Last week, the Terra (LUNC 17.08%) blockchain effectively collapsed. It started when the ecosystem's stablecoin, TerraUSD (USTC -0.56%), lost its peg to the U.S. dollar. At that point, the built-in arbitrage mechanism -- which uses the Luna coin to control stablecoin volatility -- should have resolved the problem. But it didn't.
Next, the Luna Foundation Guard, a nonprofit group created to support the Terra ecosystem, used its $3 billion Bitcoin (BTC 2.71%) reserve to buy TerraUSD. The goal was to restore the peg by creating demand for the stablecoin. That was the failsafe. But it didn't work either.
Instead, as the stablecoin continued to plunge, panicked investors began to bail on the entire project, selling both TerraUSD and Luna. One week later, both coins were essentially worthless, and $42 billion had been erased. But some investors fear the worst is yet to come. If people lose faith in decentralized finance (DeFi) or crypto in general, the ripple effects from Terra could devastate the entire industry.
Personally, I think those fears are overblown. The algorithmic nature of TerraUSD made the situation somewhat unique. More importantly, there are still dozens of cryptocurrencies backed by strong investment theses. Here are two great examples.
Prior to its collapse, Terra was the second-largest DeFi ecosystem, with nearly $30 billion invested on the blockchain. That figure has since fallen to $190 million, and some investors are worried the fallout could compromise trust in other DeFi ecosystems like Ethereum (ETH 2.22%). But the two situations are very different.
Ethereum's primary stablecoins -- USD Coin and Tether -- are backed by fiat currency, meaning cash and cash equivalents are kept in reserve accounts to ensure the stablecoins keep their peg. So Ethereum differs dramatically from TerraUSD, which was backed by nothing more than computer code. Moreover, Ethereum is the largest DeFi ecosystem by a wide margin. With $70 billion invested on the blockchain, it currently accounts for 64% of all DeFi investments across any blockchain. That means Ethereum is the frontrunner in a market that could disrupt the financial industry.
Specifically, DeFi makes it possible to save, borrow, and earn interest on money without involving banks. And by eliminating banks, DeFi makes financial services more efficient. For instance, the Compound protocol currently pays 2.25% APY on Tether deposits. That's much better than the 0.06% APY you get from the average savings account.
Looking ahead, the bull case for Ethereum is straightforward: In any setting, developers gravitate to the most popular platform, because doing so allows them to reach more users. For that reason, Ethereum's status as the DeFi market leader should cause its ecosystem of applications and services to expand rapidly in the coming years, bringing more investors to the platform. And as more transactions take place on Ethereum, demand for the underlying cryptocurrency (Ether) should rise, driving its price higher.
Since its launch in 2009, Bitcoin has parlayed its first-mover status into a more concrete competitive advantage. Today, Bitcoin boasts over 40 million holders, and its $550 billion market cap accounts for 45% of the entire crypto market. In other words, Bitcoin has become synonymous with cryptocurrency, and it ranks as the most valuable crypto asset by a wide margin.
What's behind that popularity? Fintechs like Block and PayPal have added Bitcoin trading to their digital wallets, and companies like Tesla and MicroStrategy have added Bitcoin to their balance sheets. Those moves have made Bitcoin more accessible and more mainstream. But popularity alone makes for a weak investment thesis.
So why invest in Bitcoin? Its blockchain protocol imposes a supply limit of 21 million coins, and that scarcity makes Bitcoin valuable. Any economics student can tell you that when supply is fixed, the price of an asset will rise in response to increased demand. And there is good reason to believe demand for Bitcoin will increase in the years ahead.
Beyond growing retail adoption, a recent study from Fidelity suggests that more institutional investors are diversifying into cryptocurrency, and Bitcoin and Ethereum are the most popular choices. So what? Institutional investors have over $100 trillion in assets under management, and a small fraction of that fortune could send Bitcoin and Ethereum to the moon.
During the ongoing crypto crash, Bitcoin has lost 58% of its value. Its price has dropped 15% in the past week alone, due in part to selling pressure created by the Luna Foundation Guard. But that sell-off creates a buying opportunity for long-term investors. Earlier this year, JPMorgan analysts put Bitcoin's fair value at $38,000, which implies roughly 31% upside from its current price. Better yet, Ark Invest CEO Cathie Wood believes Bitcoin's price could surpass $1 million by 2030, which implies 3,300% upside over the next eight years. That's why this cryptocurrency looks like a smart buy right now.