While it has been only nine months since Filecoin Mainnet launch, there are over 2700 active miners on the Filecoin network, collectively contributing to over 7 EiB of committed storage capacity.
Behind the incredible growth of the network, Filecoin mining has become one of the most significant economic activities in Web3, with more than 86 million FILs mined, over 92 million FILs locked as collateral, and over 27 million FILs burned as network fees. The economic value of providing Web3 storage on Filecoin is measured in billions of dollars.
However, given Filecoin’s dynamic economic model, understanding Filecoin mining economics requires knowledge of some key network economic factors, including but not limited to:
Block reward mechanism (network baseline)
Pledge collateral (circulating supply, lending)
Sector penalties (disincentive for unreliable storage)
Gas dynamics (network capacity and transaction fee)
Filecoin Plus (incentive for useful storage)
Hardware purchase and maintenance cost (off-chain investments and costs)
Without proper understanding of these factors, it is difficult for new participants to calculate mining returns and determine profitability, which might make them hesitant to join the network.
This blogpost aims to demystify the economics behind Filecoin mining and suggest the correct mental model to calculate mining return.
Filecoin Storage Providers vs. Airbnb Hosts
With Filecoin’s Proof of Useful Work, cryptocurrency mining has entered into a new era where miners have become both maintainers of the blockchain consensus and service providers on the platform economy. There are many similarities between providing Web3 storage on Filecoin and being a host on Airbnb as first proposed in this talk. As such, Filecoin Storage Providers and Filecoin Miners are used interchangeably.
Before we get into the details of Filecoin mining economics, we can first take a look at a direct comparison of a Filecoin miner’s operation to that of an Airbnb host.
As demonstrated in the table above, both Filecoin storage providers and Airbnb hosts are trying to monetize their existing space by providing valuable services for an extended period of time. The only difference is that Filecoin miners provide cloud services, while Airbnb hosts provide hospitality.
Return calculations of Airbnb hosting is quite intuitive. We can calculate either how much return is generated on one single property, or calculate the return of the entire Airbnb hosting operations (hosts might have multiple properties).
We can use similar mental models to think about Filecoin mining returns, either from a unit economics perspective, or looking at the entire storage provider operation as a whole, but first, we need to understand what are the sources of revenue, costs and initial investment.
Revenue
Revenue is the reward and payment that storage providers earn by committing storage power to the network and providing storage services for clients. Sources of revenue include block rewards, deal payments, retrieval fees, and miner tips.
Block rewards
For now, block reward is the major source of revenue for most storage providers. The network determines that every 30 seconds, Filecoin miners have a chance to win block rewards by recording and verifying other participants’ activities.
Unlike some other cryptocurrencies, Filecoin does not just follow a simple exponential decay model for token minting. Instead, Filecoin combines simple exponential decay minting and baseline minting, a KPI-driven minting mechanism, to encourage consistent storage onboarding and long-term investment in the network.
30% of storage mining allocation will be minted through simple exponential decay and the remaining 70% will be minted through baseline minting.
The Filecoin network crossed the baseline for the first time on April 2, 2021, which means the block rewards are being distributed to its full potential, unless the network power falls below baseline again. (Reference: Sustainability Goal Achieved: Filecoin Network Crosses Baseline Target)
Other Revenues
Miners are also incentivized with other sources of revenue to provide better services
Deal payments, which are fees paid by clients for data storage;
Retrieval fees, which are fees paid by clients for data retrieval;
Miner tips, which are fees paid by network participants for on-chain activities.
As block rewards continue to decay in the future, deal payments, retrieval fees, and miner tips can replace block rewards to become the major revenue sources for miners.
Cost
Cost is the expense that occurs during the mining operations, which include both on-chain costs and off-chain costs.
On-chain costs
There are two main types of on-chain costs incurred during the mining process, network transaction fees and penalty fees.
