To understand the inner workings of the Anchor Protocol you need to be familiar with two things Staking and Decentralized Lending and Borrowing.
Staking
Staking is when you lock up your cryptocurrency for a certain amount of time in exchange for something. Usually more of the same cryptocurrency in proof of stake validators stake cryptocurrency to process transactions.
On that cryptocurrency's blockchain in exchange they earn transaction fees and block rewards in this case validators on terror stake. Lunar and earn about 9 percent per year in transaction fees and block rewards which are of course paid in Luna.
DEFI
Now the catch is that terror validators must lock up their Luna for at least 21 days and if they try and manipulate transactions on the blockchain they will lose some of their stake. In a process known as slashing staking is also possible in many DEFI protocols rather than earning transaction fees and block rewards in exchange for processing transactions. DEFI stakers often earn protocol fees and earn the right to participate in community governance AKA vote on how the protocol is changed in this case stakers on the Anchor Protocol stake the ANC token and earn about 20 per year in protocol fees. Which are of course paid in ANC stakers can also table and vote on proposed changes to the protocol.
The catch is that the ANC token is very inflationary and this means it has a harder time holding its value compared with other cryptocurrencies. ANC is a bit of an exception in this regard more on that later as for decentralized lending and borrowing this basically consists of two components lenders and borrowers so far so good.
So on the lending side lenders deposit their cryptocurrency into a borrowing and lending protocol. This makes it possible for individual lenders to withdraw their funds whenever they want. Since it's very unlikely that all the lenders will withdraw at the same time in this case lenders on the Anchor Protocol deposit UST into the protocol to clarify lenders are synonymous with savers in this context.
This means that when you deposit UST into the Anchor Protocol what you're actually doing is lending your UST to borrowers behind the scenes on the borrowing side borrowers deposit a dollar amount of cryptocurrency that's worth more than the dollar amount of cryptocurrency they want to borrow this is called over Collateralization and it exists to ensure the protocol always has enough money to cover the cost of the crypto being borrowed.
In this case borrowers on the Anchor Protocol deposit either Luna or ETH to borrow an amount of UST from lenders that's worth up to 80 of the dollar value of the crypto they deposited.
Suppose that, If a borrower deposits 1,000 of Luna they can borrow 800 of UST. You're wondering why anyone would ever take out this kind of Over-Collateralized loan the answer is leverage. Many traders will use their crypto as collateral to borrow stable coins and use those stable coins to buy even more crypto when the market is rallying lots of people also use over collateralized crypto loans to pay their bills between paychecks without having to sell any crypto.
On the lending side lenders are incentivized to deposit their idle coins and tokens in exchange for the interest that borrowers pay on their crypto loans on that note if a borrower borrows more than 80 of the dollar value of their collateral in UST. If this threshold is met because of the interest they owe on any UST they borrowed the collateral they put up is liquidated.
Sold this again to ensure that the protocol has enough money to remain solvent.
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