Over the last year, the collective value of all cryptocurrencies has soared 150% from $875 billion to $2.2 trillion. That’s even more impressive when you account for the fact that the crypto market has fallen 31% from its all-time high. Of course, that doesn’t mean every token has been a winner, and the market itself is rife with volatility. But if you can handle those wild fluctuations in price without panicking, I think it makes sense to own a little cryptocurrency.
Building on that idea, there are dozens of investable crypto assets, but one that has my attention right now is Terra (CRYPTO:LUNA). Over the last year, its price has soared over 14,000%, and it’s become the second-most-popular decentralized finance (DeFi) platform behind Ethereum. More importantly, given its ambitious vision, I think there is plenty of upside left for investors.
Here’s why.
Image source: Getty Images.
A stablecoin ecosystem
The Terra blockchain features an array of stablecoins, cryptocurrencies designed to track the price of fiat currencies. For instance, TerraUSD tokens are tied to the price of the U.S. dollar, and TerraEUR tokens are tied to the price of the Euro. There are several other examples, but in all cases, those stablecoins are able to maintain their value because of LUNA, a token on the Terra blockchain that is specifically designed to absorb volatility.
Like any asset, the price of each stablecoin fluctuates based on supply and demand. That means a spike in demand for TerraUSD could push its price above $1. To solve that problem, the protocol incentivizes LUNA token holders to convert LUNA to TerraUSD, thereby increasing the supply (and lowering the price) of TerraUSD. That works because $1 worth of LUNA can always be used to purchase one TerraUSD token, even if that token is currently worth $1.01.
The same is true in reverse. Falling demand for TerraUSD can pull its price below $1, at which point the protocol would reduce its supply (to boost its price) by incentivizing participants to convert TerraUSD to LUNA. That works because it’s always possible to buy $1 worth of LUNA with one TerraUSD token, even if that TerraUSD token is worth $0.99. Put simply, LUNA plays a critical role in keeping Terra’s stablecoin ecosystem stable.
The investment thesis
If you’re following along, a question may have occurred to you: Why own a cryptocurrency designed to absorb volatility? After all, when demand for TerraUSD falls and a portion of its supply is converted to LUNA, that event is inflationary for LUNA, which effectively makes each token worth less. Why own such an asset?
There are a few good answers. First, investors that hold LUNA can stake their tokens to earn rewards. In fact, you could earn approximately 7% on an annualized basis by staking LUNA right now. At the very least, that would help offset the value lost to inflation.
Second, Terra aims to make financial services and e-commerce payments more efficient. Specifically, consumers can use the system to exchange, spend, and save Terra stablecoins, and they can access a growing number of DeFi products. Moreover, because Terra is powered by blockchain technology, the system can function without traditional financial institutions. And by eliminating those intermediaries, transactions on the Terra network incur fewer fees and are settled more quickly.
On that note, the project has already had some success, as the Terra blockchain powers the Chai payments app in South Korea, which has seen adoption by over 2 million users. Similarly, the Terra blockchain powers the Anchor protocol, a DeFi product that allows investors to earn interest by lending stablecoins to the platform. Currently, the Anchor rate sits at 19.6% APY, an incredible figure considering the average savings account with a bank pays just 0.06% APY.
In both cases, Chai and Anchor create demand for stablecoins, which translates into increased demand for LUNA, putting deflationary pressure on the cryptocurrency. In other words, as Terra-powered payments platforms and DeFi services continue to gain traction, the LUNA token should become more valuable. That’s why this cryptocurrency looks like a worthwhile long-term investment.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
