Picking Apart the Filecoin Whitepaper

or why there is no market for the Filecoin network

As far as ICOs go, none has been more lucrative than the $205 million Filecoin ICO. What is Filecoin? It’s a Decentralized Storage Network (DSN) according to the incredibly wordy whitepaper written by Protocol Labs. I use the term whitepaper only because it is the trendy word to use for these documents that are supposed to set out a philosophy for an organization in a way that people can understand. In reality, they are more likely to resemble software design documents or scientific papers with pages upon pages of definitions. Filecoin’s paper describes their product as “novel” no less than 9 times presumably because they raised money at thousands of dollars per word rather than because their users actually find their platform novel. That is, if they had any users. Or even a product. No, Filecoin in its current state is nothing more than a paper that describes a filesharing protocol and internal market for how Filecoins will be spent. It will not succeed for the reasons I will describe hereafter, and people will lose money. Filecoin’s ownership can not be held accountable by any of their ICO investors, except a few insiders who will do just fine. There is no market for a DSN in a world where cloud storage is almost free. Tying storage costs to a currency influenced by outside market pressures is anti-economical for users. Filecoin has succeeded in raising in raising a substantial amount of money and is attempting to solve a difficult problem in decentralization. The market case for a DSN is called into question here.

The Inside Job

Filecoin counts, among its many accredited investors, a few big names in venture capital who have never actually been publicly named by Protocol Labs, but have been reported to include Winklevoss Capital and other investors in Protocol Labs itself. These early investors, dubbed as advisors, were able to purchase Filecoins at a price of 75 cents, whereas outside investors were given a starting price of $1. The average price for Filecoin was $2.65 in the first hour of the token sale to outside investors.

When (if) Filecoin goes live and the token becomes available on exchanges, the inside investors will already have made 350%. This is under the assumption that Filecoin will trade at minimum $2.65 upon launch. Given that investors were willing to pay this price before there was even a product, I think it is a safe assumption that they will value their holdings at the same price when the platform is live. These advisors have reportedly agreed to receive their Filecoins over a 1+ year vesting schedule so it may not be fair to say that they will immediately make this money on launch. However, with the CME launching Bitcoin futures next month, it is not hard to imagine that many cryptoexchanges and similar organizations will begin to offer futures for big-name cryptoassets. Even without access to a futures market, advisors will only need to sell a small fraction of their coins in order to make their money back at initial market prices, and they have no doubt scheduled their Filecoin releases to have taken advantage of this.

As I am arguing that Filecoin is not going to succeed, it is counterintuitive to suggest that the Filecoin token will be worth anything at launch. The economics of the token itself may remain robust for some period of time at launch because of the large investment these coin purchasers have made, and because of the current sky-high demand for cryptoassets as investment vehicles. However, the market demand for the DSN itself is in question.

On the issue of accountability, one can ask the question: “When will the Filecoin network go live?” In fact, this question was already asked by one potential investor. The answer given:

We do not like giving such estimates since most software timing estimates tend to be wrong. That said, we are targeting 6–12 months, but it could be more.

Having worked in software for many years, I can attest that software estimates are often wrong but definitely do not “tend to be wrong”. I can also attest that deadlines are set for big projects with large investments because that’s how business works. Similarly, a timing estimate that is wrong is better than no timing estimate at all. The investors in the ICO do not actually own any equity in the company developing Filecoin, so they have no accountability mechanisms to fall back on. There is no board of directors that can oversee management decisions to keep development on schedule, if a schedule were to exist. The answer given by Protocol Labs is laughable and unprofessional.

A Market Without a Market

Cloud storage is ubiquitous. Google gives away unlimited photo storage for free, Apple gives limited free storage, Amazon charges pennies per gigabyte of cloud storage. Filecoin, like many in the crypto space, presumably claim that the novelty of decentralization makes their platform desirable to some segment of the market. One could try to envision who this segment of the market may be.

Simply confirming the “put data into the DSN” transaction on the blockchain could take on the order of minutes and that does not even include the transfer time for the data being stored in the network. Actual transaction time is unclear and likely cannot even be estimated but a transaction on Bitcoin takes ~10 minutes to be added to the chain, whereas Ethereum takes ~30 seconds to be added. Given a transaction requires multiple blocks added ahead of it to become confirmed, assuming that a transaction could take on the order of minutes is safe. So ease of storage is not something this market segment values.

The whitepaper also describes that a user storing data in the DSN is required to specify a “replication factor” to provide redundancy where “Higher redundancy results in a higher tolerance of storage faults.” An example here with no replication would be if the node holding the user’s data was offline at the time of retrieval, the data would not be retrievable. Some level of redundancy is required for even reasonably reliable data storage, so it may be concluded that the target market is users who do not value reliable storage of their data.

