Filecoin (FIL): Dissecting storage market incentives

We explore the Filecoin network and the tokenomics behind FIL

April 20, 2023

Filecoin (FIL): Dissecting storage market incentives

At a glance

The Filecoin network represents a crypto-native solution to data storage that aims to disrupt centralized incumbents with a fundamentally different approach. By leveraging open-source protocols and token-based incentives, the Filecoin network can provide users with greater control over their data and offer a more secure and cost-effective method of storing and sharing data without relying on centralized intermediaries.

Key takeaways

  • While Filecoin has made meaningful strides in terms of building out the storage capacity of the network in recent years, much of this growth is attributable to an ongoing incentive program (Filecoin Plus) that offers storage providers increased rewards for participating in “verified” storage deals.
  • These enhanced rewards allow storage providers to charge de minimis fees (typically zero) to data providers (clients). As long as the Filecoin Plus program is available, we think the risk is that this may distort the market for FIL by effectively subsidizing the true cost of storage.

Written by

  • Brian Cubellis, Research Analyst

Introduction

The Filecoin network represents a crypto-native solution to data storage that aims to disrupt centralized incumbents with a fundamentally different approach. It works as a decentralized peer-to-peer file storage network that aims to let anyone store, retrieve, and host digital information. By leveraging open-source protocols and token-based incentives, the Filecoin network can provide users with greater control over their data and offer a more secure and cost-effective method of storing and sharing data without relying on centralized intermediaries.

In this report, we explore the recent growth and adoption of the Filecoin network and attempt to assess the long-term sustainability of the incentives at play. While Filecoin has made meaningful strides in terms of building out the storage capacity of the network in recent years, much of this growth is attributable to an ongoing incentive program (Filecoin Plus) that offers storage providers increased rewards for participating in “verified” storage deals. These enhanced rewards allow storage providers to charge de minimis fees (typically zero) to data providers (clients). As long as the Filecoin Plus program is available, we think the risk is that this may distort the market for FIL by effectively subsidizing the true cost of storage.

That being said, the incentives currently in place have seemingly been successful in that both the storage capacity and utilization of the network are on a positive trajectory. However, the long-term sustainability of the network may depend on expanding the demand for storage capacity in the absence of subsidies. While the duration of the Filecoin Plus program is uncertain, storage mining rewards will eventually trend towards zero and storage providers will increasingly need to be compensated through fees paid by data providers.

Background

The market for global data storage is estimated to approach ~US$250B in 2023 and grow to nearly ~$800B by 2030. Supported by a massive addressable market and attractive margins at scale, the cloud-based segment of the data storage industry has become dominated by a handful of centralized players including Amazon Web Services (AWS), Google Cloud, and Microsoft Azure (aggregate market share of ~66%). Filecoin is a newer entrant into this space that doesn’t rely on centralized cloud data storage. 

While the Filecoin mainnet went live in October 2020, a core piece of the infrastructure underpinning the network – the InterPlanetary File System (IPFS) – predated the advent of Filecoin by over five years. IPFS was launched by Protocol Labs (the same team behind Filecoin and a well-respected name in peer-to-peer technology) in February 2015 as a decentralized alternative to centralized web storage. Architecturally similar to the communications protocol BitTorrent, IPFS sought to create a distributed file system to allow users to store and share data in a more secure, efficient and trust-minimized environment. 

Critically, IPFS was designed to remedy the issues inherent in the existing web 2.0 Hypertext Transfer Protocol Secure (HTTPS) infrastructure that relies on URLs for data retrieval. The current HTTPS system can be inefficient and susceptible to centralization risks including internet service provider outages or internet censorship (1). IPFS aims to resolve this by connecting “all computing devices with the same system of files” according to its inventor, Juan Benet.

It does so by utilizing an addressing format called content identifiers (CIDs) that differ from location-based Internet Protocol (IP) addresses in that they leverage cryptographic proofs to link directly to the content itself. If the content/data within a given CID were to change, the address also changes, providing users with enhanced data integrity assurances relative to IP addresses.

But while IPFS provided a novel method for storing and sharing data in a distributed manner, it faced the challenge of incentivizing users to contribute storage capacity to the network. This dynamic catalyzed the creation of Filecoin which effectively represents the “incentivization layer” that complements the IPFS protocol. While actual data is stored off-chain (via IPFS), the Filecoin network is instead used to record cryptographic proofs which verify the data is properly stored.

