Anchor Protocol: What is it, and how did it destroy the Terra-Luna stablecoins

The Anchor protocol worked like a bank savings account. For instance, say Ram owns $1000 worth of Terra coin, but instead of selling the coin or exchanging it in form of Luna, he wants to earn stable profits from his investment. So, Ram enters into an Anchor Pool, which promises to give a flat 20 per cent interest on his investment.

Now, say Shyam wants to buy Terra coin but in the form of a loan, puts down some of his crypto assets as collateral. With some interest levied on him he buys Terra. The interest that he pays is then paid to Ram in the form of incentives. What is also interesting here is that borrowers, in this case, Shyam also enjoyed some rewards on borrowing Terra coins.

Interestingly, more than 72 per cent of all Terra holders deposited their coins in Anchor. However, there were not enough borrowers of the Terra coin. The big question is: Where did all the money come from?

While Anchor’s enticing yield rates created a massive demand for Terra. Every other crypto investor flocked to buy Terra and deposited it for earning stabilised profits. Then a new proposal by Terra founders surfaced, which said that the rate of yield will change from 20 per cent, either it could be an increase or a decrease, that was not mentioned.

At that time, Anchor’s dashboard displayed that there was only one borrower for four lenders. This meant more supply but very less demand. The Terra founder started depositing funds in the Terra reserve to ensure that the supply and demand ratio matched. Essentially, the founder of the coin was buying more and more coins so that interest rates are been sent out to the investors. However, the rate of borrowers did not change.

When the demand and supply ratio broke, a rumour circulated that the investors can slice down on interest rate every month, which eventually led to people taking out their Terra coin from the Anchor and the majority of the people now started exchanging Terra for Luna.

During this time, crypto lending business Celsius had at least half a billion dollars of funds parked in Anchor Protocol but appears to have pulled all of it out over a frantic 24 hour period earlier this week.

Ultimately, the supply of Luna spiked, and its price plummeted. With more and more people dumping the Terra coin, the balancing mechanism stopped and both the coins—Terra and Luna crashed. According to Coinmarketcap, the Terra coin price dropped to a whopping 0.225 on May 11, meaning that what was meant to be a stablecoin lost almost 80 per cent of its value in a few days.