- Coinbase Earn: Get Free Cryptocurrency for Completing Educational Content
- All About Terra’s LUNA Cryptocurrency and Anchor Savings Protocol
- How to Earn 20% APY with Terra’s Anchor Protocol, a DeFi Yield-based Savings Account
Disclaimer: The opinions expressed in this article are solely those of the author, and do not constitute investment advice. Frugal Flyer is not responsible for any losses you may incur (but we are happy to take credit for any profits you make 😉). As always, do your own research and invest at your own risk.
At Frugal Flyer we mostly focus on leveraging travel and credit card rewards to save money. However, investing and personal finance is also important for saving money. Today, we take a detour to talk about one of the most hyped alternative investment categories today: cryptocurrency. Specifically, Luna is a cryptocurrency I’ve taken a personal interest in, and is one that is less well known compared to the big players like Bitcoin and Ethereum.
All About Luna
What is Luna?
Luna is the primary cryptocurrency of the Terra blockchain. Terra is a ‘layer-1’ blockchain, meaning it acts as a base architecture, upon which other blockchain-based applications can be built. Like Ethereum, Terra leverages smart contract functionality. However, it also has a ‘stablecoin’ protocol built into the base layer. The protocol actively and algorithmically modulates the monetary supply of different assets to maintain a certain price peg.
Terra was built using Cosmos SDK, which is an open-source framework for building Proof-of-Stake blockchains. The main thing to know about Cosmos is that it allows for interoperability natively. That is, all blockchains built on Cosmos are able to communicate with each other. This is a key problem in the crypto/blockchain world that multiple projects are trying to solve (another example being Polkadot, built by Ethereum’s CTO).
Some of the key layer-2 projects that are live on Terra are Mirror, Pylon, and Anchor.
Mirror Finance: Mirror uses Terra’s concept of monetary supply modulation and applies it to US exchange-traded equities to create so-called synthetic assets. Why would one want to buy synthetic versions of US stocks? Well, in foreign countries, access to investing in the US market is limited. Mirror solves this problem and makes the market more accessible.
Pylon Money: Pylon is a suite of savings and payments products that enables exchanges of value between value providers and consumers. It makes use of customizable, decentralized deposit contracts to do so. See this Medium article for a nice summary of Pylon Money.
Anchor Protocol: Anchor is a decentralized savings account that offers low-volatility yields on Terra stablecoin deposits. Anchor offers >19% APY on UST deposits as of January 2022. We’ll discuss UST and Anchor in more detail below.
What is UST?
TerraUSD (UST) is the pre-eminent stablecoin built on the Terra blockchain. It is a decentralized cryptocurrency that algorithmically maintains a 1:1 peg to the US dollar. How does it do this?
Terra uses its primary cryptocurrency LUNA, as a reserve asset to maintain the price of all stablecoins running on its network. Smart contracts enforce programmed rules around how UST (and other stablecoins) and LUNA are minted and burned. This is done in such a way that an arbitrage opportunity is created if UST’s price is anything other than $1.
For example, suppose $UST is at $0.95 (below peg). In this case, anyone can buy $UST at $0.95 and then burn it to receive $1 worth of $LUNA, which will in turn result in $UST reapproaching its peg and the user receiving a $0.05 risk-free profit.
The cost of minting new UST is equal to the value of the stablecoins minted — so then in order to mint 1 UST, $1 USD worth of LUNA must be burned. UST monetary policy is purported to be infinitely scalable — something that competitor algorithmic stablecoins such as Maker’s DAI have had challenges achieving.
What is Terraform Labs?
Terraform Labs is the company that developed the Terra blockchain. It was founded in 2018 by Daniel Shin and Do Kwon and is headquartered in Seoul, Seoul, South Korea. Kwon has now taken on the role of CEO of the company.
Terraform Labs has been seeded by over 60 million in venture funding from Galaxy Digital, Coinbase Ventures, Pantera Capital, Hashed, Arrington XRP, and Kenetic Capital.
The Bullish Outlook on Luna
Terra has Real World Payments Usage
Terra is one of the few layer 2 ecosystems with relatively advanced real-world use outside of the cryptosphere. By this I mean everyday usage, things like taxi drivers, restaurants, cafes, and shops. This is via CHAI, a fintech app created by Terra and used in South Korea where users/merchants pay/accept in Korean WON (KRW) for their day-to-day activities. On the backend, the KRW is converted to Terra KRW and transactions are settled on the blockchain with fees accruing back to Luna stakers.