Tokenomics

The Filecoin protocol introduces a native token (FIL) and corresponding consensus mechanisms in order to create an open marketplace for data storage and retrieval. Within this context, the FIL token serves multiple functions including:

  • being used to purchase storage,
  • being “pledged” (akin to staking) as collateral by storage providers,
  • being rewarded to storage providers (miners) for their services, and
  • being burned via transaction fees or slashing.

Filecoin employs two consensus mechanisms – Proof of Replication (PoRep) and Proof of Spacetime (PoST). PoRep demonstrates that a unique copy of a given piece of data has been stored by a miner, while PoST verifies the continued storage of the data over a specific time period. Both of these mechanisms utilize zk-SNARKS (Zero-Knowledge Succinct Non-Interactive Argument of Knowledge) to cryptographically prove that miners are properly storing client data both at the initiation of a deal (PoRep) and throughout the tenure of a deal (PoST). Miners (storage providers) must stake or “pledge” collateral in the form of FIL in order to participate in these consensus mechanisms. Accordingly, if miners are unable to successfully provide these proofs, their FIL collateral may be slashed.

The maximum supply of FIL is 2 billion tokens. At launch, 30% of this maximum supply was allocated to Protocol Labs, the Filecoin Foundation, and early investors. The allocations for Protocol Labs and the Filecoin Foundation are subject to a 6-year linear vesting schedule, while the cohort of early investors is subject to linear vesting schedules ranging from six months to three years. As shown in Chart 1 below, the remaining 70% of the maximum supply is reserved for mining rewards (55% dedicated to storage mining; 15% dedicated to retrieval mining, repair mining, and future mining types that are yet to be determined). 

Chart 1. FIL supply distribution

Chart 1. FIL supply distribution

The ongoing issuance of storage mining rewards is a function of a hybrid model that combines two distinct minting mechanisms, “simple minting” (16.5% of total supply) and “baseline minting” (38.5% of total supply).

  • Simple minting distributes rewards to miners in proportion to their share of the network’s total storage capacity, while
  • baseline minting distributes rewards to miners based on their contribution to the network’s “baseline” storage capacity (a target level of capacity that Filecoin aims to achieve over time).

Both of these mechanisms for new issuance are subject to an exponential decay curve with a half-life of six years, although rewards from baseline minting are deferred if the network doesn’t surpass the predetermined threshold of overall storage capacity (initial baseline began at 1 exbibyte and grows at 200% per annum thereafter). As shown in Chart 2, the annualized issuance rate for FIL (including token rewards, unlocks and burns) has been steadily declining since inception and currently stands at roughly ~40%. As of April 8, the total circulating supply of FIL is 459.3M FIL, the total amount of FIL mined is 274.9M FIL, and the total amount of FIL locked (“pledged”) is 141.4M FIL. 

Chart 2. FIL supply growth and annualized issuance rate

Chart 2. FIL supply growth and annualized issuance rate

Assessing network growth

The Filecoin network has exhibited impressive growth since its inception, in terms of both the supply side (storage providers) and the demand side of the network (clients storing data). Over the trailing two-year period, total storage capacity onboarded by providers has increased by ~382% and currently stands at ~19.63 exbibytes (EiB)(2). Over the same period, the demand for this capacity in terms of active storage deals has increased by over 100x (albeit from a much smaller base) and currently stands at 766 pebibytes (equivalent to ~0.748 exbibytes or ~862.4 million gigabytes). Despite this rapid growth in demand for storage, the overall utilization rate of the network remains relatively low at ~3.8% (shown in Chart 3). For context, the average utilization rate for centralized public cloud storage providers is in the range of 40-70%. 

Chart 3. Total storage capacity and utilization rate

Chart 3. Total storage capacity and utilization rate

Filecoin Plus (FIL+)

It is important to note, however, that much of this recent growth – particularly on the supply side – has been largely a function of an ongoing incentive program called Filecoin Plus (FIL+). Launched shortly after the Filecoin mainnet went live, the Filecoin Plus program was designed to prevent users from onboarding arbitrary data in order to “game” the rewards system and instead incentivize “meaningful” data from “verified” clients. In order to achieve this, Filecoin Plus effectively acts as a client verification mechanism and introduces an element of social trust to the process of deal negotiation. 

