A Deep Dive into Terra and Anchor: The Reliable Savings Protocol

Markets Mar 10, 2021

Decentralized Finance (DeFi) has exploded in the last 12 months.  As DeFi projects like Uniswap, Maker, Aave, Yearn, and Compound became billion-dollar protocols, we saw a transition from ‘degenerate finance’ to ‘regenerate finance’ where the community set a higher bar for fiscal responsibility, smart contract security, and user experience.

This week, we had the privilege to learn about one of the most exciting projects in the DeFi ecosystem in 2021 — Anchor Protocol.

Built by the team at blockchain platform Terra, Anchor is a savings protocol that provides crypto natives, fintech companies, and regular investors a stable, high-yield interest rate for DeFi. We sat down with Do Kown, Co-Founder and CEO of Terra to discuss what they are building and what makes Anchor more reliable and attractive than other DeFi savings protocols. Let’s dive in.

1. To start, can you provide us with a brief overview of Terra and what problem is solves?

Terra is a Tendermint-based, proof-of-stake permissionless blockchain built using the Cosmos SDK. Terra’s design is based on bringing mass adoption to cryptocurrencies, blockchain, and DeFi by making it easier to spend, save, and invest using the tooling of a new financial system.

Terra differentiates itself from other major smart contracts blockchains in several key ways:

First, Terra’s network is based on an elastic supply model, where its native token, LUNA, is used to collateralize a cadre of stablecoins that form the basis of Terra’s suite of applications like Chai (payments), Mirror (investing/trading), and Anchor (savings). Having stablecoins form the infrastructure of Terra instantiates an environment conducive to network velocity and utility of its applications. Ethereum’s stablecoins have become the preferred medium of transacting on the network. However, on Terra, stablecoins are baked into the protocol — even offering an on-chain swap function that serves as a forex market with high-throughput and low fees.  

Second, Terra is built with the Cosmos SDK, meaning that the network is compatible with the IBC standardized communication protocol with other Tendermint-based applications within the Cosmos Network ecosystem — such as ThorChain, Oasis Labs, and Cosmos Hub. The IBC enables rapid interoperability between Terra and other networks, empowering the network to mutually benefit from application-specific chains and their explicit advantages.

2. How does Terra UST achieve stability without being backed by real-world assets?

Terra’s native token, LUNA, collateralizes a cadre of fiat-pegged stablecoins operating on the Terra network. LUNA’s money supply is elastic, meaning that the circulating supply of LUNA expands and contracts depending on the demand for Terra’s stablecoins, such as UST.

The idea is that more demand for Terra stablecoins equates to a contracting LUNA supply since $1 worth of LUNA can always be swapped for a stablecoin like UST at the exchange rate of the protocol.

For example, if excessive demand for UST pulls the peg above $1, then arbitrageurs are incentivized to mint 1 UST by burning $1 worth of LUNA — contracting the LUNA supply. The minted UST can be sold on the open market for a profit. Importantly, this functionality is baked into Terra’s protocol and can be performed at scale, with up to $10 million/day capable of UST minting before slippage becomes unreasonable.

On the other hand, if the UST peg deviates below $1, then arbitrageurs are incentivized to buy UST on the open market and redeem it for $1 worth of newly minted LUNA — expanding the LUNA supply.

As you can see, increasing demand for Terra stablecoins like UST initiates LUNA supply contraction, making LUNA more scarce. More scarce LUNA should correspond to an increased value per unit of LUNA. Additionally, as Terra stablecoin adoption increases via the use of Terra applications like Mirror, Chai, and Anchor, the velocity of stablecoins also increases, furnishing more fees to LUNA stakers, who progressively accrue lucrative long-term cash flows despite absorbing the short-term volatility of Terra’s stablecoins.

3. Terra supports a rich ecosystem of products, including Mirror, Chai, and MemePay. Can you briefly describe why you built the ecosystem and what each of these supporting ecosystem products does?

The primary ethos of Terra is mass adoption. However, this doesn’t necessarily mean that users need to be aware that they’re using a blockchain network to still reap the benefits. Abstracting away the underlying complexity of crypto and infusing it with the benefits (e.g., DeFi) while the user interacts with a friendly UX has always been the primary hurdle of crypto adoption.