CHAI payments is currently used in Korea quite widely, even though most of the people on that payment system don’t even know it runs on the Terra network. It is frictionless, as it should be! And in Dec 2020, CHAI raised a $60m Series B from Hanwha, Softbank, and other strategic partners with the end goal to expand CHAI in other neighboring countries such as Taiwan, Thailand & Vietnam.
LUNA is Burned as Stablecoin Demand Increases
Terraform Labs is working to bring use cases like CHAI to more countries which would increase the demand for Terra stablecoins. As explained, the supply of Terra stablecoins directly influences the supply of Luna tokens. As the supply of stablecoins is continually increased to meet demand, LUNA will be burned. This brings about a unique characteristic of LUNA; the price of LUNA can increase without its overall market capitalization increasing.
The prominent stablecoins in the crypto space are all USD-based, including USDT, USDC, BUSD, UST, and so on. UST is the only of these to be algorithm based, and also the fastest-growing stablecoin by market cap. At the time of writing, UST is approaching 16 billion USD in market capitalization, which still leaves a lot of room to grow with USDT sitting at 81 billion USD.
Terra’s Decentralized Finance (DeFi) Ecosystem is Innovative and Tops DeFi Revenue Generation Globally
As we mentioned earlier, Mirror, Pylon, and Anchor are some examples of innovative DeFi (or ‘TeFi’ as they are called in Terra ecosystem) applications being built on Terra. And there are many more being launched all the time, with over 100 expected in 2022.
You can track current Terra DeFi applications specifically on DeFi Llama.
Terra has quickly become considered the #2 network of choice for decentralized finance applications, after Ethereum. According to data from DeFi Llama, Terra has 26 billion in total value locked (TVL), compared to Ethereum’s 122 billion. What’s more encouraging, Luna has achieved this size with only 25 protocols compared to Ethereum’s nearly 600. Said another way, Luna has achieved 1.5 the TVL of Ethereum with only 1/24 as many defi applications.
All About Anchor Protocol
What is Anchor Protocol?
Anchor Protocol is a decentralized savings and borrowing protocol offering low-volatile yields on Terra stablecoin deposits, primarily UST. Currently, the target interest rate is maintained at ~20% APY.
The Anchor interest rate is backed by a diversified stream of staking rewards from major proof-of-stake blockchains (including Terra, Cosmos, Ethereum, Polkadot, and many more to be onboarded). As a result, Anchor returns are expected to be more stable than typical money market interest rates.
How is this target rate achieved? Through the demand for borrowing UST.
Borrowing from the Terra money market is as straightforward as locking up collateral in exchange for a loan. If the staking reward from the collateral provided is greater than the target rate, the excess returns are added to Anchor’s reserves. If rewards are less than the target rate, reserves are drawn upon to make up the difference.
As Terra scales and as demand for Anchor’s yield outpaces demand for borrowing UST, the reserves can get depleted quickly. Therefore, Terraform Labs has subsidized these reserves with a large initial deposit and follow-up injections of capital. If the reserves were to be entirely depleted, the target rate would ultimately have to be lowered.
This is a contentious subject in the Terra-verse, and something to be aware of for those looking to invest in Anchor and Terra: the juicy 20% APY may not last forever.
Is Anchor Safe?
We generally consider Anchor to be a safe place to deposit assets (but remember to read our disclaimer, nothing is absolute).
As far as the protocol and ecosystem go, Anchor has minimal risk. Their smart contracts have been audited and you can read about their security protocols in detail if interested.
The biggest risk I see storing UST in Anchor, or rather in holding a large amount in UST regardless of where it’s held, is the risk of UST losing its price peg, or ‘de-pegging’. If UST were to lose its peg to the US dollar, your assets would have lost value accordingly.
However, to me, this still beats having a 3rd party risk like with most other stablecoins backed by hard assets or actual USD, rather than algorithms.
Also of note, UST has survived some significant ‘stress tests’. Notably, it survived the May 2021 market crash, albeit with a few small hiccups:
- Anchor’s APY dropped to 18% from 20%, but quickly returned to 20%.
- UST lost its peg for a few days due to a limitation in the amount of arbitration per day (this is a security feature that prevents large players from exploiting the peg).
