What’s Luna Worth? Looking Into Terra’s Tokenomics

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Terra is an algorithmic stablecoin that is aiming to become the first mass-adopted cryptocurrency. Terra was built with the Cosmos SDK and Tendermint, a Byzantine Fault Tolerant Proof-of-Stake (PoS) consensus algorithm. The stablecoin is collateralized by a second native token called Luna (LUNA).

In this article, let’s analyze how both these tokens will grow in valuation over time.

CHAI dApp and Partnerships

One of the critical factors that directly affect the pricing of a token is its usability. Does it make sense to use the token? Is it easy to use the token?

Thankfully Terra’s payments dApp – Chai, provides a solution to all these queries. The dApp’s popularity has allowed Terra to process 1.5 million dollars in transactions per day, making it South Korea’s fastest-growing payment network. Chai has made several key partnerships that have bolstered Terra’s usability. Some of the main ones are:

• TMON, one of the largest eCommerce platforms with 9 million users.
• Yanolja – the biggest hospitality app in the country, which can be thought of as its Hotels.com. It annually processes $2 billion.
• CU – The largest convenience store chain in Korea with 14,000 locations.
• BC Card – the largest payment processor in Korea which had revenues worth $150 billion in 2018. This partnership will lead to the “CHAI Card,” which will allow users to transact around the country with Terra’s payment network.

Along with the partnerships, another key factor that makes Chai so popular is that it offers several compelling rewards and cashback offers. The reason why they can do so is because of Terra’s integrated seignorage system. Seignorage is the difference between the cost of manufacturing a currency and the real value of the currency itself. So, if it takes $1 to create a $100 note, the seignorage will be $99. Popular stablecoin Tether can’t leverage the benefits of seignorage since its algorithm uses $1 fiat to create $1 worth of Tether. With Terra, the situation is a little different. As Terra head of research, Nicholas Platias, says:

“On the contrary, if you look at Terra, that situation is very different, because the cost of production is much smaller. Basically, we do keep a certain cash buffer in order to supplement the main stability mechanism, but the vast majority of the currency that is issued comes from seignorage.”

Since the cost of production of Terra is much lower than its face value, it allows Chai to leverage this considerable seignorage and provide very rewarding cashbacks and bonuses, which other payment processors simply can’t provide. As Platias puts it:

“I think that the key ‘growth hack’, if you will, that Terra has used and CHAI has leveraged by receiving Terra seignorage, has been precisely that idea.”

Terra and Luna

Luna is the staking coin in Terra’s proof-of-stake ecosystem. Luna’s work in the ecosystem is two-fold:

• To protect Terra from volatility.
• To reward stakeholders.

Protecting Terra from volatility

To stabilize the price of Terra, Luna acts as a counter-party to anyone looking to swap Terra and Luna at Terra’s target exchange rate. So, when:

• When Terra’s SDR price < 1 SDR, users and arbitragers can send 1 Terra SDR to the system and receive 1 SDR’s worth of Luna.
• When Terra’s SDR price > 1 SDR, users and arbitragers can send 1 SDR’s worth of Luna to the system and receive 1 Terra SDR.

Rewarding stakeholders

Stakeholders who lock up their Luna within the ecosystem take part in Terra’s proof-of-stake consensus network. Luna stakeholders play a key role in securing the network and are rewarded with fees from all transactions, aka the “Terra tax.” This economically incentivizes people to take part in the ecosystem.

This is a crucial point to keep in mind as Terra, like any decentralized network, needs more nodes (stakeholders) within its system to get stronger and increase its valuation. If the stakeholders earn more rewards from the Terra tax, then it might incentivize more people to join the network. So, will the tax increase with time?

The answer is a resounding, “yes.”

As Baek Kyoum Kim notes in his article, back in September and October Terra’s tax rate was just 0.05%. However, following the Columbus-3 hard fork, the tax rate has spiked to 0.5%. As its usability increases, Terra’s tax rate will increase as well, attracting more people into the network.

NOTE: The tax is fiat-pegged and paid by all the consumers and businesses who use the network. This is different from most of the other POS networks which use inflation-funded rewards.

Luna and Token Velocity

Another key factor that will increase the valuation of the Luna tokens is token velocity.

Popularized by Multicoin’s Kyle Samani, “Token Velocity” is something that many use to determine the long-term valuation of a particular cryptocurrency. If you were to define Token Velocity in strictly mathematical terms, then it would look like this:

Token Velocity = Total Transactional Volume / Average Network Value.

If we were to flip the formula then:

Average Network Value = Total Transactional Volume / Token Velocity.

Now, that leads to two conclusions:

• More the token velocity, less the average network value.
• More the transactional volume, more the token velocity.

So tokens that have little to no value will usually be accumulated by investors and sold off to make profits. These tokens are only useful for speculative trading. We can also conclude that that tokens and cryptocurrencies which are not going to be frequently traded for a quick cash grab will have the potential to grow more valuable over time.

Staking is a great way to incentivize investors to hold on to a particular token. Since investors will be staking the Luna tokens, they will automatically decrease its velocity and potentially increase its valuation. When you factor in that staking will lead to increased rewards (via the Terra tax), we are potentially looking at a situation where holders can:

• Hold on to the tokens, which will increase in value over time.
• Collect ever-increasing rewards on the side for doing practically nothing!

Conclusion

Platias wonderfully sums up the relationship between the two tokens and the overall architecture of Terra:

“A lot comes down to making the right design decisions, and thinking hard about what properties you want your currency to have and where you want the value to accrue. So for us, we thought very hard. We went through a bunch of iterations of the protocol and a bunch of white papers before we concluded what we wanted to do.”

Looking through its whitepaper, Terra really does look like a very well-thought-out project. Don’t be surprised if you see this coin ruling the South Korean market in the near future.

About the Author: 

Douglas Lennon

Douglas Lenon is a Finance Manager and part-time journalist who has set his eyes on the world of DeFi. Using a Traditional Finance background to trade & invests in Altcoin