Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight

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Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
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Crypto DeFi Digest                                                            April 7, 2022

Anchor Protocol Update - Dynamic Earn Rate

            Walter Teng

   Dynamic Earn Rate NFT Genesis Mint 1/69

                                For important disclosures, see Page 14                  Page 1
Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
Crypto DeFi Digest                                                     April 7, 2022

Anchor Introduces Update to Earn Rate Calculation

Two issues ago, I wrote about Anchor Protocol, a dynamic savings platform that leverages
money market demand and diversified staking rewards to pay out attractive stablecoin
Much has developed since - as they say, one week in the depths of DeFi feels like one year in
real life.

Acknowledging how the macro environment has affected its micro mechanics, Anchor
Protocol garnered enough support on March 24th to pass Poll #20, in which a Terra protocol
researcher suggested the following changes to the Anchor Earn Rate:

% Earn Rate Change = min (abs (1.5%, ((YR % Change)), where
   YR = Yield Reserve

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Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
Crypto DeFi Digest                                                     April 7, 2022

    Figure: Poll #20 Results

    Source: Anchor Protocol

Effectively, this change allows Anchor to adjust the monthly yield payout to UST depositors
in proportion to the monthly rate of increase or decrease of the Yield Reserve balance.

The Anchor Earn Rate can be adjusted by a maximum of +1.5% in either direction. For
example, if the Yield Reserve increases by 10%, the Anchor Earn Rate increases by 1.5%. If
the Yield Reserve decreases by 0.5%, the Anchor Earn Rate can be adjusted by a maximum
of -1.5% and -0.5%. Here, Anchor Earn Rate reduces by 0.5%.

Updating Our Model

Given this material protocol update, I have expanded on the model from our Anchor
introductory issue to account for these changes and introduced other moving parts to more
precisely define the variables affecting the Anchor Run Rate, including these assumptions:
   Firstly, I’ve introduced the dynamic earn rate according to the previous periods’
   change in yield reserve balance.
        Due to the sheer size of UST borrowed, however, the Anchor Earn rate will
        consistently reduce by 1.5% per month until the Yield Reserve gets depleted.

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Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
Crypto DeFi Digest                                                     April 7, 2022

   I also assume bETH and bLUNA collateral growth starting at 25.0% (Oct’ 21 - Mar’ 21
   growth rates stood at 23.5%), with growth rates adjusted downward by a factor of
   0.80 from month to month.
        Because wasAVAX is a new collateral addition, I assume growth starts at 90%
        and is adjusted downward by a factor of 0.90 month to month. These
        assumptions project $15.3b, $5.0b, and $3.4b in bLUNA, bETH, and wasAVAX
        collateral respectively for Mar’ 23.
        These are probably the most fluid assumptions in the model and are subject to
        change quite frequently. However, this provides us with a proper framework to
        estimate collateral runway.
   I assume the same conservative growth assumptions for Anchor Earn deposits,
   starting at 25% (March growth rates were 45.5%) and adjusted downward by a factor
   of 0.8, resulting in $20b UST deposited by early June. The model also assumes staking
   rewards remain unchanged throughout the projection year (neglecting Ethereum 2.0’s
   projected post-merge surge in staking yields).

    Figure: Anchor Dynamic Earn Rate Model

    Source: Fundstrat

To understand the relative impact of each variable in the model above, we can again
sensitize the Anchor Earn deposits and collateral growth inputs below.

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Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
Crypto DeFi Digest                                                                   April 7, 2022

    Figure: Days Until Yield Reserve Needs Replenishment Sensitized Against bLUNA and bETH Collateral
    Growth and Earn Deposits Growth

    Source: Fundstrat

Unsurprisingly, the takeaways are not dissimilar to my previous point-in-time analysis. As it
stands, Anchor has 80 days of run rate assuming bETH and bLUNA grow at 85% from their
end March collateral balances, and Anchor Earn deposits grow at 67.5%. These are fairly
aggressive for estimating the run rate (giving Do the benefit of the doubt), given that Earn
deposits have grown by 45.5% in March.