However, UST quickly regained its peg over the next few days. The protocol was also upgraded following that crash to allow for a tighter peg to the dollar. This better aligns with the large increase in the market cap of UST since then too.
Nonetheless, if that’s not enough to give you confidence in holding your assets in Anchor, there exists a risk management solution: insuring your deposits against hack and de-pegging with decentralized insurance providers.
So let’s talk about insurance.
Insuring Anchor Deposits
|Insurance Provider||Smart Contract Coverage||De-peg Coverage||Cost Per Annum||Total Value Locked (TVL)|
|InsurAce||✔️||✔️||2.50%, 3.27%, respectively||40M|
|Unslashed Finance||✔️||✔️||8.95% for both, 4.69% for depeg only||73M|
|Risk Harbor – Core||✔️||✔️||10M|
|Risk Harbor – Ozone||✔️||❌||2.00%||10M|
If you purchase Protocol Cover for Anchor on Terra, your deposits on Anchor are protected against a loss of funds in the event that:
- Code is used in an unintended way (e.g., a hack or exploit)
- Assets are liquidated due to economic design failure (e.g., like the MakerDAO Black Thursday event)
- Assets are liquidated or lost due to severe oracle failure or oracle price manipulation
- A governance attack occurs that leads to a loss of funds within the protocol
With Protocol Cover, you get cross-chain protection under one policy. The cost for cover is 2.6% per annum, but 10% of your premium is reserved for claims filing and can be withdrawn 35 days after cover expiry. Because members can file claims for up to 35 days after a cover policy expires (for a loss within the covered period), the 10% reserved for claims filing can be withdrawn on the 36th day after expiry. This means the real cost of Nexus cover is 2.34% per annum.
Members often ask how they would file a claim in the event a loss of funds within Anchor’s smart contract system occurred. There is a guide within the Nexus documentation that walks through the process of How to File a Claim. If you file a claim, the Nexus UI guides you through the process, and to provide proof of loss, the Nexus UI will direct you to sign in to your Terra wallet and sign a transaction or send a 0 value transaction to prove ownership of the wallet. From there, the UI will direct you through the rest of the claims process. If you’d like to read about past claim payouts, you can review the Claims History section of the Nexus documentation.
To date, Nexus Mutual has paid out over $2.5mm in successful claims.
InsurAce.io Protocol is a Singapore-based DeFi Insurance protocol and competitor to Nexus Mutual. It is now the second-largest protocol in DeFi insurance.
InsurAce offers coverage on both Smart Contract Vulnerability and Stablecoin De-Peg risk.
InsurAce’s Smart Contract Cover protects against:
- Smart contract hacks/ bugs
- Severe economic attacks
- Governance attacks
At the time of writing, Smart Contract Cover premium is 2.50% annually.
Meanwhile, the De-Peg Risk coverage insures the value of the quantity of the UST for a value of 1 UST = 1 USD when UST moves off its peg. According to the full policy wording, UST must trade below $0.88 USD based on a 10-day Time Weighted Average Price (TWAP).
At the time of writing, the premium for UST de-peg coverage is 3.27% annually. The target price for the premium is between 2% and 3% but is determined algorithmically based on supply and demand (range 0.63% to 4.30%).
Here is a good video review of InsurAce by the Babylonians.
Bridge Mutual is another decentralized insurance protocol, and as such, all claims must be voted on and approved by BMI (Bridge Mutual Insurance) token holders.
Bridge Mutual only offers protocol (smart contract) coverage, which protects against the permanent loss of assets occurring due to malicious acts that:
- exploited vulnerabilities in the Protocol’s code; or
- drained virtually all of the value from the Protocol’s native assets (commonly referred to as a “rug pull”); or
- caused the Protocol’s website or application layer to direct the Policy Holder’s funds to a foreign address (including by way of oracle manipulation, DAO governance attack, or a “rug pull”)
You can read the full details of the BMI protocol coverage in this document. Overall it looks fairly reasonable and comparable to other insurance protocols.
However there appears to be a glitch, whereby the coverage cost is meant to sit at 2%, but on their app is showing an inflated annual cost. 15% is obviously not competitive with other insurance providers for Anchor.
For this reason, and because they are a relative newcomer to the decentralized insurance industry, I would avoid them right now.
Unslashed Finance is the third-largest insurance provider by TVL, and has two policies, one which covers both Anchor Protocol and De-peg risk, and one which covers only De-peg risk.