Obviously, there is no market of users who wish to store data in an unreliable manner so I’ll assume that some non-zero replication factor is default, and increasing it will provide higher redundancy for those users who wish to more reliably store their data, but this entire concept is unclear from the whitepaper. The nodes of the DSN are meant to be regular people’s home computers so these nodes will be offline from time to time. The smaller the network is, the riskier it is to store data in it. This essentially puts a higher price on not just high redundancy, but reasonable redundancy.

I should mention here that Filecoin’s solution to the above problem is a collateral placed by the storer of data (or “pledger of storage” as described in the paper) that is returned as the storer proves storage of the data over time. This is possible through the fact that data storage requests are made by requesting an amount of storage for an amount of time (and thus the paper has, a bit arrogantly, redefined the term “spacetime”). If the Filecoin token value were to significantly drop, the collateral would simultaneously drop in value and the storer has less incentive to continue storing the data. This ties the internal network incentive to store data to an external factor of the Filecoin price on the open cryptoasset market, which is famously volatile. This further adds to the lack of storage safety but does add one assumption about this market segment which is that it values storing data not for an indefinite period of time, but for a specific, limited period of time.

The logical path leads to a market segment of users who highly value decentralization and do not intend to store data indefinitely. An example of this might be a whistleblower who wants to send files to someone else by sharing his private key and does not want to rely on any centralized storage network. The issue here is that there are already many established channels for this type of communication such as SecureDrop or even plain old analog mail. A whistleblower is usually trying to get data to a media organization, like the New York Times, so decentralization in this case is not valued.

Any data can be stored securely on any server, public or private, as long as its encrypted with a private key. Therefore you don’t have to trust the storage provider to not read your data, because they can’t read it, you just have to trust them to store the data, which of course is a cloud computing provider’s entire business model.

Filecoin’s whitepaper fails to identify the market for which the network is useful and also fails to identify or even estimate the prices at which the storage will be sold (other than describing their prices as “hypercompetitive”). Of course, the internal market for storage paid in Filecoin is distinct from, but influenced by, the external market for Filecoin on the open cryptoasset market.

Schmacroeconomics

The currency used to pay for storage on the DSN is internal to the network, and can only be used within the network. Since no one (except maybe a few people at Protocol Labs) gets paid in Filecoin, there has to be at least one exchange from an outside-the-network currency to Filecoin. Let us assume that this outside currency is the dollar and the “real” price of storage on the Filecoin network will be defined as the price of storage in dollars. As the price of Filecoin changes with respect to the dollar, so does the real price of storage. So a transaction can start at a real price of $1 for 1GB over 1 year, but end at any price. The DSN works by having the user make micropayments of the total amount to the storer of the data over time, as the storer proves that they have been storing the data over that time. So although the price in Filecoin for a transaction stays consistent over that year, the real price can increase indefinitely with the exchange price of Filecoin. Exchange market conditions could create a situation in which it is anti-economical to spend any Filecoins in order to use the network, but it is profitable to simply hold them.

It must be stated that the demand for Filecoin is not necessarily correlated for the demand for storage in the DSN. Likewise, the investors that bought Filecoin during the ICO are not necessarily the same people who will be storing data on the network. The investors are not necessarily the users. Demand for cryptoassets as a speculative investment vehicle drives up prices while not adding to the utility of the network itself.

The real price of providing storage to the network, as a collateral for not running away with the data, behaves conversely. If the real price of the collateral goes down, the incentive to continue storing data on the network goes down, decreasing the reliability of the network. This would be further amplified if there was a competitive DSN whose cryptocurrency was worth more on the exchange market.

You can’t spell DRASTIC OVERVALUATION without ICO

Filecoin is the largest ICO to date. I do not believe that investment in this token is due to the utility of the network, but is instead a bet on the value of a cryptoasset itself. Note the use of the term cryptoasset, rather than cryptocurrency. The Filecoin cryptocurrency is only used within the network while the Filecoin cryptoasset is speculated upon in external exchange markets for real currency. I have read Filecoin’s whitepaper and believe I understand it to the best level one can outside of the authors themselves. The paper is itself difficult to get through, and this is a function of the complexity of decentralization itself. I do not take anything away from the difficulty of the problem of decentralization but I do question the validity of the market case for Filecoin itself and I would love to further discuss the arguments provided. I also believe that similar arguments apply to the ICO market as a whole, and to the entire cryptoasset market. I plan to continue writing about this on my path to understanding it and hope some readers find it interesting along the way.