Filecoin deep dive: the key to unlocking web3?

The world of crypto is suffocating in buzzwords.

And the biggest buzzword of them all is web3.

What is web3?

It’s easiest to define using the eras that came before it.

Web1: read

Web1 lasted from the early 90s to the early 2000s. Web pages were mostly static and users simply read them.

Only experts knew how to make, manage and maintain websites and they usually had to do it out of their own pocket.

Web2: read-write

Web2 kicked off around 2003-2004, with sites like Myspace and Facebook, and services like WordPress.

Web2 sites were basically platforms for users to create content with. They could both read them and write on them.

Oh, and everything was free!

Instead of hosting your own website or message board on your own server, you could just use Myspace or Facebook.

The unwritten deal was… in exchange for making these platforms and paying to host them, the companies behind them collected massive amounts of user data and sold it on to advertisers.

Or, to put it another way: Web2’s users are its currency.

This is how pretty much all of the “free” platforms we use work: Instagram, Twitter, YouTube, Google, TikTok… you name it. They mine data on their users and sell it to advertisers.

I used to think most people knew this. But then in 2018 the Cambridge Analytica scandal happened and the entire world was in uproar.

It turns out no one got the memo about the whole “free” deal.

This led to the Big Tech backlash, billions of dollars in fines and, most important of all, Google dropping its “don’t be evil” motto.

It was official. Big Tech was embracing being the villain.

Just as all this played out, blockchain burst onto the scene.

(Well, it had already been around for a long time. But 2017 was the year everyone’s relatives started asking them about it.)

Web3: read-write-own

The central idea behind web3 is ownership.

Not only do users own their own data, but they also own the platforms they use as well.

So, for instance, in a web3 version of twitter, not only would users own their own tweets and own their own metadata, but they’d also own the twitter network itself.

It achieves this through three main mechanisms:

1. Decentralisation.
2. Tokenisation.
3. Leveraging greed for the greater good.

I write a lot about decentralisation here, but let’s have a quick refresher of why the idea is so revolutionary (at least in terms of the internet).

In a centralised system, like a bank, the central authority sets the rules and collects the profits.

In a decentralised system, like for example Ethereum-based DeFi platform AAVE, the people who use the system set the rules and collect the profits.

You could change “bank” here for anything: social media platform, video sharing platform, insurance company, online marketplace… you name it.

And how do the people using the network “own” it? Tokenisation.

Tokenisation is basically representing a real-world asset or contract in the form of a crypto token.

You can tokenise anything: debt, property, businesses, networks… again, you name it.

In the AAVE example I used above, here’s what AAVE tokens are used for (From AAVE):

AAVE is used as the centre of gravity of Aave Protocol governance. AAVE is used to vote and decide on the outcome of Aave Improvement Proposals (AIPs). Apart from this, AAVE can be staked within the protocol Safety Module to provide security/insurance to the protocol/suppliers. Stakers earn staking rewards and fees from the protocol.

(Of course the Securities and Exchange Commission (SEC) might argue that if you’re collecting profits from owning a part of the network you’d be venturing into unregistered securities territory, but that’s a topic for another day.)

Which brings us to number three, leveraging greed for the greater good.

I first covered this idea in my everything you need to know about crypto essay. But let’s have a recap:

Remember that quote we began [that essay] with: “In a society governed passively by free markets and free elections, organized greed always defeats disorganized democracy.”

Well, the genius of Bitcoin is that it does the exact opposite. It harnesses greed to create democracy.

The Bitcoin network is maintained by “miners”. These are people that lend their computer power into keeping the Bitcoin network secure. For doing this, they get rewarded in Bitcoin.

Anyone can become a Bitcoin miner. All you need is a computer and an internet connection.

And the more people that decide to mine Bitcoin, the more decentralised, democratic and powerful its network becomes…

It’s a very elegant model to harness greed and self-interest for the good of the many.

Tokenisation is just the evolution of this idea. But instead of mining to get tokens, you can simply use the network (at least in the case of most DeFi protocols).

