The Traditional Investment Case for LUNA

(This should not be taken as financial advice, cryptocurrencies can be incredibly risky. Consult a financial advisor before making any investment decision.)

Cryptocurrencies, as a brand new asset class within the financial space, can be extremely difficult to explain to those from a traditional financial background or for those who only passively invest in the stock market. This can be especially tough when diving into very specific tokens with unique value propositions and tokenomics, as there is a lot of fundamental understanding of the market and technology that is needed to make informed investment decisions.

However, there are many ways in which one can fill the gap between those that only understand traditional equity markets and the investment thesis of cryptocurrencies. When it comes to Terra’s native asset LUNA, I believe there are very easy parallels that can make it a lot easier to understand for those people. Here I lay out LUNA’s value proposition with the perspective of someone with a more traditional background. I focus on four main topics

  1. Terra as a FinTech Application Layer
  2. Dividends and Revenue Generation
  3. Community Stock Backs
  4. Price to Earnings Ratios

FinTech Application Layer

The first thing investors often do when evaluating a company is to understand what they actually do and how they fit into the overall market. The best way to simplify what Terra does is it provides an application layer for extremely unique and groundbreaking FinTech applications. So you can think of investing in Terra like investing in a basket of FinTech apps, each with their specific use case and potential customer. So rather than having ownership of one app, say Chime for example, you have the chance to own the application layer that runs Chime, Robinhood, Mint, and Spaces. And that number of applications could grow as much as developers are willing to build on Terra’s base layer. Let’s take a quick look at some of the apps currently built, or being built, on top of Terra:

Anchor Protocol — A crypto savings account paying 19.5% interest, 39x higher than the leading banks

Mirror Protocol — A synthetic asset protocol allowing users to trade U.S. equities 24/7, from anywhere in the world.

Chai — A payments app in South Korea with over 300,000 daily users and looking to expand internationally

Nebula Protocol — Algorithmic ETF’s, in which any user can program what information will cause position rebalancing. (One example: have an asset that tracks the follower accounts of various companies and rebases assets based on changes)

Alice — A Venmo-like application that allows users to send money to each other, benefit from Anchor’s high yield on deposits, and pay using a native debit card

Spar — An asset management platform that lets anyone create or passively invest in managed funds.

Suberra — Subscription service product that uses Anchor’s high yield in order to allow users to deposit a lump sum and effectively pay nothing for the underlying subscription.

These are just some of over 70 confirmed projects set to be built on Terra. For a full list, go to this link.

Now let’s look at the industries LUNA makes up: FinTech and Cryptocurrencies. The global FinTech market was valued at about $127.66 billion in 2018, and is expected to grow to $309.98 billion at an annual growth rate of 24.8% through 2022. The entire cryptocurrency market as of September 2020 was around $320 billion. As of today, the market is over $2 Trillion, a 525% increase over just a year. Since 2014, the market has grown at an average of 350% per year. Both are extremely high growth industries and at the beginning of their overall adoption.

Now that there is a fundamental understanding of what Terra is, and the markets it encompasses, we can now look at how Terra rewards LUNA holders.

Dividends and Revenue Generation

One of the ways publicly traded companies reward their investors is through dividends, the process in which the company awards its shareholders with excess company earnings. The equivalent to dividends for LUNA would be the process of staking. This is essentially agreeing to lock up tokens as a pledge towards validators who verify transactions in the network, and in return the user is rewarded with transaction fees. Since there are no middle men involved, all of the protocols revenue can be transferred directly to the shareholders, essentially creating close to a 100% dividend payout ratio. This is much more capital efficient, and can therefore allow the users of the applications to consume much lower fees than traditional financial outlets, and provides stakers with generous rewards.

As of the writing of this article, the current staking APY is around 6.5%, which would put LUNA on par with some of the highest dividend paying stocks in the market. With the Columbus-5 network upgrade coming in early September, this number is expected to be over 10% due to the addition of swap fees as rewards to stakers. This number would be larger than the dividends of any single U.S equity.