Network transaction fees, also known as gas fees, are fees that miners pay to the Filecoin network when recording mining activities. Because the number of transactions that the network can process is limited, network transaction fees are charged for the usage of public resources. The fee amount often reflects supply and demand of the Filecoin network capacity usage.
Penalty fees are penalties that miners pay for unreliable storage. Penalty fees are in place to incentivize reliable storage and punish malicious behaviors.
Off-chain costs
Off-chain costs mainly occur during the daily operations of Filecoin mining, which include costs such as data center, internet, rent, and labor cost. Operating costs are related to the organization structure and operation management of each miner entity, which are dependent on the miner’s scale and sophistication.
Other operating costs can be implicit or in non-cash format. For example, the depreciation cost of mining hardwares should be counted as a cost item, even though the cash outflow may occur at the beginning of the mining period. Similarly, the capital requirement of miners collateral carries an implicit cost of capital, which should be counted as a cost item as well.
For simplicity, we intentionally leave out hardware depreciation cost and collateral capital cost in the cost section. We will discuss these two items in depth in the initial investment section.
Initial Investment
Initial investment measures the money required to kickstart mining operations.
If we use the Airbnb hosting analogy again, the initial investment should include investment of property and the capital required to cover initial deposits and early expenses before receiving any client payments or platform subsidies.
Similarly for Filecoin mining, sources of initial investment are mainly capital expenditure (purchase of initial pledge collaterals and mining hardwares) and operating working capital reserves (cash to cover early mining operations).
Collateral
Filecoin uses an upfront token collateral mechanism to ensure dedication of storage capacity and security of the network. Therefore, miners need to make an initial investment to purchase Filecoin tokens as initial pledges.
When Filecoin prices are high, collateral can be considered a big initial capital requirement for miners. However, what matters the most may not be the Filecoin price at which a miner pledges the collateral. Instead, it is the price trajectory during the operations, and the price volatility can be hedged with various solutions.
It can be tricky to think about collateral as a cost. From an accounting perspective, collateral is more like an asset item in the balance sheet, instead of a cost item in the income statement.
The better way of thinking about collateral from a cost perspective is to think about the opportunity cost that is associated with the investment of collateral.
Miners can ideate a cost of capital for the token collateral. Depending on the capital structure, such cost can be on equity, debt, or a mixture of both. The cost associated with collateral is just the cost of capital incurred over the mining period.
There are three kinds of Filecoin mining collaterals that serve different purposes:
Initial storage pledge: estimated 20 days worth of block reward.
Initial consensus pledge: share of 30% quality adjusted power-normalized circulating supply.
Deal provider collateral: share of 1% raw byte-normalized circulating supply as minimum.
Initial storage pledge and initial consensus pledge are to make sure that miners commit resources and behave rationally in the network.
Deal provider collateral is dependent on how much storage providers are willing to commit to ensure storage deal reliability. Its purpose is to align incentives between miner and client, and to allow miners to differentiate themselves in the storage market.
Hardware and operating working capital reserves
The capital expenditure of purchasing mining hardware is a major part of initial investments for Filecoin mining. The amount of capital required for hardwares depends highly on hardware market prices. Because different miners can access mining hardwares at different prices, the hardware acquisition costs can vary among different miners.
Operating working capital reserves are invested to cover early operating costs before block rewards and deal payments are sufficient to maintain the business.
The Filecoin block rewards are not immediately released to miners once they are mined. Only 25% of block rewards are immediately available. The other 75% will follow a 180-day linear vesting schedule to align miners with the long-term success of the network and make miners less sensitive to short-term price movement.
The block reward vesting schedule resembles the account receivable collection period in accounting, which is quite significant to a miner’s operating working capital and affects initial investment.
Return Calculations
Now that we have discussed different components of Filecoin economics, let’s talk about specific approaches to calculate mining returns. At a high level, mining returns measure how much value can be generated given a certain amount of committed resources.
There are two approaches to calculate mining returns.
