So what’s Luna all about? Well as of 23rd November 2021, it’s ranked 14 with a $17 Billion Market Cap!
Terra (Luna) is the world’s biggest dual-token platform, which is a network with two intertwined tokens that have separate utility. LUNA coins are on its native blockchain, while Terra USD (CRYPTO: TUSD) stablecoins are on the Ethereum blockchain.
Before we actually get into the details, we want to start off with our opinions on LUNA and where we see it going from here. In all honesty, we are not huge fans of Price Targets as they are a bit arbitrary in our opinion. BUT, we will give one for the sake of making this information easier to digest and it gives us a benchmark to measure our success against.
In short, we see LUNA as one of the strongest buys in the entire crypto space. You heard us correctly, the conviction on this coin is up there with the likes of Bitcoin, Ethereum, Chainlink, etc. Does this mean go all in on LUNA? NO! What it means is to make a sizable risk-adjusted bet on LUNA!
For us, LUNA now holds the 4th largest position in our portfolio after Bitcoin, Ethereum, and Chainlink. Essentially, LUNA is our highest conviction alt-coin investment. What you decide to invest in LUNA is up to you, but we would not recommend LUNA making up a greater position of your portfolio than Bitcoin or Ethereum.
So… What’s the target? Our analysis gives us a target of ~$53.5 billion for LUNA’s Market Cap. At a current market cap of ~$17 billion, that gives us an upside of ~3.15x. The time frame for this is roughly 1 year, so let’s say Q4 of 2022. While we’re predicting a market cap of $53.5 billion, we’ll also give the low-end and high-end estimates. Our low-end estimate is a market cap of $14.5 billion, for a downside of .829x. And our high-end estimate is a market cap of $145 billion, for an even better upside of 8.53x.
Why do we give these targets in terms of market cap and not price? We’ll explain in more depth later on, but the supply of LUNA tokens aren’t exactly easy to predict. Want to see how we arrived at this target? Well, keep reading!
What is LUNA?
The first, and arguably most important, question to ask when analyzing any coin is “What is it?” As we mentioned in our Altcoin Investing Post, that is the first thing you should always do. If you can’t answer that question, you shouldn’t invest!
As for LUNA, it is the Native Token of the Terra blockchain. The Terra blockchain is a decentralized layer 1 smart contract platform with the goal of creating decentralized algorithmic stablecoins…What the hell does all that word salad even mean!?! Alright, try to stick with us here as we explain. Terra is a blockchain which enables the use of smart contracts. What this means is that various dApps and protocols can be built on the blockchain, enabling things such as DeFi, NFTs, and other tokens to exist on the Terra blockchain. Similarly to how ETH is the token used to power Ethereum, LUNA is the token used to power Terra.
However, the main use case and importance of the Terra blockchain is creating decentralized algorithmic stablecoins. The main one being UST. If you haven’t heard of stablecoins, they are a form of cryptoassets which mirrors the price of a fiat currency, most usually US Dollars. Basically, they are the crypto version of a dollar. Most stablecoins, such as USDT and USDC are centralized. They are controlled by a central entity which acts as a middlemen. For every “dollar” issued on the blockchain, they typically have a dollar backing it in the real world. This, of course, is an issue for crypto. One of the main purposes of crypto is to remove centralization. By decentralizing, it removes points of failure and decreases costs associated with middlemen.
This is where Terra comes in. What’s the point of crypto if people are gonna use a centralized stablecoin? It’s counterintuitive. Terra aims to solve this problem through UST, a decentralized stablecoin.
LUNA & UST: The Key Relationship
So, how does UST work? Essentially, it all comes down the relationship between LUNA and UST. UST can only be created by burning LUNA. If you want to create $1 of UST, you must burn $1 of LUNA. In theory, the $ value of LUNA should always be convertible to the $ value of UST at a 1:1 ratio. This works in reverse also. If you want to create $1 of LUNA, you must burn $1 of UST.
This seems all fine so far, but what happens if UST isn’t trading at $1.00? Since it’s a stablecoin, we know it should be worth $1.00, but that doesn’t always happen. Let’s say UST is trading on the market at $1.05. How does the Terra blockchain fix this? Remember that 1:1 ratio mentioned? That always holds true. If you know that UST is trading at $1.05, you simply burn $1 of LUNA and receive 1 UST which is worth $1.05. Then, sell the UST on the market for $1.05. Congrats! You just arbitraged the market and are rewarded with $.05 of profit for each UST you created! How long could you do this for? Well, probably not too long. Other people will begin to notice and do the same thing you’re doing, thereby driving down the price of UST to it’s natural peg of $1.00. Not getting it? Here’s a diagram to help explain:
So without the use of a middleman, the Terra blockchain creates a decentralized stablecoin through market forces!
The relationship between LUNA and UST serves as the cornerstone of our forecast. Let’s establish some assumptions:
- The price of LUNA is directly related to the demand for UST. If demand for UST goes up, we should see an increase in the price of LUNA.
- This is because to create UST, you need LUNA. If you need LUNA, you got to go buy some! This creates upwards price pressure on LUNA
- Does this relationship actually hold true? The market cap’s of LUNA and UST have a correlation of .802. While not perfect, it is a pretty strong relationship.
- What this means is that LUNA’s price is a function of UST’s supply. If we can project out the supply of UST, we can also project the price of LUNA
- Problem: LUNA’s supply is constantly changing at a non-fixed rate due to LUNA-UST arbitrage.
- Solution: Use market cap instead of price.