Stock Buy Backs

Another way companies like the improve their shareholder value is through stock buy-backs. This is the process in which a company uses excess cash to buy up shares of their own stock in order to reduce the number of outstanding shares on the market and therefore increasing the value of each individual stock. However, there has been a lot of issues surrounding this method of improved shareholder value. The first has to do with incentives, as the management that decides to buy back shares are direct recipients of the benefit since they often have stock options. It can also artificially inflate the price and metrics to make the company’s financial situation look a lot better than it really is. People also argue that the money could be well spent elsewhere, whether that be for new research and development, company growth, or just direct dividends to shareholders.

LUNA has a mechanism that can be seen as similar to this process, but with very important differences. In order for there to be new stablecoins created within Terra applications, someone must buy that amount of LUNA on the market and burn it out of existence. This can be seen as a “community” buy back, in which any new money entering the system must “buy back” and equivalent amount of LUNA and erase it from the circulating supply. To make a similar comparison, imagine if every time someone deposited money into Robinhood, that cash was immediately used to buy back HOOD shares on the open market. But again, apply this to not only one FinTech app but many. This value accrual is unlike anything that could be seen in traditional markets.

This buying and burning mechanism also solves for many of the issues surrounding traditional buy-backs. There is no management making the decision, so there isn’t any misalignment of incentives or selfish interests at hand. It shouldn’t be seen as an artificial price increase because it only happens when there is an equal increase in value in the system. For problems with allocating capital, 100% of the revenue is already attributed to dividends, this buy-back only uses excess capital within the system. And with respect to R&D, each application is able to figure out their own form of funding, whether through VC, the community, or TFL’s own wallet. In every way, it provides a much better alternative to traditional stock buy backs.

Price to Earnings Ratios

Let’s take a look at LUNA through the lends of traditional value metrics and see how that compares to similar assets in the cryptocurrency market. We’ve already measured a near 100% dividend payout ratio with a potential double digit yearly APY, which would put LUNA above all other traditional equities. Now let’s take a look at the Price to Earnings ratio.

Token Terminal currently puts LUNA’s P/E ratio at 1500x. This may seem like it is extremely high, but this is due to the fact that Terra is able to provide super low fees for transactions. We can compare this to other blockchains with low fees as well: Solana 4650x, Tezos 2150x, Cosmos 9000x, Stellar 280000x, etc. With the median of all blockchains coming to around 4500x, LUNA is clearly towards the lower end of the market. This also doesn’t take into account that the largest revenue could be seen as coming from the buying and burning of the LUNA token, if you were to argue Terra’s stablecoins are part of the product. Legomakers (@tlagomi on Twitter) put out a fantastic thread explaining LUNA’s P/E ratio as a result of both the protocol revenue and the “earnings” accrued from the minting of Terra’s stablecoins, and was able to compare that with Ethereum as it has a similar burning mechanism. If you want access to the full thread its right here, but here’s his conclusion:

When compared to Ethereum, the smart contract platform leader in the market with a similar burn mechanism, LUNA has a P/E ratio 14x less. This means in its relative market it is extremely undervalued.

Conclusion

If one was to compare LUNA to a stock in the traditional markets, this would be an asset with a 100% dividend payout ratio, stock buy-backs with all cash entering into the system, a P/E ratio well below the industry leader, and is gaining market share in an industry growing at over 300% per year. Therefore, if you were to compare LUNA with the likes of traditional equity investments, it far supersedes anything in terms of shareholder value and high growth potential by large orders of magnitude. For readers who are coming from more traditional financial backgrounds, I hope you were able to come away with a better understanding of how one can value LUNA and other cryptocurrency projects using a long-established value investing framework.

If you enjoyed the content, consider following my Twitter @WestieCapital, and if you have any questions my DM’s are always open. Cheers.

References

Crypto currency investor and researcher. Focus on DeFi, Layer 1s, and the Terra ecosystem