What case are Sequoia, A16Z, USV and others underwriting by buying the FileCoin ICO pre-sale at $0.75 per coin?
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With Filecoin completing its record breaking, $257 million ICO last week, we have undertaken a multi-part analysis of the decentralized apps category, which starts with today’s sector report of the day on Decentralized File Storage and Sharing ICOs.
At a high level, decentralized file storage makes a lot of sense. Platforms in this sector attempt to unlock the world’s unused hard drive capacity by connecting and making available for storage a network of distributed computers and, in doing so, increase the efficiency, privacy and redundancy with which files are stored. It will not be the right solution for everyone (we expect that enterprises, for example, are likely to continue to rely on more “traditional” cloud solutions). But if it’s right for even a small fraction of cloud storage users (there are 1.8bn of them), the serviceable addressable market (SAM) can still be very large.
One key question, which we investigate more thoroughly in our report, is how best to approach the topic of valuing a cryptocurrency (an exercise which is specifically distinct from assessing the value of the service or mining layer that supports a given cryptocurrency or decentralized app). What follows and the report itself really represent the start of this exploration rather than anything conclusive. Cryptocurrency is sufficiently dynamic and the technology that supports it is sufficiently intricate that we present everything as our preliminary findings and a conversation starter.
That said, by our initial analysis, current trading levels for Storj, Maidsafe and Sia and the volume weighted price at which FileCoin completed its ICO imply that the market for decentralized file storage and sharing will reach anywhere from ~$40bn (in the case of Storj) to ~$1.7t (in the case of FileCoin) in the intermediate term. That would represent 40% to +2,000% of the estimated value of the overall cloud storage market. That in turn strikes us as anywhere from possible to completely implausible. In case we haven’t couched it all enough, we note that the platforms above are each different and that the nuances of those differences, if not properly accounted for here or in any analysis, could account for significant variations.
How do we imply a market size based on current trading levels?
What follows runs the risk of being fairly elementary. At the same time, we kind of dig basic, fundamental approaches. And currencies are a lot about basic supply and demand, which we believe this framework captures. So we’ll run with it as a conversation starter and look forward to improving it over time.
To consider the intrinsic value of a cryptocurrency, we employ the following equation:
Where T is an estimate of potential future transaction volume derived, in this case, from an estimate of the serviceable addressable market for decentralized file storage, V is the velocity, and S is the supply of tokens.
- We estimate the SAM in 5 years for decentralized file storage at ~$23b, and include the full detail in our sector report. As a point of reference, the overall cloud file storage market is expected to reach $75b by 2021, so our estimate assumes that decentralized apps will be very successful in this category. For illustrative purposes, we also present our analysis with the assumption that the relevant token / platform achieves 30–60% share of the serviceable addressable market (SAM). Current market share dynamics support the perspective that this is likely to be a winner take most market.
- We apply a range of Velocity assumptions between 10 and 100. The velocity of the M1 US Dollar money supply at its peak was 10. We base our estimate range on the fact that crypto tokens are easy to trade and will likely change hands at a higher velocity than basic US currency. For context, a single Bitcoin could be utilized as much as once every ~10 minutes and more realistically at ~ once every hour (or 8,760 annually). Our analysis is highly sensitive to this assumption, and we would classify the high end of our range as fairly conservative (i.e. it assumes the analyzed cryptocurrencies will have fairly high velocity and therefore on a per unit basis be worth less).
- We use the ultimate supply of a given cryptocurrency, rather than the supply of currency that is currently released. A central component of most cryptocurrencies is the ability for more currency to be mined / released over time. Seeing as we are thinking about a market in the future, we believe the future supply of currency is a better estimate than current.
This framework allows us to consider current coin trading prices in two ways:
- SAM => Price: First, we can use our own market sizing analysis to imply an intrinsic value of each currency. Using our $23b SAM estimate, the implied intrinsic value of one Storj coin, assuming velocity of 100 and 50% market share, would be $0.266. It is currently trading at $0.485, or a 82% premium to the intrinsic value estimate.
- Price => SAM: Second, if we flip the analysis on its head, we can also use the current market price of one Storj coin to consider what investors buying the currency at current levels are implicitly underwriting as the size of the decentralized file storage and sharing market in the future. The current Storj coin price of $0.485 implies a SAM of $41bn. To put that in context, estimates suggest that the overall file storage market will reach $75b by 2021, and, as mentioned above, we estimate the SAM for decentralized file storage and sharing at $22.6b.
It’s noteworthy that the price of Storj tokens has traded down ~70% over the past month from $1.58 — due in part, we would estimate, to investor attention on the FileCoin ICO.
What case are Sequoia, Andreesen Horowitz, Union Square Ventures and others underwriting by buying the FileCoin ICO pre-sale at $0.75 per coin?
The FileCoin ICO has a number of noteworthy factors including:
- It was the largest to date.
- Only accredited investors were allowed to participate.
- Some of the biggest names in venture capital, including Sequioa, Andreesen Horowitz and Union Square Ventures, participated in a pre-sale at a discounted (and ultimately a significantly discounted) price of $0.75 per FileCoin.
- The price at which other investors ultimately bought FileCoin, given the offering’s dynamics, was $5.15, or a 586% premium to the price at which the pre-sale was completed.
It prompts us to consider the logic behind $0.75, as our bias is to believe that the people at the firms mentioned above are acting rationally. And actually our analysis would suggest they just might be. But that same analysis suggests that anyone buying FileCoin at $5.15 is likely significantly over valuing the opportunity.
At that the same range of assumptions outlined above (i.e. SAM of $23b, velocity of 10–100, and market share of 30–60%), the implied fundamental future value of FileCoin would fall in range of $0.04 — $0.68. Obviously a very wide range. Relatedly, the price paid by Sequoia, A16Z and USV would imply a market size for the distributed file storage market of $25-$500b.
Both of these analyses assume that at some level FileCoin’s primary, and by far largest, market will be the file storage market. It could in theory expand into other markets, computing for example included. We believe that upside is offset in part by what we consider to be our fairly aggressive market sizing above. That is, if the decentralized file storage market grows to be ~30% of the entire cloud storage market over the course of the next 5–10 years, we would view that as big success.
This analysis perhaps raises more questions than it answers:
- How does everyone get comfortable with the “general public” buying the FileCoin ICO at such a significant premium to where venture capitalists bought in? Using our framework, buying a FileCoin for $5.15 is underwriting distributed file storage as a +$2.0 trillion market.
- Given how sensitive the analysis is to a Velocity assumption, what is a reasonable expectation on this front? Storj, which will ultimately have ¼ the supply of coin that FileCoin will have, should therefore have a faster (i.e. larger) velocity than FileCoin.
- What are we missing? This is a starting point, so hopefully we are directionally correct. But we could be very wrong. And so it’s worth caveating that.