Table of Links Abstract and 1. Introduction Abstract and 1. Introduction Stablecoins and Lending Markets
Fixed-Rate Lending Protocols and Derivatives
Staking Derivatives
Staking Fees as Stable Interest
Stabilization Mechanisms
Some Caveats
Diversification, Interest Rates Swaps, and Tranching
Towards Universal Basic Income
Closing Remarks
Acknowledgements and References Stablecoins and Lending Markets Stablecoins and Lending Markets Fixed-Rate Lending Protocols and Derivatives Fixed-Rate Lending Protocols and Derivatives Staking Derivatives Staking Derivatives Staking Fees as Stable Interest Staking Fees as Stable Interest Stabilization Mechanisms Stabilization Mechanisms Some Caveats Some Caveats Diversification, Interest Rates Swaps, and Tranching Diversification, Interest Rates Swaps, and Tranching Towards Universal Basic Income Towards Universal Basic Income Closing Remarks Closing Remarks Acknowledgements and References Acknowledgements and References 6 Stabilization Mechanisms But the scenario of always being able to offer savings interest rates as high as staking fees yield is an unrealistic ideal. It assumes that all of the savings deposited by savers will be successfully loaned to borrowers. In reality, borrower demands fluctuate. If the terms of the loans are sufficiently favorable, enough borrowing should happen. It is understandable that borrowers will find a lower overcollateralization ratio attractive, as it allows them to borrow a higher amount with the same collateral size. But not maintaining a high overcollateralization ratio would mean that the protocol is exposed to a higher level of risks, so the room for maneuver in this regard is not unlimited. This leaves the other parameter, the ratio for the split of the staking fees, as the primary leverage for regulatory control. In the Anchor protocol, when there is insufficient borrowing, the split changes so that the borrower can keep a relatively higher portion of the staking fee; when enough of the savings are successfully loaned out, this split changes in the other direction so that an increased amount of the staking fee goes towards the savers. It is possible that depending on the availability of other borrowing opportunities in the market, even at a very favorable split of the staking fees there may not be enough borrowing demand. Some other lenders may offer a lower interest rate; some are already offering 0% [32]. Others may also be able to offer a lower overcollateralization ratio. We will discuss more about these possible competitions in the next section. As such, borrower demand will necessarily fluctuate over different market conditions. This is why the current Anchor interest rate for savings is set at a few percentage points below expected staking fees income. This allows the extra income to go into a reserve. So if future staking fees income is to fall, the interest rate for savings does not have to change immediately without sufficient warning to the savers. By using the money from the reserve, the interest rate can be maintained temporarily even if staking fees income cannot sustain the rate in the longer run. 7 Some Caveats At the time of writing, the initially offered 20% annual rate Anchor interest rate has been maintained around the same level successfully since inception earlier this year (2021). Notably, even during the market crash in May 2021 when the price of Bitcoin dropped by over 50%, the Anchor rate sustained at around 18% which was within the expected limit. It has been suggested that this highly competitive rate may become a new industry standard [44]. However, staking derivatives are a relatively new type of financial instrument. The market is still at an early stage of development, with new trends emerging rapidly. At the time of writing, Anchor only accepts staking derivatives from the native Luna network as collaterals. Although there are plans to accept staking derivatives from other major PoS networks in the near future, it may be more difficult to fully anticipate what that would entail. One reason is that staking derivative tokens generated by staking the native Luna currency are perhaps not so widely accepted as collateral for loans yet. Therefore, holders of these derivative tokens do not have many other options for generating immediate liquidity via borrowing. But if this general protocol design is to scale up, and to accept other staking derivatives as collaterals, one has to face the market competition offered by other lenders. As mentioned in the last section, some other lenders may be able to afford taking a higher level of risk, by requiring a relatively marginal overcollateralization ratio as low as just 110% [32]. At such a tight margin, should the value of the staked currency suddenly drop substantially during a flash crash, one would have to seize the collateral and sell it very quickly to avoid a loss. The Liquity protocol [32], for instance, is able to do so because of a more efficient and automated liquidation process supported by an internal liquidity pool. Furthermore, they are also able to offer zero interest rate for the borrowers. Currently Liquity only accepts Ethereum (not its staked derivatives) as collateral. But it is conceivable that similar forms of competition may soon come into play for other major cryptocurrencies, as well as their staking derivatives. According to one analysis [45], the Anchor protocol may do particularly well during a bear market. On the savings side, this seems intuitive; saving demands should increase as riskier investment opportunities do not look promising. However, the borrower demands are again more difficult to predict. In a mild downturn, it is possible that some ‘HODLers’ may be more inclined to stake their cryptocurrencies, to wait for the expected market recovery. But if the market is perceived to be in a strong downward trend, or if it is highly volatile, fewer people may be willing to stake. Importantly, the main motivation for borrowing may be to create leverage for further investment. In a downturn, the risk of liquidation (as one fails to maintain the overcollateralization ratio, such as during a flash crash) may render this rather unappealing. Accordingly, since May 2021, the Anchor Protocol have had to offer extremely generous staking fee splits to attract borrowing. At such splits, even if borrowing demand is high, the earned fees cannot fully support the high interests paid out to savers. That is because the income of the protocol is just a multiplicative product of total staking derivative deposited as collateral and the fees split earned per collateral unit. As such, in July 2021, external funds had to be injected into the reserve in order to sustain the high savings interest rate [46]. Despite these caveats, like many others [44, 45], we agree that Anchor is a very timely product, with elegant protocol design and stimulating foresight. Below we outline some areas of further development, for achieving similar goals. Authors:
(1) Hakwan Lau, Center for Brain Science, Riken Institute, Japan (hakwan@gmail.com);
(2) Stephen Tse, Harmony.ONE (s@harmony.one). Authors: Authors (1) Hakwan Lau, Center for Brain Science, Riken Institute, Japan (hakwan@gmail.com); (2) Stephen Tse, Harmony.ONE (s@harmony.one). This paper is available on arxiv under CC BY-SA 4.0 DEED license. This paper is available on arxiv under CC BY-SA 4.0 DEED license. available on arxiv

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Anchor’s 20% Savings Rate Isn’t All That Meets the Eye

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