My experience with Anchor protocol and thoughts about the TerraLuna ecosystem crash

My experience with Anchor protocol and thoughts about the TerraLuna ecosystem crash
Photo by Mónica Ballester / Unsplash

The TerraLuna ecosystem crash this week was devastating to many crypto investors, from the small retail investors to the huge venture capitalists. No matter how smart you are, as long as you are active in financial markets, big losses from time to time are inevitable. Sometimes, one manages to escape a crash that engulfs people surrounding him. I was one of the luckier ones who got out of Anchor just in time. I am not writing this to gloat about my just-in-time escape from the TerraLuna crash, given the enormous pain suffered by so many investors. I am no better as I had my share of bad investments this year. Since I was heavily invested in UST and Anchor this year, I believe I am qualified to write an article and share some thoughts about this crash.

Many investors fell in love with Anchor because of the 19.5% yield with stablecoin UST as the deposit currency. It gave people the impression of being a high-yield savings product and appealed to many who hated to have cash rotting in low-yield savings accounts in traditional banks. This was why the damage caused by the Anchor fiasco was so far-reaching. If it was portrayed as a high-risk investment product, investors would have put in much less money. Anchor fan-boys happily talked about their high passive income, thanks to Anchor, on social media. If you put in $300,000 into Anchor, you will be getting $4875 monthly passive income which is enough to feed a frugal family with 2 kids in Singapore. I hope nobody quit his job because of Anchor.

For the less savvy folks, it was not hard to get the impression that Anchor was fairly safe. UST stablecoin looked safe for 99% of the time when it hovered near the stable price at $1 until this week when it crashed 80%. Anchor attracted billions in deposits. Its size gave people the impression of safety and wide acceptance. At its peak, Anchor attracted deposits of up to USD17 billion. The timing of peak deposits was most unfortunate. It was only about 1 week ago. The deposits were wiped out at their peak.

Source: Anchor went from hero to zero within a week from its peak

What really wipes out investors is when something is thought to be safe but turns toxic because investors tend to put more money in what is deemed safe. It happened this week to Anchor depositors. It happened 14 years ago during the 2008 financial crisis to big institutional banks who bought AAA-rated securities by the truckload which blew up later.

When I first read about Anchor, it was obvious the high 19.5% yield was unsustainable. One can view Anchor as a company operating in the lending business. To attract depositors, it offered a juicy 19.5% yield. Unfortunately, Anchor was unable to generate enough income from its borrowers to pay the high yield to its depositors. So, Anchor set up a Reserve Fund from its own pocket to pay depositors the shortfall. To put it simply, if a business has to pay you lucrative amounts of money to use its product and lose money as a result, how can this product be sustainable?

There are ultra-rich venture capitalists who ploughed a lot of money into the TerraLuna ecosystem. If I could see that Anchor is unsustainable, how could these VCs who are much richer and smarter not see it as well? Of course, they know Anchor was unsustainable but who is to say it will remain unsustainable forever? Most start-ups start off with an unsustainable business. Most lose money in the first year and most fail anyway.

As an investor, I do not mind investing in money-losing businesses because there is always a chance that they will turn around one day, reaping good returns eventually.

Some Anchor critics call it a Ponzi scheme but what if it is a very transparent Ponzi scheme? What I like about the crypto world is transparency. You cannot lie on the blockchain. Anchor's financial operations are transparent. How much lending, borrowing and when the Reserve fund is going to run out can be tracked in real-time on the blockchain. If it is on the blockchain, you can be sure it is 100% accurate and authentic. This is more transparent than any public-listed company I have come across.

While Anchor's 19.5% yield was not sustainable, its operations are highly transparent. I decided to put UST funds in Anchor as the transparency lowers the risk. UST was a liquid stablecoin and I can easily exit my position within the same day. The liquidity mitigates the risk. My UST position was by far my biggest this year. I decided not to take any leverage on Anchor mainly because of the risk and partially because of bad experiences with crypto exchanges which sometimes delay my fund withdrawals for hours. Even my favourite crypto exchange FTX does this to me sometimes. I do not want my funds to be liquidated because the exchange delayed my fund withdrawal at the worst possible time when I need to top up to avoid a margin call. I was lucky I did not use leverage because many investors got liquidated on Anchor due to network congestion during the crash.

