Filecoin Miners Face Harsh Reality Behind the Project’s Tokenomics

Filecoin raised over $250 million via an ICO, gained popularity in the red hot Chinese crypto market, and is looking to take on tech giants like Google and Amazon to democratize cloud storage.

Starting this big, however, has its drawbacks. With expectations so high, and the blockchain community’s infamous impatience, a loyal community can quickly turn hostile.

So has been the case for Filecoin.

News broke over the weekend that the platform’s miners went on strike due to insufficient rewards and harsh penalties. Although the CEO of Protocol Labs, the network’s parent company, attempted to debunk the accusations, the overarching issue remains.

Filecoin Miners Get Rekt

On the one hand, the hype surrounding the project has attracted professional miners who treat participation in the network as a formal business. This means they need to recoup steep initial investments and start earning profits fast. 

On the other hand, Filecoin must impose restrictions to ensure that miners stick around and provide services to its potential clients for years to come. 

These two forces, plus the sheer size of the project, has spelled disaster for enterprise-grade miners.

Shortly after Filecoin went live on Oct 15, mentions of insufficient incentives for miners began to appear. Eventually, news outlets reported that several miners had gone on strike and shut off their rigs.

While the team denied the strike, it became clear that miners have been struggling with financing their operations. The primary reasons for that are the substantial upfront costs and vesting of miner rewards. 

The pain from pledging tokens is exacerbated by high hardware costs, as pointed out by social media users. 

Stop, read it again. $240M worth of hardware, ready at mainnet launch. Not including all the one waiting to be installed. Not some market valuation, real money changed hands, real servers. This is a conservative estimate.
(14/n)

— Nico Deva (@NicoDeva_) October 18, 2020

Filecoin’s tokenomics were criticized before the mainnet launch, after the extensive explainer’s release. However, there may be a reason why it didn’t change up until now.

Alignment of Incentives

To better understand Filecoin’s economic model, one must first focus on the network’s value proposition. The platform’s ultimate goal is to store files like photos, videos, music, books, and other media formats. 

Many already use similar services like Google Drive or iCloud, for which users may be paying monthly subscription fees. Now imagine being offered to store the same valuable data on a lesser-known network like Filecoin. 

Before joining, users would want to know that their files will be safe and that they will be able to download them again in a year, maybe even later. 

Unlike traditional cloud storage servers, where files are stored in large, centralized data centers, Filecoin stores this data locally with participating miners. Miners are rewarded for maintaining and securing this data and are even incentivized to continue expanding their storage capacities as the data grows. This is the central function of the platform’s tokenomic design.

The incentives for miners to continue expanding does, however, hinge on the demand for Filecoin’s services.  Obviously, there’s no use in offering substantial storage power if it remains idle.

What’s more, Filecoin must ensure that miners who arrive to reap the network’s rewards also remain after these early incentives end. It’s not uncommon to see miners swiftly move between networks as new opportunities emerge. Such mercenary behavior can be catastrophic for the health of a platform.  

For Filecoin, losing miners would mean users also risk losing any data stored on the network.

(7.10.) Also: we already have huge capacity, and don’t need much more yet. The network must now focus on making that capacity useful, by storing valuable data for users.

More capacity is great to have! But it’s not very useful until we actually use it & start running out.

— Juan Benet (@juanbenet) October 19, 2020

The initial pledge that the miners are unhappy about serves to protect against possible failures or malicious practices as a new sector is created. 

A sector is a technical term and refers to a placeholder for user data. Once a miner receives all of a user’s data, they seal the sector and store it on their hardware. Sealing provides a compact proof that the data is actually stored, which is then sent to the blockchain. If miners fail to perform this critical duty, their initial investment will be penalized.

Sector sealing. Source: Filecoin

Moreover, the initial pledge protects the consensus algorithm’s integrity, which is also essential to securing users’ data. Committing financial resources to the network creates a mechanism similar to Proof-of-Stake (PoS), where acting maliciously is costly and counterproductive.

The upfront cost is substantial, more than 20 days worth of block rewards, but the vesting of rewards should help alleviate some of the burdens. Mining rewards can be partially funneled to pay costs for new sectors.

Rewards vesting also protects end-users by ensuring that miners will provide services as agreed and that data will remain accessible for the full duration of storage deals. Once a sector with a user’s data is sealed, it’s unprofitable for a miner to drop the deal.

Overall, Filecoin’s tokenomics make sense from a business perspective. Although miners are important players in the ecosystem, their gear and commitment would mean nothing without users’ demand. 

However, some external factors have skewed the team’s economic model at the project’s initial stage.

