What is Anchor Protocol (ANC) and How Does it Work?|KuCoin Crypto Gem Observer

2022/03/01 10:01:48

Decentralized Finance (DeFi) has emerged as one of the most promising sub-sectors of the crypto industry. Over the past few years, the sector has recorded explosive growth, with different companies rolling out an array of financial applications. At the moment, DeFi comprises platforms for decentralized lending, decentralized exchanges, and prediction markets.

However, the space lacks a simple and convenient savings application that attracts even the population that has not yet embraced crypto. While some platforms attempted to address this need by introducing staking, the inherent volatility of many digital assets discourages most people from locking their funds for a specified amount of time to earn yield.

On the other hand, platforms like Maker and Compound offer cyclical interest rates for stablecoins, a feature that makes the protocols unsuitable for a household savings product.

To address this persistent need, Anchor went live as a protocol that accepts Terra deposits, enables instant withdrawals, and offers clients that deposit their crypto a low-volatility interest rate. By offering these services, Anchor believes it can foster the mass adoption of DeFi.

How does Anchor protocol Work?

Anchor generates yield by lending out deposited funds to borrowers that use liquid-stake Proof-of-Stake (PoS) assets from leading blockchains as collateral, bonded assets (bAssets). The platform stabilizes the deposit interest rate by transferring a variable asset of the bAsset yield to depositors.

Anchor ensures depositors never lose principal by liquidating the borrowers’ collateral through liquidity contracts and third-party arbitrageurs.

BAssets are a core component of the Anchor protocol. They are essentially tokens that represent the ownership of PoS assets. The platform works with bAssets because they offer holders block rewards, just like the underlying staked asset. More importantly, bAssets are transferable and fungible, unlike the staked asset.

Another key part of the Anchor protocol is the Terra money market, a web assembly (WASM) smart contract on the Terra blockchain. This smart contract enables the depositing of Terra stablecoins like UST. The money market comprises a pool of deposits that earns interest from borrowers.

Borrowers put down digital assets as collateral to borrow Terra from the pool. Anchor determines the interest rate algorithmically by calculating the pool’s utilization ratio, a process that involves dividing the value of borrowed deposits by total deposits.

This means that depositors will get more interest as the utility ratio increases because borrowers will have to pay more. A decrease in the utility ratio means borrowers will pay less interest, translating into lower interest for the depositor. However, this algorithm is deeply flawed, seeing as the interest rates are sensitive to market cycles.

What Makes Anchor Protocol Unique?

Unlike protocols like Compound, which settle for cyclical interest rates, Anchor is unique because it uses a stabilization mechanism to create the Anchor Rate. With the Anchor Rate, depositors get returns that are a function of the on-chain income of borrowers. The protocol gets the Anchor rate by considering all bAssets put down as collateral for borrowing from the Terra money market.

Specifically, the Anchor smart contract calculates 12-month moving averages for yields obtained from all bAssets used as collateral for borrowing Terra-based stablecoins.

By offering depositors a stable interest rate, Anchor eliminates the cyclical nature of deposit interest rates, one of the shortfalls of Maker and Compound as DeFi-based savings products. Apart from offering a low-volatility yield, the Anchor Rate provides investors a single, reliable rate of return across all blockchains.

What is the ANC token and What is it used for?

The Anchor protocol has a governance token dubbed Anchor Token (ANC). Holders can deposit ANC to create new governance polls, which ANC stakers can vote on. The token’s design captures a fraction of Anchor’s yield, allowing its value to increase linearly with the protocol’s assets under management (AUM).

Anchor distributes protocol fees to ANC stakers in proportion to their stake. This means that stakers stand to get more benefits as the Anchor protocol catches on. Anchor incentivizes stakers to propose, discuss, and vote for proposals that help improve the platform.

Apart from serving as a governance token, ANC is used as an incentive to bootstrap borrow demand and offer initial deposit rate stability. Anchor distributes ANC to stablecoin borrowers, pro-rata to the amount borrowed.

At the moment, there are 257,533,220 ANC tokens in circulation, and the supply is capped at 1,000,000,000 coins.

Who created the Anchor protocol?

Terraform Labs (TFL) created Anchor as part of its vision to integrate three primary financial fundamentals. These are payments, saving, and investing. TFL founded Anchor to help increase the demand for UST by offering lenders a stable yield.

Closing Thoughts

Anchor protocol is playing a massive role in revolutionizing the DeFi sector. By addressing the needs of lenders and borrowers, the platform is attracting more people to DeFi, helping the sector inch closer to going mainstream.