Anchor Protocolo Liquidations Analysis

The Anchor Protocol allows users of crypto to borrow UST stablecoins by providing LUNA or ETH as collateral. Once the loan amount has been repaid along with interest, the collateral will be given back to the user. In the event that users are unable to repay their loans or the value of collateral decreases below a predetermined threshold, Anchor Protocol will liquidate the collateral and repay the loans.

As we look back at what happened in 2021 and what led to the Anchor Protocol liquidations, it is pertinent to understand why those liquidations occurred. There were 16,240 liquidations carried out by Anchor Protocol in 2021 and the total amount repaid was 240.65 Million USD. As a result of this process, 14.2 million worth of LUNA collateral was liquidated in the open market and sold to pay back the loans. The following chart shows total amount of LUNA liquidated along with number of liquidations carried out on weekly basis in 2021.

In the following paragraphs we will speak about two significant incidents that led to the liquidation of LUNA collateral. The first incident is linked to a faulty price feed used by Anchor Protocol that resulted in LUNA being liquidated by mistake and this happened on December 9th, 2021. A second incident we will look at is May 2021 crypto flash crash that resulted in a sudden drop in the LUNA price, which in turn led to cascading liquidations in Anchor Protocol.  

Around 690K LUNA tokens were liquidated by Anchor Protocol on December 9th, 2021, which frustrated borrowers who had deposited LUNA as collateral as it was not their fault. When the liquidations took place, Anchor Protocol thought the LUNA price had dropped significantly when in fact it was not the case. Anchor Protocolo had been receiving information about the LUNA price as $58.44 during the incident. However, the actual LUNA price was $66.10. In response to this 11.5% drop in the LUNA price, Anchor Protocolo triggered a cascading liquidation event. This resulted in 690K from 239 borrowers being liquidated by mistake. 

Anchor protocol team came out with a communication to all its on users on December 10th and explained in detail about what happened during incident. As this was not borrower’s mistake, Anchor team is looking at ways to compensate the borrowers whose LUNA was liquidated. The first community proposal (https://app.anchorprotocol.com/poll/10) to compensate the impacted borrowers was voted on Dec 24th and rejected by the governing members of Anchor Protocol. A new proposal with a better compensation strategy is being discussed by Anchor Protocol and likely will come up for voting in the coming weeks.

Despite the fact that Anchor Protocol is preparing to compensate the borrowers for their losses, it must be frustrating for the borrowers to sit on losses for more than three weeks while waiting for the Anchor Governance team to review the compensation proposal and come up with a strategy to compensate them. It is these kinds of risks that crypto users take when they chase high yields as compared with traditional finance.

Let’s take a look at the second incident which resulted in a whopping 6.8 million LUNA liquidations in the month of May 2021. The entire crypto market panicked and pushed the “sell” button during this incident. As a result, cryptocurrency prices experienced substantial drops during this period. The king of cryptocurrencies, Bitcoin, lost 30% of its value and carried all other cryptocurrencies down along with it. In the space of four days, the price of the LUNA token dropped from $16 to $4.5 following the suite of the price of Bitcoin.

Due to the dramatic drop in the price of LUNA, 11,000 collateralized loans worth 40.28 million dollars were liquidated.    

Liquidating collateralized loans through automated means is a relatively new concept, which is being pioneered by crypto-based applications. Considering that the whole crypto industry is still in its infancy, the technology isn’t yet mature, and as a result, early adopters of crypto applications are faced with some challenges. However, it is encouraging to see that there is significant progress being made in order to address these problems. It is no secret that those who venture into the crypto ecosystem reap high rewards and are exposed to high risks at the same time. During 2021 the Anchor Protocol was able to liquidate 14.2 million LUNA tokens by performing 16,240 automated liquidations. It can be said that most of the liquidations occurred due to flash crash in May, and some are primarily attributable to a faulty price feed relying on Anchor Protocol. There were also cases where users over leveraged their positions and did not plan for fluctuations in the LUNA price. 

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