The Aftermath of the Mainnet

Market speculation and insufficient circulating supply have created challenges for Filecoin miners. However, this is a natural outcome of the project’s tokenomics design, and the team intends to help the community go through rough times.

FIL, the platform’s native token, surged over $200 on some exchanges upon the mainnet launch day. While the price has declined to around $30 since then, it’s still expensive for miners looking to provide an initial pledge.

FIL/USDT. Source: Huobi Global

The initial price jump was the byproduct of hype around the project and low circulating supply. 

A large portion of the total supply (70%) is reserved for miners, while the ICO’s, team’s, and foundation’s tokens (30%) are vested. Consequently, the current circulating supply of around 17,5 million FIL constitutes only slightly more than 0.87% of the total supply.

The team claims that it spent money on market-making services. However, it won’t be enough to keep the supply pressure under control, considering how low the circulating supply is.

(8.1.) The FIL in question is part of a market stabilization program which has become an industry standard. These programs engage firms to provide liquidity & stability to the market in the early days after launch, when prices are at risk of being volatile. pic.twitter.com/RUzZC8sA8P

— Juan Benet (@juanbenet) October 19, 2020

What complicates the issue is that Filecoin isn’t designed to favor early contributors for simply showing up and validating blocks. It’s rather unconventional as many  Proof-of-Work (PoW) platforms are famous for being generous to early adopters. 

Filecoin also features a baseline for the network’s cumulative storage capacity. Once this baseline has been reached, mining rewards will be far more lucrative. Until this point, however, 70% of the network’s rewards will remain locked. 

The baseline is set to one exbibyte or 1,024 pebibytes. The current network’s storage power is 605 pebibytes, which is far below the baseline. As a result, mining rewards are lower, and the circulating supply inflates slower, which slows down the creation of new sectors. 

A natural way to solve the miner’s issues would be through user demand. The team’s initial idea was to distinguish between miners and people who need storage through easy client verification. Verified clients would then create verified deals, meaning that the network participants know they will host real files instead of dummy ones. Miners serving verified clients would get more block rewards.

The difference between regular and verified deals. Source: Filecoin

However, the concept of verified deals isn’t finalized yet. It’s also difficult for a just-launched network to generate substantial demand from users. Storing data on Filecoin at this stage isn’t very user friendly either. There’s only one platform with a user interface, Slate, but it’s currently not generating sufficient traffic.

The network’s miners face a situation where they have to commit significant resources to the project upfront and stick with it until it starts generating profits. It’s painful for many who used to enjoy steady profits participating in other networks. 

Fortunately for them, the team is ready to step in.

Filecoin’s Band-Aid

In a series of recently published tweets, CEO of Protocol Labs, Juan Benet, highlighted two measures the team will take to fix the ongoing problems. 

First, the miners will soon start getting 25% of the block rewards immediately. A corresponding improvement proposal, FIP-0004, was accepted on Oct. 18. According to the project’s official Slack, it will be implemented on Wednesday or Thursday this week.

Second, Protocol Labs will provide small loans to miners. The details of these loans are also expected to be published this week, according to Benet. These loans will be sized to ensure the network’s growth at a “healthy rate,” which again signals the team’s focus on long-term sustainability. 

(6.4.) Third, PL is working with a partner (TBA) to provide small loans to miners from now until broader loan markets take off. More on this during the week. pic.twitter.com/uxcoGt9eNx

— Juan Benet (@juanbenet) October 19, 2020

Although Benet claims that the current situation is not surprising for the team and proposals like FIP-0004 were discussed weeks before the mainnet, there’s no data to support this. 

For instance, the FIP proposal discussion was initiated on Oct. 14.

It’s a positive sign that the team stewards the protocol’s development at the early stages. Miners are central players of Filecoin’s ecosystem, and the team’s support should help convince them to stay with the project.

Still, there’s concern that some miners will liquidate their rewards instead of pledging them, which will negatively impact the price, considering the low circulating supply.

Closing Thoughts

Mainnet launches of projects like Filecoin aren’t well-positioned to be smooth. Large amounts of funds raised, lengthy development, and big communities create pressure at the very start for nascent technologies.

The blockchain space is still largely an experiment, but it’s slowly beginning to offer real value for laymen users still unfamiliar with the sector.  The hype from 2017 is far behind, and simply having a whitepaper isn’t enough to make money, and the market has now realized that.

Being able to commit to projects long-term becomes important, and Filecoin demonstrates it. While there may still be many opportunities to get rich quick, these opportunities won’t move the industry forward.