Everyone who holds the tokens is incentivised to make sure the network works as it should and keeps improving. The better the network gets, the more it’s worth. And so the more the users’ tokens are worth.

This idea is at the centre of pretty much everything in crypto, blockchain, DLT… whatever you want to call it.

It’s one of the best things about it. It’s literally taking something bad: greed. And turning it into something good: democracy.

Sure, it’s not perfect. We still have issues like concentrations of wealth having more power (See my Aptos deep dive for more on that). But it’s definitely a big step in the right direction compared to the Goldman Sachs model of the 20^thcentury.

So, what’s at the heart of web3?

Read-write-own.

Or, as I like to think of it, leveraging greed for the greater good.

It all started with the Inter Planetary File System (IPFS)

Now, be warned. This section is going to get a little complicated. But I’ll write it all out as plainly as I can.

Unfortunately, in order to understand the significance of IPFS, we need to understand a bit about how it works.

Okay, here we go…

The idea of centralisation is so ingrained in the internet, that if you really want to build web3, you have to start from the ground up.

You have to start from the protocol level, which is where the team behind Filecoin come in.

They’re called – surprise, surprise – Protocol Labs.

And before Filecoin, they created something called the Inter Planetary File System (IPFS).

IPFS literally decentralises the internet.

I covered a bit about how the internet works in the vision section of my Cosmos deep dive.

But today, we’re going even deeper, because IPFS is a true layer 0. Actually, it’s below layer 0.

As I mentioned before, it’s a protocol.

The way the internet works is through Hypertext Transfer Protocol (HTTP). If you click or tap on the address bar of your browser when you’re on any website, you’ll see that before the website name it says http://.

(Actually, it’s more likely to say https:// because it’s using a secure connection, but for simplicity’s sake, let’s just think about the http part.)

That’s the protocol pretty much all websites use. It’s designed for a system where a single server stores a website’s files.

HTTP tells your browser where to look to find those files.

The important part is it’s based on location, and it works well in a centralised system where website files are stored in a single location.

IPFS is designed for a decentralised system. In a decentralised system you can’t look up files by location because they could be anywhere. They aren’t stored in one central place.

So instead of their unique location, IPFS instead finds files by their unique content.

It does this by creating a unique hash of the file and shares these hashes across all the computers participating in the IPFS network.

A hash is kind of like a phone number. You can create a hash of any file and it will give you a short string of digits that is unique to that file.

So you could hash a 100gb file down into a few bytes.

(If you want a good explanation of hashing, IPFS has one here.)

IPFS then adds these hashes to a database – a distributed hash table (DHT) – that’s shared across all the computers on the IPFS network.

Then, when a computer on the network wants to retrieve a file, it uses the DHT to find out where it’s currently located.

That computer requests the file, and it is shared across the network and sent to it.

This means that files can be stored in a decentralised way. It doesn’t matter where they are located because the DHT is updated to show where they are when they are moved or changed.

In fact, it gets even smarter than this because the file itself can be broken up into many smaller blocks and each small block can be stored and shared by any computer on the IPFS network. Then they get reassembled when they reach the computer requesting them.

As an aside, this is very similar to how BitTorrent works, if you’re familiar with that.

Now, we’ve covered a lot here in a relatively short space of time (and we haven’t even got onto Filecoin itself yet!)

But you’d like to go deeper, IPFS has a longer explanation of how it works here.

In conclusion: IPFS means websites, files, content, can be decentralised. This makes them secure and censorship resistant, among other things.

It also means you don’t need to rely on servers, because the network itself becomes the server.

This is revolutionary.

But there’s just one problem…

Where’s the incentive to use IPFS?

IPFS certainly ticks the decentralisation box. But what about the leveraging greed part?

In the traditional internet, you pay companies to host your websites and the files they need to run.

What incentive is there to participate in IPFS, host files and make it function?