I believe many crypto investors had large positions in stablecoins when TerraLunaUST crashed because of the bear market this year. Bear markets tend to cause investors to raise their portfolios to higher cash levels. I do not think I was alone among crypto investors in having a heavy position in UST because of the high yield.

I view the biggest risk in holding UST as de-pegging risk. Depegging means that the stablecoin which is supposed to hold stable at $1 fails to hold on to $1. Unlike currencies, UST is not backed by hard assets like cash and government bonds. It is backed by software algorithms. I do not feel comfortable with pegs maintained through algorithms and not hard assets. However, the advantage with algorithms is again the transparency. You can know with precision how the algorithmic pegging mechanism works. This knowledge can be used to work out a plan for exit. The stability of UST is dependent on the strength of Luna. To put things simply, as long as Luna price remains strong, UST will be safe.

My plan for investing in Anchor goes something like this;

  • Monitor the Anchor Reserve Fund closely and be on the alert to exit when the Fund is going to run out within 45 days. Once the fund's runway reaches 15 days, withdraw all deposits. If the Reserve Fund is topped up later, deposit funds back.
  • Monitor the price of Luna. If Luna's price shows strength, ignore UST price weakness as long as it remains above $0.975.
  • Monitor the price of UST closely and be on the alert when it drops below $1. If it drops below $0.995 and Luna's price shows weakness, withdraw some funds out and convert UST to USD, particularly if there is no immediate rebound. If it drops below $0.99 and Luna's price is weak, convert even some more UST to USD. If it drops below $0.98 and Luna's price is weak, convert all UST to USD.
  • If UST price falls below $0.975, convert some to USD regardless of Luna price. If UST continues to fall, use discretion to decide whether to take the loss and exit completely. I usually will take complete loss quickly with little hesitation.
  • If UST price restores to $1, stabilises there and Anchor Reserve is topped up later, place deposits back with Anchor.

This plan of action saved me from serious losses. Luna's price started to weaken one month ago. UST price weakness followed 2 weeks later. During normal times, I observed a pattern of UST price strengthening on days when crypto markets weaken, probably because traders moved more of their positions to safe-haven stablecoins. During the past 2 weeks, the opposite happened. That was an unusual sign of UST price weakness. The price weaknesses plus the Anchor reserve runway falling below 45 days near the beginning of May made me nervous. When I feel nervous, it is a good signal for me to exit. I exited.

When the crypto market was crashing this week, I saw many people giving advice on Twitter and Telegram not to sell. They gave advice like "fortune favours the brave" and "Don't be the idiot who sells at the bottom out of panic". When markets are in a state of panic, it is important not to listen to the advice of online strangers on whether to sell or hold. It is everyone for himself. Maybe he wanted to sell UST and Luna but cannot due to network congestion or the liquidity is too thin for his huge bag. So, he does not want you to sell so that he has the liquidity to sell everything at a better price later.

Whether the decision is to sell or hold, make sure it is your own decision and you're not following others. If you lose money as a result of your own decision, you learn something. If you lose money because you followed others, you learn nothing and the school fees are wasted. If someone offers facts and sound reasoning, hear him out but ignore him when he advises you to sell, hold or buy. It could be biased and self-serving advice, particularly when he has a vested interest and the market is in panic.

The distressing aspect of the TerraLuna crash is social media accounts of attempted suicides by people who lost their life savings. Losing money and becoming poor is a temporary situation. As long as a person's health is in good shape, he can always make it back over time with hard work. Please do not do anything silly like suicide, especially when there are dependents.

For aged people who no longer have the health and energy to work and recover from financial setbacks, the standard and sound advice is never to take big risks with large sums of money and practise diversification. When I become old, I will try my best to avoid concentration even if the asset looks safe.

Lesson from Anchor

The deepest lesson that the Anchor fiasco taught me is ... It is what looks safe but turns out to be unsafe that kills people.


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