Since writing, Anchor emissions that subsidize bETH and bLUNA collateralized UST
borrowings have also dropped - seekers of leverage are currently paying a net 4.43% APR.
The strategic thinking behind this move eludes me, as lesser emissions translate to more
expensive (and less) borrowing, which results in less interest used to subsidize the Anchor
Earn Rate.

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Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
Crypto DeFi Digest                                                      April 7, 2022

    Figure: Net Borrowing Rate on Anchor as of 4/7

    Source: Anchor Protocol

The preliminary takeaways here are that:
   increasing collateral growth is helpful in closing the gap between the sources and uses
   of the Anchor Protocol, but slowing deposits has a greater relative effect, and
   regardless of actions taken, the sensitivity ranges presented above would only result
   in at 43 days of the incremental runway at maximum

Bolstering the Peg by Purchasing BTC using Luna Foundation Guard (LFG)

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Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
Crypto DeFi Digest                                                        April 7, 2022

    Jump Trading’s Proposal

    Source: Terra’s Agora Forum

In addition to reducing the Anchor Earn Rate, Do Kwon and his investors have been working
hard at restoring users’ confidence in the Terra ecosystem.

One high-profile initiative includes LFG’s purchases of BTC detailed in last week’s Crypto
Weekly, in which Sean wrote extensively about the effects of these purchases on spot price.

The $1.3b bitcoin (out of $3b) purchased is currently held in LFG’s wallet. LFG has indicated
that the reserve created through the $3 billion capital injection will effectively act as a
“release valve” for UST redemptions; it is designed to ensure that the price of the stablecoin
remains pegged to that of the dollar during sharp selloffs in crypto markets.

The introduction of LFG’s BTC reserve should temporarily appease concerns from investors
(as the market has indicated with LUNA and BTC rallying) in the broader Terra ecosystem in
the short term, but potentially introduces other vectors of risk.

By enabling redemption of UST for BTC instead of LUNA, BTC might see additional liquidity
flowing into exchanges from the Terra ecosystem during market distress. Nevertheless, this
new redemption mechanism is in aggregate safer (than without it), albeit at the cost of the
broader crypto ecosystem.

                                                                                          Page 7
Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
Crypto DeFi Digest                       April 7, 2022

… And Leveraging DeFi 1.0 Giants…

   Figure: Do Kwon Announcing 4pool on Curve

                                                       Page 8
Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
Crypto DeFi Digest                                                       April 7, 2022

    Source: Twitter

Additionally, Terra plans to deploy a permissionless pool on Curve called 4pool, consisting of
UST, FRAX, USDC, and USDT. The 4pool will be tested on Fantom and Arbitrum before
launching on the Ethereum mainnet once some Curve infrastructure is enabled.

Through a partnership with FRAX, the 4pool will realize Convex (CVX) and Curve (CRV)
synergies by leveraging Votium (delegated voting power protocol) incentives. Additionally,
4pool enables UST to become a collateral asset for the partially backed stablecoin FRAX
(apart from FXS).

By doing this, Do has also hinted at intentions to ‘starve’ the 3pool, comprised of DAI, USDC,
and USDT. For context, DAI, the overcollateralized stablecoin from MakerDAO, has long been
a rival of UST and Terra. To this point, Do frequently states that ‘Decentralized economies
need decentralized money’, alluding to the need for UST over its centralized competitor, DAI.

Should this vampire attack succeed, it will be a huge win for both leading algorithmic
stablecoins FRAX and UST, which we will cover in-depth in a future issue.

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Walter Teng DIGITAL ASSET STRATEGY ASSOCIATE - Anchor Protocol Update - Dynamic Earn Rate - FSInsight
Crypto DeFi Digest                                                        April 7, 2022

… And Recruiting the Help of Degens

Leveraging Protocol-Owned-Liquidity mechanics first popularized by OlympusDAO,
Redacted Cartel is a layer on top gauges (like Curve Finance) with the mandate of
accumulating control over the CRV, CVX, FXS, TOKE, and gOHM ecosystems. Its treasury
boasts over $100m in governance tokens, and has developed plans with Terra to leverage it

Firstly, the Terra will leverage Redacted Cartel’s Hidden Hand, a generalized incentive market
protocol for veTokens to secure a Tokemak Reactor. With the Hidden Hand marketplace,
protocols will be able to create markets for their ve-tokens while Redacted captures a fee
that is redistributed to lockers of BTRFLY.