The first approach is to calculate unit mining return, where return on investment is measured at a sector level. Unit mining return can provide a general guidance on mining return for the entire network because some economic factors are shared across the network. For example, the block rewards that a sector expects and the gas fees that sealing a sector requires are generally the same for all miners.
The second approach is to calculate holistic mining return, where return on investment is measured at a business level. Holistic mining return is more miner specific as most economic factors depend on the miner's economic decisions. For example, the total committed storage power and the sector sealing speed are determined by the miner’s operation strategy, and can be very different from other miners.
Unit Mining Return
For unit mining return, we look at all the economic factors that go into a sector.
If we use the Airbnb hosting analogy, it’s like calculating the return of a single property. Initially, the host needs to purchase the property and pay necessary registration fees to list the property on Airbnb. The revenues of the property come from platform incentives and client payments, and the operating costs mostly come from property maintenance fees. The return is calculated as the operating profits divided by the initial investment.
For Filecoin mining, initial investments of a sector include hardware costs, miner collaterals, and on-chain costs (charged or reserved upfront). The revenues are mainly block rewards and deal payments, and the operating costs are mainly sector maintenance.
If we use one year period as the return horizon, we can calculate the unit mining return as the following:
Annual operating profits = annual revenue - annual operating costs
Unit mining return = annual operating profits / initial investments
Initial investments
Among the initial investments, initial storage pledge and initial consensus pledge are the same among all miners because they are dependent on expected block rewards and circulating supply. Deal provider collateral depends on the miner’s willingness to win storage deals, so it differs among miners.
Hardware investments depend on the hardware market prices. Although miners may have different acquisition costs of the hardwares, we can look up the latest hardware prices to make a ballpark estimate.
On-chain costs are part of the initial investments because they are required to be paid or reserved upfront. Network transaction fees are required to be paid when miners want to seal a sector, and penalty fees are already reserved when miners lock collaterals to the network.
Operating profits
As previously discussed, sources of Filecoin mining revenue includes block rewards, deal fee, retrieval fees, and miner tip.
Expected block rewards per sector are the same among all miners as they are determined by the network. However, miners can decide whether they want to take deals or retrieve files for clients in order to earn deal fees, which can increase the sector’s revenue.
Moreover, if a sector contains verified deals, its expected block reward will be significantly higher because it receives Filecoin Plus benefits. Thus, miners can participate in the Filecoin Plus to improve the unit mining returns of their sectors.
Over the operating period, the main costs are sector maintenance costs, which are primarily off-chain operating costs because on-chain costs are paid or reserved upfront. Per sector operating costs can be calculated as the total operating cost divided by the number of committed sectors.
From a unit mining return perspective, breakeven is achieved when operating profits can cover initial investments.
Use cases and limitations
This analysis shows what happens to a single sector during Filecoin mining. The input assumptions can be calculated or observed in a relatively straightforward way, and the output result is easy to calculate. Therefore, the unit mining return approach is suitable for getting a quick overview of mining returns. We can also use this approach to estimate the unit economics of an average miner on the network.
With this model in mind, miners can elevate their unit mining returns by improving specific economic factors that affect returns. Moreover, this model gives miners a good idea on what the incremental capital is required to add another sector, as well as what economic benefit it will bring.
However, there are some limitations of this approach. For instance, the compounding effect won’t be reflected in the unit mining return. Once a sector breaks even, there is no way to further invest the cash in additional sectors to earn more economic benefits. Reinvestment of mining returns can only be reflected by looking at returns of the mining business as a whole, which is the holistic mining return approach that we will discuss below.
Holistic Mining Return
For holistic mining return, we look at the economic factors that go into a mining business.
Using the Airbnb hosting analogy, this approach is like calculating the return of a hosting business. The business owner can purchase multiple properties and register them on Airbnb. The business owner can decide the number of properties to be listed on Airbnb and the speed of business expansion. At the end of the operating period, the holistic return is the increase in business value divided by initial investments.