As we already covered, the genius of Bitcoin was that you get paid to maintain and secure the network.

You don’t get paid to maintain and secure the IPFS network.

Remember I mentioned BitTorrent earlier? Well, a big issue with BitTorrent is files can just disappear. Unless someone agrees to “seed” them permanently, no one can access them.

And in order to “seed” you have to keep the file on your computer and keep your computer connected to the internet and let other people constantly download it from you… for free.

So older and less popular files tend to disappear.

The same thing could, and likely would, happen with IPFS.

That’s why Protocol Labs created Filecoin.

Enter Filecoin

Filecoin is basically the incentivisation layer for IPFS.

It’s the “tokenisation” and “leveraging greed for good” part of the equation.

The Filecoin network is basically a marketplace for people to buy and sell storage that’s built on top of IPFS.

Storage providers put up some collateral in the form of Filecoin’s FIL token, and they can then sell their storage in exchange for FIL.

In the Filecoin network you basically mine its token (FIL) by providing storage.

The more storage you provide, the more FIL you’re rewarded with.

In order to become a storage provider, you have to put up collateral in the form of FIL that’s proportional to how much storage you want to provide.

And Filecoin has a number of automatic mechanisms to ensure you’re actually providing the storage space, and storing the files, you claim to be.

So, if you lose the files you’re storing or go offline, you’ll also lose your collateral.

At the other end of the spectrum, if you want to store your files with Filecoin, you pay to store it with FIL. But instead of paying a centralised company like Amazon or Google, you’re paying a decentralised network.

Filecoin puts it more succinctly in its whitepaper:

The Filecoin DSN is a decentralized storage network that is auditable, publicly verifiable and designed on incentives. Clients pay a network of miners for data storage and retrieval; miners offer disk space and bandwidth in exchange of payments. Miners receive their payments only if the network can audit that their service was correctly provided.

(Since that whitepaper was written, Filecoin prefers to call miners “storage providers”, so that’s what I’ll call them in this deep dive.)

As a storage provider you also make money by securing the network itself, like how Bitcoin works. But unlike Bitcoin, your chance of mining a block isn’t dependent on the power of your processor, but on the size of your storage space.

This means Filecoin has the coolest sounding consensus mechanism in all of crypto: proof of spacetime.

Again, from the Filecoin whitepaper:

We propose a useful work consensus protocol, where the probability that the network elects a miner to create a new block (we refer to this as the voting power of the miner) is proportional to their storage currently in use in relation to the rest of the network. We design the Filecoin protocol such that miners would rather invest in storage than in computing power to parallelize the mining computation. Miners offer storage and re-use the computation for proof that data is being stored to participate in the consensus.

By now we have a pretty good understanding about web3, IPFS and Filecoin.

And, hopefully, you can see just how revolutionary this technology could be. A lot of crypto projects talk about decentralising this or that, or creating a new, fairer internet. But this is the first one I’ve seen that’s actually gone and done it.

And it’s been a long time in the making. The first Filecoin whitepaper was published in 2014 – the same year as the Ethereum whitepaper.

Filecoin had its ICO back in 2017 and its network launched in October 2020.

It absolutely blew up in 2021, going from $24.33 on the 1^st of January to $236.84 on the 1^st of April – an 873% gain in three months.

And then it crashed spectacularly.

Even considering the crypto winter and the 70-90% drop we’ve seen in most cryptos, Filecoin is an outlier. It’s down 97.8% from that all-time high.

But I don’t deal in crypto price predictions or speculation. There are plenty of outlets doing that.

What I do deal in is the vision behind a project. I try to imagine what it could mean for the world, and for us as individuals, if the project pulls off its vision.

And Filecoin is about to take a giant leap towards fulfilling its vision later this month, with the release of Ethereum-Virtual-Machine-compatible smart contracts on the Filecoin network.

However, that’s not to say that Filecoin is all stardust and rainbows. There are some major caveats with this project, which I’ll cover in the rest of this deep dive.

So let’s get on with it…