Clients can apply to become verified, and an elected group of fiduciaries (“notaries”) makes a determination based upon the reputation of the client and the usefulness of their data. Once verified, clients receive a token from the notaries called DataCap, which can then be used to enter deals with the storage providers (DataCap is not transferable and is effectively a single-use–credit). Importantly, storage providers are highly incentivized to onboard verified clients because by doing so they can earn 10x the block rewards relative to unverified client deals. Accordingly, ~99.7% of all active deals on the network are Filecoin Plus deals at current. 

In our view, the Filecoin Plus program represents an indirect subsidy for clients looking to store data, as the enhanced rewards allow storage providers to charge de minimis fees to data providers (in terms of FIL, typically zero). We believe this may be distorting the true cost of storage and in turn the true demand for storage. While these incentives have seemingly catalyzed the recent growth in network activity, it remains uncertain how long the Filecoin Plus program will be in place. Over the long-term, mining rewards will approach zero and storage providers will increasingly need to be compensated through fees paid by data providers. Ultimately, without the benefit of 10x rewards, storage providers would likely be forced to raise the storage costs for clients, at which point the true market demand for storage could be observed. Moreover, the process of client verification required to participate in the Filecoin Plus program introduces a form of permissioned access to the network, which could be viewed as antithetical to the broader vision of a truly decentralized market for data storage.

Resource imbalance

Another dynamic related to the market distortions caused by the Filecoin Plus program is the growing demand from storage providers to borrow FIL. That is, there are more miners who want to earn the rewards from providing storage capacity (and pledging FIL to participate in consensus), but do not necessarily want exposure to the price of FIL. Moreover, because they are typically not demanding any FIL from clients for verified storage deals, they are forced to source FIL from the open market. This has resulted in a mismatch in resources between Filecoin holders and storage providers. In order for token holders to earn incremental FIL, they would need the “know-how” and hardware to put their tokens to work as part of consensus, whereas storage providers (who have the know-how and hardware) need FIL to pledge on the network in order to participate in consensus. 

This mismatch presents an opportunity for FIL holders to earn interest on their holdings by lending to storage providers. For larger, institutional FIL holders, options are limited, but DARMA Capital, CoinList, and PalladiumX are facilitating the flow of FIL from token holders to storage providers, allowing them to earn a portion of those rewards earned by the storage providers once they pledge those tokens in the network. For individuals, it’s possible that the advent of the Filecoin Virtual Machine (FVM) will allow individual FIL holders to participate in the same strategy but instead via decentralized applications on the FVM. As we will explore in the following section, the FVM could make storage provider loan markets possible via trustless applications.

Key protocol initiatives

Launched on March 14, 2023, the Filecoin Virtual Machine (FVM) represents an important step on the Filecoin development roadmap. The Filecoin team has articulated a three-step “masterplan” which involves (1) building the largest decentralized storage provider, (2) onboarding as much of the world’s data as possible, and (3) bringing compute capabilities to the data to allow web scale applications to live on the network. The launch of the FVM aims to catalyze the third phase of this plan, facilitating a more programmable environment for developers looking to build applications that leverage Filecoin’s data storage services. 

Some of the potential use cases for this programmable layer include lending protocols (which could help resolve the resource imbalance discussed previously), perpetual storage solutions (to provide clients with more flexibility in structuring storage deals that don’t need to be manually renewed), and data DAOs (to allow multiple parties to coordinate communal storage). Broadly speaking, smart contract functionality promises to expand the utility of the Filecoin network through applications that drive demand for storage capacity.

Conclusions

In order to catalyze a marketplace for data storage and retrieval that is sustainable over the long-term, we believe Filecoin must continue to generate meaningful traction on the demand side of the network. In a future state of the network where mining rewards approach zero and storage providers are more reliant on fees paid by data providers, the true market demand for storage may emerge. That said, the subsidies currently provided by Filecoin Plus do appear to be effective in the sense that both storage capacity and utilization are growing.

Notably, the Filecoin Virtual Machine may represent a key unlock in terms of potential demand for storage if it can successfully catalyze a network of specialized applications leveraging Filecoin’s open marketplace for storage capacity. Further, the FVM could help alleviate the resource mismatch between token holders and storage providers, providing holders with an avenue to lend FIL to storage providers via trustless applications.

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