For Filecoin mining, Initial investment measures how much money a miner needs to put in to start the mining operations. End period value measures the value that the mining operations can be sold at.
The holistic mining return is calculated as the following:
Holistic mining return = (end period value – initial investment) / initial investment
Below, we demonstrate an example that shows how a holistic return could be calculated. We note here that this is merely a numerical exercise to demonstrate a miner’s cash flow, and the numerical value is not a realistic representation of actual returns. A more realistic version will be later published after more research on the network.
Initial investment
As discussed above, the initial investment of Filecoin mining includes capital expenditure (purchase of mining hardware and initial pledge tokens) and operating working capital reserves (cash to cover early mining operations).
Unlike unit mining return, the operating working capital reserves of holistic mining return do not need to cover all on-chain costs. As miners add sectors gradually, some on-chain costs are distributed over the operating period. Because mining can generate token cash flow, some operating costs in later stages can be covered by early revenues.
Purchase of mining hardware and initial pledge tokens does not need to happen all at the beginning as well. With different sector sealing schedules, some capital expenditures can happen during the mining period and may be partially supported by early revenue.
Therefore, the amount of initial investment required is highly dependent on the miner’s operating strategy.
End period value
The end period value is how much miners can sell their mining businesses for at the end of the operating period. The value would mainly rely on four things: cash balance, hardware residual value, receivable earnings, and unreleased collaterals.
Cash balance is a combination of fiat balance and fully vested token balance. Over the operating period, the cash position can increase due to mining incomes and released collaterals.
Hardware residual value is the resale value of mining hardwares at the end of the operating period. Because commercial hardwares are used for Filecoin mining, they would still be valuable to many other business use cases. Therefore, miners may be able to sell their mining hardwares at a certain price, depending on the second-hand market demand.
Receivable earnings are the block rewards to be earned by a mining operation due to the block reward vesting schedule, which can make up a very big part of the end period business value. The correct way to calculate receivable earnings is to perform a token cash flow projection, and assign a discount rate to convert future cash flow to present value. It is similar to a discounted cash flow valuation method in traditional finance.
Unreleased collaterals are the collaterals pledged to the network but not yet released. Because collaterals are fully returned only when services are successfully fulfilled, we can assign a discount rate to the unreleased collateral to price in potential faults.
From a holistic mining return perspective, breakeven time is calculated as the time it takes to accumulate enough cash flow to cover initial investments.
Use cases and limitations
The holistic mining return is significant as it answers how much cash is required to put in at the beginning of mining and how much cash can be taken out at the end. It is more miner specific and requires a lot of miner inputs. This approach is suitable for investing in a Filecoin mining business.
The holistic mining return calculation requires miners to have a thorough understanding of their mining business as well as the Filecoin mining economics. It cannot be generalized across the network, so it’s very hard to produce an average mining return for all miners with this approach.
Conclusion
Cryptocurrency mining has entered a new era with the launch of Filecoin, thanks to proof of useful work. While it sets the stage for mainstream adoption for Filecoin and blockchain technologies, it also requires some paradigm shift to think about mining economics.
In this blogpost, we discussed Filecoin mining economics and the correct mental models to think about mining returns. To explain mining economics, we drew an analogy between Filecoin mining and Airbnb hosting and mapped out the similarities. We then discussed sources of mining revenue and cost in detail and pointed out how miners should think about initial investments.
We proposed two ways of thinking about mining returns: the unit mining return approach and the holistic mining return approach. Unit mining return analyzes operating profits versus the upfront investments of a single sector, and holistic mining return looks at the relationship between end period value and initial investments of an entire mining business. We have also discussed the use cases and limitations of each approach.
Combining ‘usefulness’ and ‘profitability’ in cryptocurrency mining is never a trivial task. The Filecoin team has put in tremendous effort in designing and implementing an innovative economic network to combine both aspects, and the results so far have been very significant. We are very excited to participate in the Filecoin network from a data analytic perspective, and we look forward to witnessing what Filecoin will become in the future.
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