Some thoughts regarding development of Terra capital markets and Anchor's role in it

General
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There are a lot of things that I find really interesting and I would like to start a discussion about implication of the Anchor Rate design for the future development of Terra. These are some rough musings that are a little rambling so apologies for that. I’ve tried to do my own research and I’m not sure if some points have already been discussed, so please forgive me if they have been. There are no proposals here, but if people are interested, I’d like to engage in a discussion about how the Terra market structure could develop in the future out of the parameters defined in Anchor now.

The primary goal of Anchor at the moment seems to be to attract capital into the Terra ecosystem. Inflows into Terra translate to higher LUNA price, which means appreciating collateral values of bLUNA. As more bLUNA is staked, staking yields will go down all else equal, unless transaction activity in Terra keeps up at the same pace (Is this right?). While deposit demand is driven by high yields in the stablecoin, (Classic FX carry trade: Sell USD, buy UST, deposit in Anchor and make risk free money), the borrow demand is currently driven by the ANC incentives.

However, at the moment, there is little to do with the UST borrowed other than leveraged speculation on LUNA and LPing on Mirror, or to deposit straight back into Anchor. Once the ANC incentives run out (albeit in 4 years time…), what do we do then? Who’s going to borrow stablecoins at higher than fiat rates?

In the fiat world, there is too much cash searching for assets and that why we have negative bond yields. In DeFI, at the moment, demand for capital far outstrips available capital and thats why there are higher interest rates. When the overall market is booming, the return on DeFi activities can beat the (very high) cost of capital. However, in the long run, I don’t think this is sustainable.

My main point is that:

At some point, Anchor rate is going to have to go down. If the shortest duration interest rate is at 20% for investors, projects are going to have to promise much higher returns to attract capital for a longer period, unless ALL projects are going to be funded via the fiscal policy mechanism of Terra.

There are lots of other things to explore too:

  1. How can we build interest rate derivatives on top of Anchor? what would they look like?

  2. If Anchor incorporates other stableCoins, what should the relationship of interest rates be across different currencies? If all FX rates are pegged via the miner voting mechanism, but if interest rate differentials in fiat vs terra are different, does that open the system to arbitrage? My gut says yes, but I haven’t fully thought this through.

  3. I think FX forwards in Terra will be a useful thing. Maybe this isn’t the forum to post this, but being able to lock in FX rates for a future date is a desirable functionality for end users. FX Forwards and interest rates are intertwined instruments. If Anchor offers multiple currency deposits and the implied interest rate differentials of Terrafx forwards are not consistent, then someone somewhere is going to get arbed.

Happy to start talking about any of the above or offshoots of these.

2 Likes
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Love this critical thinking.

Been having some long term stability thoughts aswell. What happens to the algorithmic peg and the APY in a bear market? Still a big questionmark for me, but an important one to drive adoption.

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It’s a good discussion to have and a lot of the dynamics of the borrow rate will indeed be driven by staking yields.

If I’m correct in my current calculation (w/ current staking yields and the loan-to-value of the borrow pool), the borrow rate could be zero today (perhaps even slightly negative) and still be able to pay the deposit yield. This should sustain borrow activity. However, if the price of Luna rises much faster than network fees, this could throw off the balance and affect borrower demand.

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Its nice to finally have someone respond!

@Ilo_Muoto - in a bear market, I think the algorithmic peg (I’m assuming you mean the UST peg here) is sustained by an increase in Luna supply, diluting existing luna holders. If miners in Terra want to keep their proportional voting power in the system constant, then they need to step in and buy Luna. By guaranteeing a steady LUNA denominated incentive for miners in Terra, the system thus creates actors that have skin in the game and are willing to invest additional capital at times when there is capital flight. This is what I gleaned from the Terra white paper.

Capital flight out of the system would probably be both UST selling and LUNA selling for fiat or other cryptocurrencies. Depositors pulling UST out of Anchor would cause the APY to go up. In emerging markets, when there is a currency crisis and capital flight, central banks often have to raise rates to defend the currency at the price of bringing their economies to a screeching halt. I guess in Anchor, this would happen automatically: as deposits are pulled, the Anchor rate will go up, enticing capital to come back. This should have consequences for other protocols such as Mirror. For example, I’ve borrowed from Anchor to yield farm in Mirror. If Anchor rate goes up and the value of my collateral goes down I may be forced to delever. I think the 21 day cool down period and fees for un-bonding LUNA act as sort of soft capital controls that reduces the risk of such events.

@ZenDog - could you share your calculations? I guess Luna staking yields are denominated in Luna so Luna going up would not impact the staking yields in terms of Luna. However, if there is more LUNA staked, then the yield should go down. (Am I right?)