They're probably crypto speculators looking to lever up. If crypto could double in one year then borrowing at 25% isn't crazy.

where do the new Terra coins come from? If Anchor pays me in more stable coins, they had to buy USD to be allowed to mint them right?

Terra was pegged to $1 but it wasn't backed by USD. Terra was backed by Luna and it was possible to convert Luna to Terra without any USD being involved. People called this out as unsafe in 2021.

Why not just take USD to lend USD to get USD to return USD?

I'm not sure regulators would allow anyone to do this kind of lending in the real banking system.

I’m ignoring answers like money laundering and avoiding KYC and other financial regs.

Don't ignore it. The purpose of a lot of DeFi is to allow people to do things that regulations don't allow.

And again who borrows money, probably denominated in some crypto, at >20%? ... You’d need those people for this to work?

AFAIK Anchor never had enough borrowers to sustain itself. I suspect the long-term plan was to draw in deposits with the 20% rate as a teaser, then lower rates over time and hope depositors stayed due to inertia. Other lenders like BlockFi and Crypto.com offer have also lowered their rates multiple times over the past 18 months.

I'm not trying to defend Terra/Luna/Anchor here; it was always doomed and it failed. But it wasn't obviously doomed; only a few people did the math that showed the danger. If you only look at the surface it looks like it works.

The reality is that these juiced returns were not sustainable and in the end made it even harder for them to defend the peg of their poorly designed pegging mechanism.

You can't compare the returns in the crypto space to the banking sector. At the moment leverage on an exchange (Binance) costs 7.3% PA at the moment. The exchange also takes a fixed percentage of your trade as a fee. This is why locking up stable coins on Binance nets you more interest than the average savings account. A bank can't or won't lend you money against crypto.

Another scenario is someone who holds say Bitcoin. They have a decent income and want to buy a new car. If they think Bitcoin will appreciate in value instead of selling Bitcoin to buy a new car (which will trigger a capital gains taxable event) they can just borrow against their Bitcoin. The cash or stablecoin for the loan has to come from somewhere. Like I said above banks won't accept Bitcoin for a secured loan.

Collect many of those short-term high-interest loans into a single bucket, and you have a longer-term high interest facility. Like being an LP in a credit fund. So there is a fairly high fundamental yield. Not 20%, but maybe 6%.

Second, as the GP mentions, they were also using their marketing budget to pay an unsustainably high yield to excite and entice investors. So on to the 6%, add another 4% of VC money.

Finally, they were underestimating the risk of the underlying loans defaulting, thereby causing them to overestimate the APY on the pool. That brought them to a place where they thought they could pay 20% instead of 10%.

There might be more to it than that but that's what I understand.

People deposited to receive incentives. They borrowed to receive incentives. That’s it.

The APY was chosen arbitrarily. Nobody there underestimated default risk.

Dumb place to stick your money FWIW.