Capitalizing on Terra’s Growth: A Valuation Framework for Luna
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Terra has come a long way since we invested in the project nearly two years ago. Back then it was an exciting vision for a stablecoin to bring crypto to the masses. Today, a few months after launching, Terra has taken a big leap in that direction by powering online payments for more than 600k users (55% MoM growth) via Chai — its partner payments application. Terra already processes over 1.5 million dollars in transactions per day, making it South Korea’s fastest-growing payment network.
Chai is now integrated with seven mainstream online platforms in Korea — including TMON, one of the largest eCommerce platforms with 9 million users, and Yanolja, the no.1 hospitality app that annually processes $2 billion. By the end of this year, Chai will launch offline payments with CU, Korea’s largest convenience store chain with 14,000 locations. Besides the imminent CU integration, the ‘CHAI Card’ is also slated to launch early next year with Korea’s largest payment processor BC Card ($150 billion in 2018). This will be a game changer, allowing users to pay basically anywhere with Terra’s payment network.
A critical piece of Terra’s puzzle is Luna, the staking token in Terra’s PoS blockchain.
Terra reinvests economic growth to provide ongoing discounts to consumers, incentivizing smart consumers to choose its payment system and stay. Luna is the asset that aligns stakeholder incentives to participate and works as a stability reserve — used to collateralize the Terra economy during contractionary cycles. Luna holders who stake to secure the network are rewarded with fees from all transactions (the “Terra tax”). The tax is a valuable revenue stream to incentivize stakeholders like ourselves to run validators and support the network. Importantly, the tax is fiat-pegged and paid by all the consumers and businesses who draw value from the network. This is in contrast to the inflation-funded rewards used by most PoS networks. Luna pays real value to those who serve the network.
In light of all these developments, we revisited our investment thesis for Luna. Our investment at the time was primarily driven by our belief in the team and the vision — there were no numbers to crunch and metrics to evaluate. Fast forward to today, the situation looks very different. Luna has a track record and trajectory that we can use to apply a more objective valuation approach. This analysis is timely for another reason: Terra’s upcoming hard fork, Columbus-3, introduces key developments for Luna, including a substantial tax increase and governance rights.
Terra aspires to become an open platform for diverse financial applications. Nevertheless, the most sensible valuation approach is to look at Terra as simply a decentralized payment network. We have ample proof to support that Terra is well on its way to making its mark as a payments use case. Centralized payment networks are well-understood businesses for which the standard valuation approaches tend to be uncontroversial.
There are a couple of key distinctions to note between centralized and decentralized networks before proceeding with this valuation approach. First: while equity cash flow is passive, Luna cash flow compensates staking (a service to the network). Second: companies need to be profitable for standard valuation approaches to apply. On the contrary, Luna cash flow is independent of the profitability of the companies/applications that pay for it by using Terra. This property of Luna significantly simplifies our job when projecting cash flow: we only need to project tax rewards from transactions, which we treat as Luna “earnings”.
Our model has two simple components:
1. The aggregate value of Luna (market capitalization) is determined by present tax rewards and the multiple the market is willing to pay for future rewards. Tax rewards are simply transaction volume multiplied by the tax rate.
2. The unit value of Luna (1 Luna) is determined by dividing the aggregate value by the number of Luna receiving rewards (staked Luna).
Unit Value of Luna = (Annualized Transaction Volume) * (Tax Rate) * (Rewards Multiple) / (Staked Luna)
We examine the four variables involved here:
Terra’s on-chain volume in November (annualized) is roughly $800 million. Transaction volume has been increasing at an incredible compounded average rate of 35% month-over-month since the network launched. We expect this growth rate to continue for the next several months given the big milestones on the horizon (offline payments, Chai card, Singapore, Mongolia and so on). Note that with regards to Chai, one Chai transaction initiates two Terra transactions (meaning that Terra’s volume in $ terms is at least twice that of Chai’s).
Terra’s tax rate was at a meager 0.05% in September and October, and has more than doubled in November by a protocol-initiated hike designed to target rewards growth. The Columbus-3 hard fork will be increasing the tax rate by another 5x to 0.5%, representing a 10x hike relative to September and October. We expect this hike to drastically boost tax rewards for Luna holders. The increased fees pose no risk to Terra’s usage, given that e-commerce companies pay a multiple of those fees (2.5~3.0%) to credit card companies.
The rewards multiple is the equivalent of an earnings multiple for Luna. We benchmark the fair multiple for Luna based on earnings multiples for a few public payment companies (data from Bloomberg 11/21/2019):
- Amex (established): 13
- Visa (established): 34
- Mastercard (established): 39
- PayPal (medium growth): 50
- Adyen (high growth): 111
Based on the above, we expect fair rewards multiple for Luna to be in the range 20 to 60 (we use 40 as a base case).
The number of staked Luna in November has averaged around 220 million, a number that hasn’t increased much in the last three months. To be conservative, we assume that staked Luna will increase at an average rate of 5 million per month for the next year.
Putting all of the above together, we get the following results for Luna cash flow and price (examining the 6-month period September 2019 — February 2020):
The above presents annualized Luna tax rewards, three months into the past (100% MoM growth) and three months into the future. We expect a drastic 7x increase in rewards between November and December, owing partly to the tax hike ($5.4mm vs $800k annualized). The projected cash flow in February 2020 is 45x what it was in September ($9.9mm vs. $220k). We expect nonlinear behavior in Luna in anticipation of those events.
Putting all those valuation factors together, we plot our projected price range for Luna (base projection in blue, range in light blue). Our methodology suggests that Luna’s unit value will likely increase during the next three months as follows: $0.92 (December), $1.22 (January) and $1.61 (February). Our projected ranges appear in the table below. And despite the fact that Luna’s market price has been declining in the past months, it is worthwhile to note that Luna’s market price over the past three months has in fact been higher than the base case estimated by the model — but within the projected range for November (current market implied rewards multiple is 55). Supported by robust growth in fundamentals, we believe that the tax hike is not only justifiable but also promising in terms of Luna’s growth in the near future.
The most questioned challenge to the crypto industry is the valuation framework of networks and validating it with real metrics. In contrary to countless Store of Value or Medium of Exchange tokens that are unable to form a structured valuation framework, Luna is unique in that we can import valuation framework from the traditional payments networks by presenting Luna cash flow as Luna ‘earnings.’
We presented a concise framework for valuing Luna based on the cash flow it generates from Terra taxes. We anticipate that Terra’s growth trajectory, coupled with the substantial increase in taxes in Columbus-3, are powerful tailwinds for the asset. Luna is unique in the crypto sphere in that it can naturally be valued using traditional methods like the above. We look forward to the ensuing discussion around the validity of our alternative valuation approach. We are in the very early phase of this race after all.