With these assumptions in mind, we can create a simple yet powerful forecast. What we did was compare the market cap of LUNA to the market cap of UST for each day over the past year. By dividing the LUNA market cap by the UST market cap, we get a simple ratio that tells us how the market is valuing LUNA relative to UST. Mechanically, it is similar to a P/E Ratio. Think of P ~ as the market cap of LUNA and E ~ as the market cap of UST. Let’s look at some basic stats of the LUNA/UST ratio:
Average: 3.957x | Median: 3.420x | 25th Percentile: 1.838x | 75th Percentile: 5.644x | Min: 0.817 | Max: 11.734x |
What can we learn by this? By furthering evaluating the data, we see that the LUNA/UST ratio expands when the market is doing good. Intuitively, this makes sense as we expect multiples and valuations to increase during bull markets. When crypto was in a slight bear market over the summer, we saw the LUNA/UST ratio shrink. Again, this makes sense as one would expect valuations to decrease during bear markets.
Why does this matter? Do you think we are currently in a bull market? Despite the drawbacks of the past week, we would say YES! So, if we’re in a bull market, the LUNA/UST Ratio should be higher, right? Well, it’s not. At time of writing, LUNA is trading at 2.603x of UST. Allow us to repeat ourselves:
LUNA is only trading at 2.603x of UST during a bull market.
We believe this is a serious mispricing of the market. Over the past 10 days, the market cap of UST increased ~123% to $6.5 billion. Over the same time frame, the market cap of LUNA decreased ~22% to $17 billion. WHAT?!?! Based on historical data, this makes no sense. LUNA’s price should increased with an increase of UST.
The only way this current valuation makes sense is if the bull market of crypto has ended. If you don’t the bull market has ended, LUNA looks like a great buy at this spot!
Taking it One Step Further: Projecting UST Growth
While the historical data points to a great short-term buying opportunity, we also want to project out the next year for LUNA. How do we do that? By projecting out the growth of UST. There are two important factors for this:
- Growth of total stablecoin market
- UST’s market share of the stablecoin market
As of writing, the stablecoin market is ~$142.5 billion and UST’s market share is 4.33%. Here are the historical growth metrics for UST and the stablecoin market:
With this information, we can create a sensitivity table of UST’s market cap. The two factors we will be projecting out are “Total Stablecoin 3 Month Growth (Annualized)” and “UST Market Share”. From this, we can actually easily project out what LUNA’s market cap should be based on historical ratios. To keep it simple, we have a bear, base, and bull scenario. Here are the results:
Bear Case with 25th Percentile Multiple:
Base Case with Median Multiple:
Bull Case with 75th Percentile Multiple:
Additionally, we can blend together these projections by eliminating scenarios which don’t make sense. For example, it doesn’t make sense to apply the 25th percentile multiple if the stablecoin market grows by 165% and UST represents a 10% share. So here is the color-coded blended sensitivity table:
Blend Case (Red=Bear, Yellow=Base, Green=Bull):
And this is how we arrived at our target. By applying the median multiple, 105.95% stablecoin growth rate, and a 5.33% UST market share, we arrive at a valuation of $53.5 billion. Will this happen? It’s possible! Let’s go over both reasons why our forecast might be correct and why it might be wrong.
Why the Forecast Could be Correct:
As you can probably tell, we make some pretty bullish assumptions when it comes to the growth of the stablecoin market. In our opinion, however, we don’t think we’re bullish enough! Over the past year, stablecoins have grown by over 467%. With that in mind, is it absurd to think that stablecoins could grow over the next year by a “modest” 100%? We would argue no, and the model reflects that. We could go over all the various institutions entering the crypto space and exploding use cases of stablecoins, but that would detract from the point of this analysis.
As for our other factor, the market share of UST, we’re probably being too conservative. Why? The Terra blockchain is becoming one of the most popular smart contract platforms in all of crypto. Let’s take you through a stream of conscious of the most relevant things happening in the world of Terra:
- Terra has $9.6 billion in Total Value Locked (TVL) in DeFi. This makes it the 5th most valuable blockchain by TVL.
- Terra has a blooming NFT scene. Projects such as Galatic Punks, Styllar, TerraBots, and LunaBulls are all pretty popular on the Terra NFT marketplace randomearth.io
- The Columbus-5 upgrade just occurred. As a part of a myriad of upgrades to the blockchain, $4.5 billion worth of LUNA is being burned
- Terra-based assets can interact with other popular blockchains such as Ethereum and Solana
- GAMEVIL, a popular mobile gaming developer, just recently announced a strategic partnership with Terra.
Why the Forecast Could be Wrong
Unfortunately, we don’t have a time machine. Therefore, our model has some risks. As much as we would love to pretend that it’s up only in the crypto space, the truth is that great projects fail all the time. With that said, let’s go over some risks for LUNA.
- BIGGEST RISK: Regulatory Pressures & Concerns- You might’ve missed it, but earlier in the month, the Biden administration put out a report on stablecoins. If you don’t want to read it (you probably don’t), allow us to summarize it for you: Regulation is coming. As we all know, regulation could certainly stifle our growth for stablecoins as the US cracks down on the growing asset class.
- Regulation could be a double edged sword. In the report, they really only mention centralized stablecoins, not decentralized algorithmic stablecoins such as UST. Regulation of centralized coins could drive users to decentralized stablecoins such as Terra. So who knows? It’s certainly possible that regulation could actually benefit Terra and UST as it’s much harder to regulate something that is decentralized