Luna Foundation Proposes $450M Cash Injection to Boost Anchor DeFi Protocol Reserves

The Luna Foundation Guard (LFG) proposed on Feb 8 to replenish the Anchor Protocol yield reserves by $450 million. The Foundation is stepping in to help the DeFi lending and borrowing protocol keep its comparatively high interest of 20% over the next year.

Anchor is at the heart of the Terra (LUNA) economy, with $9.8 billion in total value locked. But the protocol’s yield reserve, a form of a savings account, has slumped more than 80% since December due to a lack of borrowing appetite, threatening to shutter the Terra ecosystem.

A spokesperson for LFG said the proposed cash injection is a temporary fix, designed only to allow the development of a more sustainable economic model for Anchor. So far, the plan is to introduce a model that incentivizes borrowing while diversifying collateral to include new staking assets.

Anchor will be adding more assets from other blockchains such as Avalanche, as BeInCrypto previously reported, and now also Solana and Atom. These changes are expected to boost income and staking rewards, as well as dilute LUNA’s dominance in Anchor collateral to below 40%, allowing the protocol to become “sustainable.”

“This refinement process takes time,” said the spokesperson, identified only as n3mo, in a statement. “We believe having a sufficient yield reserve to continue scaling UST’s growth to newcomers and inspire existing users’ confidence will benefit all stakeholders.”

N3mo said the long-term “goal is to ensure Anchor achieves mass adoption” while it remains essentially “decentralized and self-sustainable.”

Depleting Terra reserves

Anchor pays around 20% interest on deposits of UST, the U.S. dollar-pegged stablecoin native to Terra. The rate is known as the “anchor rate.” It is fixed, and significantly higher compared with rates of between 0% to 8.5% currently offered by industry competitors.

The protocol is able to pay this high rate from interest charged on loans, liquidation fees, and yield earned from borrowers’ collateral. But as crypto markets crashed, borrowers have been in short supply, forcing Anchor to dip into its reserves in order to sustain its so-called “anchor rate,” built to become an industry benchmark.

According to Mirror Tracker, Anchor’s reserves have tanked more than 80% from $70 million on Dec 29 to $13.1 million on Feb 9. On average, reserves have been falling by about $1.6 million per day over the past four weeks. At this rate, existing reserves are enough to cover only the next eight days, as at the time of writing.

In the event that the “yield reserve depletes, Anchor will just operate like regular [Defi] money market,” with rates falling to 15%-16%, says Do Kwon, co-founder and chief executive officer of Terraform Labs, the South Korean-based entity behind Anchor.

Too big to fail

The Luna Foundation Guard worked out different scenarios regarding the projected growth of deposits, collateral, and borrows, concluding that a top-up of $450 million to the yield reserve was sufficient for Anchor to maintain its 19%-20% deposit interest rates for the next year.

The pseudonymous spokesperson explained:

Topping up the yield reserve should be viewed [as] akin to marketing expenses in bootstrapping an integral component of the Terra network. In fact, it might be the most effective way to scale UST to the masses.

Crypto investor and analyst @Route2Fl believes that Anchor has become too important for the Terra ecosystem that it is hard to see the protocol being allowed to fail.

“If the Anchor rate is lowered, some people will flee from UST to other opportunities, leading to a reduced market capitalization of UST and an increase in Luna supply, which reduces Luna price,” they wrote on Twitter.

“It’s hard to say if this will happen to an extended degree or not, but it’s one way to look at it. In my opinion, there is no way they would give up this project now, and I think the team knows very well that if they want more users and to grow faster they need to sustain the 19.5%,” @Route2Fl added.

This is not the first time that Anchor’s yield reserve has been recapitalized. Terraform Labs injected around 70 million UST into the reserve in May last year amid a market-wide decline. At the time, UST dropped below its peg to the U.S. dollar to about $0.93, creating a lot of arbitrage opportunities. LUNA crashed as traders feared a collapse of the Terra ecosystem.

LFG was established in late January “to focus on the stability and adoption” of the UST. Do Kwon said Terraform Labs “donated 50 million LUNA” — the equivalent of $2.8 billion at current market prices — to the Foundation for this cause.

LFG is based in Singapore and is overseen by a group of founders and a governing council of experts including Do Kwon, Nicholas Platias, lawyer Bill Chin, Kanav Kariya, Remi Tetot, and Jose Maria Delgado of Delphi Labs. The decentralized organization will also offer funding in the form of grants to support initiatives built on top of the Luna network.

At press time, the price of LUNA is down to $56. According to CoinGecko data, the coin is 46% off its all-time high of $103 reached in December.