With Terra, we wanted to nail down two primary aspects from a perspective of making things simpler:

  1. User adoption with applications that are intuitive and attractive.
  2. Robust incentive alignment for network stakeholders.

The first applies to the rich ecosystem of applications on Terra, including Chai, Mirror, and Anchor. Chai is a payments application based in South Korea with over two million users that transacted over $2 billion in volume last year — recently raising a $60 million Series B. Chai’s settlement is faster and cheaper than traditional payment rails, and users do not have to interact with Terra on the front-end at all.

Mirror is Terra’s blossoming synthetic assets protocol that offers “mirrored” versions of real-world assets like stocks, commodities, indexes, crypto assets, and more. Mirror’s total value locked (TVL) surged past $1 billion in just twelve weeks since launch, and is a community-governed protocol that aims to compete with the likes of Robinhood — offering a censorship-resistant and user-friendly alternative.

Anchor is Terra’s savings protocol that molds the money legos (i.e., composability) of DeFi and presents them to the end-user with a simple method for stable, high-yield savings with a few clicks. On the back-end, Anchor normalizes yield from staking derivatives of other proof-of-stake (PoS) chains, unlocking the liquidity of major stakers on their network and feeding cash flows from their staking positions to depositors (Anchor users that deposit UST to earn accumulated staking rewards).

The second aspect relates to a specific question: What’s the common theme among applications built on Terra?

They increase the demand for UST and Terra’s stablecoins since they serve as the primary mechanism to interact with the protocols. More demand to use Mirror, Anchor, and Chai stokes further demand for UST, which triggers more frequent (and larger) LUNA burns to capture the riskless arbitrage profit.

The result is that the long-term stakeholders in Terra, LUNA stakers that absorb short-term volatility, are rewarded with a scarcer LUNA supply and progressively more abundant cash flows generated by the growth of UST adoption and transaction velocity. The virtuous cycle.

4. Where are you seeing the largest adoption for your products and what is your vision for Terra ultimately?

Adoption of Terra’s two flagship applications before Anchor, Mirror and Chai, is off the charts. By our estimates, Chai is the most widely adopted crypto-oriented application that is not purely speculative, with more than two million active users and $2 billion transacted in value last year — currently growing at an even faster clip.

Mirror achieved more than $1 billion in TVL within twelve weeks of launch, placing it among the top 15 DeFi protocols by TVL on any blockchain, Ethereum included. Additionally, Mirror’s synthetic mAssets are available for trading on Terra, Ethereum, Binance Chain, and soon to be others. The idea is to take advantage of various chains’ application-specific designs and furnish Mirror users with optionality — a powerful incentive to participate. Once people in financially disenfranchised regions begin to understand the potential of DeFi and synthetic asset protocols, the sky's the limit for Mirror’s growth.

Ultimately, the vision for Terra is using applications like Mirror, Anchor, and Chai to make accessing financial primitives (e.g., investing, payments, savings) easier than ever. Democratize access to the new financial infrastructure, and DeFi can capture trillions of dead capital and onboard billions of new people into a financial system that previously excluded them.

Pair that idea with a robust incentive design for long-term stakeholders, and the goals for Terra begin to crystallize.

5. Digging into your latest product announcement in January about Anchor Protocol, can you provide us with an overview of the protocol and what was the genesis of the idea?

Anchor Protocol is a savings vehicle built on the Terra blockchain that provides a benchmark interest rate for DeFi. Anchor primarily applies to two distinct demographics:

  1. Crypto-natives
  2. Fintech companies and regular investors

Applied to crypto-natives, one of the major difficulties for a DeFi user or professional crypto fund is the variable yields that are a byproduct of speculative demand to trade on margin — particularly in a roaring bull market. Projecting cash flows and yield is challenging since demand for borrowing is volatile and dependent on exogenous market factors. Stable yields are a lynchpin of TradFi, and fixed-rate interest is ubiquitous across financial institutions, corporations, and other firms. Moreover, staking positions in DeFi are illiquid, as significant positions of the native token are bonded into the network to generate block rewards and participate in consensus and governance.

