • Pricey APRs for Borrowing Money. Anchor offers a competitive interest rate for UST deposits, however, borrowing UST through the platform will set you back a fair sum. The annual percentage rate (APR) for cryptocurrency-backed loans offered by Anchor is approximately 11%. These loans also carry the potential for liquidation if the value of the collateral you posted as security declines too dramatically.
  • We Cannot Maintain Current Savings Rates. With such a massive gap between the number of UST deposits and the amount of UST loans made, it is impossible for Anchor to continue offering savings account interest rates of 20% APY. The majority of the 20% interest is paid by UST borrowers, however, there are approximately five times as many deposits as loans as of April 2022. According to a recent proposal approved in March 2022, rates will decrease by 1.5% per month (beginning in May) until interest payments no longer deplete reserves.
  • Not Easy to Operate (Not for Beginners). Signing up for a crypto exchange and buying cryptocurrency is already a significant learning curve for crypto beginners. However, rookie crypto enthusiasts should avoid the Anchor Protocol due to the various processes required to deposit funds. Though it pays well, Anchor Protocol is not the best choice for crypto newbies.

How Does Anchor Protocol Compare?

As one of the most widely used DeFi savings apps, Anchor Protocol has attracted over $19 billion in deposits. Although it is a DeFi lending platform, it is not the only one.

Anchor Protocol and Compound are two examples of decentralized bitcoin investment platforms. The two also facilitate collateralized crypto loans, wherein consumers may borrow against their cryptocurrency reserves. Both the application and the protocol have no governing body, making them “decentralized.”

Contrast this with Anchor, which gives an eye-popping 19.50% on deposited UST, and Compound’s moderate interest rates of up to 3.0%. Those looking to borrow against their cryptocurrency holdings have fewer options with Anchor Protocol, which only allows four assets than they have with Compound, which supports more than fifteen.

The differences between Anchor Protocol and Compound are as follows.

Anchor ProtocolCompound
Savings Interest RatesUp to 19.50%Up to 3.0%
Borrowing RatesAbout 11.7%1.1% to 11.1%
FeesTerra network fees ($0.25)Ethereum network fees ($50 to $100 or more)
Supports Crypto Assets418

Bottom Line

The 20% interest rates advertised by the Anchor Protocol are unrealistic. Beginning in May of 2022, rates will drop to 18% and could go further lower if reserves are reduced further.

In any case, 10% interest on a U.S. dollar-pegged stablecoin is nothing to scoff at, even if rates were to decrease by half from their current levels. The average interest rate on a checking account is less than 0.01%, and the average interest rate on a savings account isn’t much better.

Anchor Protocol is not a good place to start if you’re a crypto rookie because of all the hoops you have to jump through to make a simple deposit. All DeFi uses are not without some danger.

The Federal Deposit Insurance Corporation does not insure customer funds, coin values can swing dramatically (yes, even stablecoins do), and there is minimal regulatory oversight to safeguard customers. There is a chance of losing all of your money if you invest in Anchor Protocol, like with any cryptocurrency.

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