The Unslashed smart contract policy covers losses due to “an unauthorized, malicious or criminal act aiming at exploiting covered smart contracts’ code vulnerabilities; and/or loss occurred due to errors or omissions in code implementation, or unavailability or failure to access or process these covered smart contracts”.
The Unslashed De-Peg policy covers the value of the quantity of the UST for a value of 1 UST = 1 USD when UST trades below $0.87 USD for a two-week Time Weighted Average Price (TWAP), based on reputable sources (CoinMarketCap, Coingecko).
At the time of writing, the premium for Anchor+UST combined policy is 8.952% annually and for UST de-peg only policy is 4.689% annually.
On Unslashed, the coverage amount is denominated in Ethereum. This means if Ethereum price fluctuates a lot, you may have to add or reduce your deposited amount to ensure full coverage of your UST assets. Claims on Unslashed are handled by a third party assessor and not by governance token holders or collateral providers.
Risk Harbor is yet another major decentralized insurance provider, a newer but rapidly growing one at that. It has two ‘pools’ for protection, Core and Ozone. Core is built on Ethereum, whereas Ozone is native to Terra.
Risk Harbor works a bit differently than other providers which rely on decentralized governance to assess insurance claims. Instead, Risk Harbor Core and Ozone use smart contracts designed specifically for detecting default events.
Anchor Protocol Risk: To protect assets held in Anchor, Risk Harbor algorithmically verifies the redeemability of aUST to UST using the EthAnchor bridge created by Terra. If the redeemability is significantly lower than expected, the user will be allowed to swap their aUST for an alternate stablecoin derivative.
UST De-peg Protection: To protect against stablecoin peg loss, Risk Harbor checks the 1-hour time-weighted average price (TWAP) of wrapped UST compared to USDC on Uniswap. If that price falls below a predefined loss threshold, the contract will say that the claim is valid and allow the UST holder to swap their UST for USDC.
This pool combines the standard protection on yield farms and money markets with UST peg protection. This means it protects not only against the risk associated with Anchor protocol but also against the risk of UST losing its peg.
There are several risks of Core pool. If a hack occurs and a claim is fulfilled, the policyholder will be paid out in USDC (as Core is built on Ethereum). As long as USDC doesn’t also lose its peg, the underwriting capital will maintain its value. Also, if another protocol in the vault suffers a default event before this pool does, then the vault may default and be unable to pay out the full value of the protection.
These risks are rather unlikely and would require a black swan event to occur. Then again, the whole point of insuring crypto assets is to protect against such events.
The Ozone pool offers protection only on the risks associated with Anchor protocol. There is no UST peg protection (although it is planned in future versions of Ozone). Ozone uses the same mechanism as Core to algorithmically insure assets (for both validating and awarding claims). You can read more about these mechanisms in the Core V1, Core V2, and Ozone whitepapers on GitHub if curious.
In Ozone V1, the underwriters are not individuals who buy into insurance collateral pools, instead, the Terra Community Fund is the sole underwriter. This will possibly change in Ozone V2.
Overall, Ozone is an exciting protocol and is beginning to attract institutional investors, who would normally shy away from uninsured assets by the way, to invest in Anchor/Terra. For example, TechCrunch Founder Michael Arrington has launched the Arrington Anchor Yield Fund, a vehicle for institutions to deposit USD into Anchor Protocol secured by Ozone.
It is also worth noting that Ozone V1 smart contracts have been audited by Oak Security & Certik, which are well-reputed in the industry.
Terra (Luna) is a cryptocurrency and blockchain that intrigues me because no other Ethereum competitors are really doing what they are with algorithmic stablecoins. I’m very excited to see if Terra succeeds in becoming a dominant player in the crypto ecosystem in the future (at the time of writing it has already catapulted to top 10 by market cap).
Even if you’re not interested in holding any cryptocurrency due to the inherent volatility, projects like Anchor offer a way to generate a stable (pun-intended) return on your capital if you’re willing to hold stablecoins. This is similar to generating returns by holding stablecoins on platforms like Celsius, which I’ve previously discussed. However, on Anchor, you are free from 3rd-party centralized risk. Of course, Anchor comes with other risks (protocol risk and de-peg risk).
For me, the higher return on Anchor (~19%) and the fact that you can insure against the aforementioned risks, make it a worthwhile investment. Stay tuned for a future how-to article where we break down step-by-step how to buy UST and stake it in Anchor for 16-20% APY.
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