Secondly, debtDAO will issue its first UST-denominated loan to Redacted Cartel, piloting the
decentralized debt marketplace catering to other protocols.

Last but certainly not least, Terra will be leveraging Redacted Cartel’s influence over Curve
and Convex.

For those unfamiliar, Curve Finance is an automated market maker which specializes in
stablecoins swap with low price slippage. As covered in a previous issue of DeFi Digest,
liquidity providers deposit stablecoins into a pool to earn trading fees. The governance token,
CRV, can be locked for a period of 1 to 4 years at 0.25 to 1 conversion rate for veCRV.

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Crypto DeFi Digest                                                         April 7, 2022

    Figure: Curve Pools

    Source: Curve Finance

This vote-escrowed CRV (veCRV) that represents locked CRV tokens then allows liquidity
providers to earn boosted rewards for their liquidity pools. For example, vote-locking CRV for
1 year gives you 0.25 veCRV, which can boost rewards by a factor of 0.8. Holders of veCRV
can either vote to direct CRV rewards towards their desired LP pool or receive ‘bribes’ from
other protocols to direct votes to them.

Sitting on top of the Curve ecosystem, Convex Finance is another project that attempts to
capture the governance power over CRV emissions. Currently, 43% of veCRV is held by
Convex as vote-locked (vlCVX), signaling that Curve wars have already found a winner.

As such, the power struggle shift towards Convex - whoever controls Convex has influence
over Curve. In comes the Redacted Cartel.

Being the third largest DAO holder of CVX, Redacted Cartel will vote for the 4pool
(UST+3CRV) and claim UST votium incentives. Redacted has also agreed not to sell UST for
other stablecoins and will use it to pay contributors, partake in seed deals, partake in single-
sided LPs, and build their treasury.

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Crypto DeFi Digest                                                        April 7, 2022

This partnership appears to be mutually beneficial as Redacted can solely receive a single
stablecoin (UST) instead of multiple tokens from Votium that are not necessarily aligned with
their mission. Terra, on the other hand, introduces another source of yield for UST (apart from
Anchor) and bolsters broader adoption for UST in DeFi.

Bottom Line

Through the Redacted Cartel and Frax initiatives, Do Kwon attempts to ease the pressure on
Luna and the Anchor Yield Reserve from the public lens, but the numbers don’t lie - despite
the proposed changes to the protocol, and apparent new use cases for UST, Anchor
yields cannot sustain at these rates for much longer without significant changes to the
model. When yields compress, market participants will at best leave for greener pastures in
the 4pool or at worst stablecoin farms elsewhere.

While it is tough to estimate the aggregate effects on UST from Terra’s initiatives and the rate
at which Anchor’s Yield Reserve is depleting, one cannot help but wonder: “Anon, 73% of UST
is currently deposited in Anchor. Will Terra be able to support demand for UST before Anchor
Yield Reserve depletes? If not, what happens to LUNA price?”

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Crypto DeFi Digest                                                       April 7, 2022

    Figure: Anon Trying to Ascertain the Aggregate Effects of All This

It is all too easy to paint a picture of gloom for Anchor, Luna, and UST based on the
commentary above. Nonetheless, I can imagine a world in which UST succeeds as the first
widely-adopted decentralized algorithmic stablecoin (and LUNA price continues its surge up).

Regardless of what happens in the ensuing months, one thing is for sure - Do has proved
himself to be an exceptional community and narrative builder, deserving of the success Terra
has had so far.

If the race to facilitate organic demand for UST started one year ago on Anchor’s birthday, it
surely feels like we are in the homestretch now.

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Crypto DeFi Digest                                                                    April 7, 2022


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Crypto DeFi Digest                                                                   April 7, 2022

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