FileCoin Analysis: Figuring out the fundamental value of cryptocurrencies

September 21, 2017 · 8 min read

I recently began consulting for Radicle as a Partner Analyst attempting to develop a fundamental outlook of various cryptocurrencies/ICOs. As you can imagine these tokens straddle a line between commodity and currency making it very tricky to establish a basic framework with which to value them. The below is the product of multiple weeks of research and analysis attempting to solve this question. Hope you enjoy it. —Nick

What case are Sequoia, A16Z, USV and others underwriting by buying the FileCoin ICO pre-sale at $0.75 per coin?

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 on Decentralized File Storage and Sharing ICOs.

The Opportunity in Decentralized File Storage

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 really represents 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 — from possible to completely implausible.

How Do We Imply a Market Size from Current Trading Levels?

To consider the intrinsic value of a cryptocurrency, we employ the equation: Price = T / (V × S), where T is an estimate of potential future transaction volume derived 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. 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 achieves 30–60% share of the 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.

We use the ultimate supply of a given cryptocurrency, rather than the supply of currency 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, the future supply of currency is a better estimate than current supply.

Two Ways to Read the Analysis

This framework allows us to consider current coin trading prices in two ways:

  • SAM → Price: 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 an 82% premium to the intrinsic value estimate.
  • Price → SAM: If we flip the analysis, we can use the current market price of one Storj coin to consider what investors are implicitly underwriting as the size of the decentralized file storage market. The current Storj coin price of $0.485 implies a SAM of $41bn — compared to our estimate of $22.6b and an overall file storage market of $75b by 2021.

It's noteworthy that the price of Storj tokens has traded down ~70% over the past month from $1.58 — due in part, we estimate, to investor attention shifting to the FileCoin ICO.

What Case Did Sequoia, A16Z, and USV Underwrite at $0.75?

The FileCoin ICO has a number of noteworthy factors:

  • It was the largest ICO to date.
  • Only accredited investors were allowed to participate.
  • Some of the biggest names in venture capital — including Sequoia, Andreessen Horowitz, and Union Square Ventures — participated in a pre-sale at a discounted price of $0.75 per FileCoin.
  • The price at which other investors ultimately bought FileCoin was $5.15, or a 586% premium to the pre-sale price.

It prompts us to consider the logic behind $0.75 — our bias is to believe that people at these firms 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 the same range of assumptions outlined above (SAM of $23b, velocity of 10–100, market share of 30–60%), the implied fundamental future value of FileCoin would fall in the range of $0.04 — $0.68. Relatedly, the price paid by Sequoia, A16Z and USV would imply a market size for the distributed file storage market of $25–$500b.

Open Questions

  • 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 it's worth caveating that.

Full LinkedIn post: FileCoin Analysis — Figuring out the fundamental value of cryptocurrencies

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