For fintech companies and the typical TradFi investor, one of the major limitations of DeFi is the sheer complexity of the space. A deluge of yield farming, DEXs, money markets, derivatives, and other platforms make navigating DeFi a dense jungle — not to mention the challenge of understanding exactly what composability entails. Accessing high yields is also exceptionally difficult in a perpetually low-interest rate environment, leading investors and funds into more risk-on environments like equities.

So the question becomes:

How can we mold the power of composability (e.g., high yields and composability) while retaining simplicity? More specifically, how can we create a simple DeFi app for the average investor or fintech company to integrate that maintains yield stability to appeal to degenerate yield farmers and professional crypto funds that helps unlock the liquidity of staking positions?

Enter Anchor.

First, on the supply side (bAssets), Anchor’s liquid staking derivatives enable stakers of major PoS chains to deploy their staking positions as liquid capital within a money market. Not only does this improve capital efficiency across DeFi, but it passes on the cash flows (e.g., emission rewards) to the UST depositors within Anchor — the average retail user.

Anchor stabilizes the yield generated from the staking derivatives, passing it on as a stable, high-yield interest savings account to whoever interacts with the protocol. This can be a regular investor looking to accrue interest at a fixed rate, but it also appeals to fintech companies, mobile wallets, and exchanges that want to integrate low-volatility, high-yield savings as a featured offering to their users using the Anchor API.

Anchor makes this process very simple. It becomes the “Stripe for Savings” where an application can trivially imbue its offering with the power of composability (e.g., high yields from staking derivatives) while masking the underlying complexity — a win-win.

For DeFi users, Anchor represents a stable savings account that requires minimal management. No need to actively port your capital from yield farming opportunity to opportunity, spending significant capital on gas, or continuously calculate your position’s cash flow. Just deposit UST into Anchor, and you have high-yield, fixed interest.

To conclude, Anchor represents a savings vehicle for the average investor mired in the low yield opportunities of TradFi, offers fintech platforms a trivial avenue to offer instant, high-yield savings, and improves the capital efficiency of network stakeholders by unlocking their capital.

6. How does the Anchor savings protocol work? In particular, what makes it more reliable and attractive than other DeFi savings protocols?

Anchor passes the yield generated from liquid staking derivatives, stabilizes it, and forwards it to users that deposit UST (the demand side) into Anchor. Anchor functions similarly to any decentralized money market protocol (e.g., Compound) but with the exception of only accepting liquid staking derivatives from PoS chains as collateral.

Anchor is attractive because of its simplicity, stability, and attractive yields. For stakers on major PoS chains, Anchor also unlocks an avenue to deploy their staked capital in ways not available previously. This enhances capital efficiency and passes on staking yields to average investors via Anchor that may simply access the protocol via an integration with a fintech platform, exchange, or wallet.

If you want to learn more about the technical components of Anchor, you can find them in the formal papers below:

7. What do you think have been the biggest roadblocks to DeFi achieving mass adoption?

The major hurdle for DeFi is similar to that of crypto in general -- user experience. UX is a byproduct of the underlying complexity of crypto. It is challenging to abstract away and achieve parity with mainstream apps that populate the app stores of Apple and Google.

However, the UX of crypto and DeFi has come a long way in recent years, and is showing signs of making headway into mainstream adoption. Anchor helps push the needle forward on DeFi reaching mass adoption, and we’re excited to see how users respond to a savings vehicle that wields the power of DeFi’s composability while hiding the complexity.

First, watching how the current macroeconomic and financial backdrop interplays with the onboarding of more users to DeFi. DeFi’s capital inflows are already exploding, and the pace of innovation is astounding. The previous year was a rollercoaster ride, but we can expect 2021 to bring something similar when applied to the parabolic growth of crypto and DeFi.

Second, 2021 has the potential to be a banner year for interoperability in the industry as cross-chain bridges develop and assets can be easily ported between application-specific chains. The idea of superfluid collateral can truly be realized. Various chains that offer distinct advantages can interact in ways that are mutually beneficial to their communities and the broader industry.

Finally, watching how UX develops and whether or not DeFi reaches an inflection point of mainstream adoption. Where accessing DEXs like Uniswap, savings protocols like Anchor, or derivatives platforms like Injective Protocol become as easy as exploring popular social media apps or trading on apps like Robinhood.

Stay tuned for more exciting news from the Terra team!

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