September 7, 2017

Factom ($FCT) Analysis And Valuation

by Myles Snider

An executive summary is presented below. Download our complete 16 page analysis, including full valuation and price targets:

Executive Summary

Factom is a blockchain protocol built to leverage the security and immutability of Bitcoin (and other) blockchains for the purpose of recording data. Factom exists as a layer above the Bitcoin blockchain, allowing for data to be committed to the blockchain continuously and in real-time, secured by the consensus mechanism of the Factom protocol itself. The Factom protocol takes this security one step further by anchoring the results of this consensus to the Bitcoin blockchain every 10 minutes using a data-efficient Merkle tree. Factom’s native tokens are called Factoids, or FCT.

Bitcoin is the largest, most secure, and most trusted distributed ledger that exists in the world today. This is a function of network value and hash power. Bitcoin leads all cryptoassets on both. Data contained in the Bitcoin blockchain is immutable and auditable in a way that was impossible before Bitcoin was created. While the majority of development within the Bitcoin ecosystem has focused on Bitcoin as a payment or value transfer mechanism, the security and immutability of the Bitcoin blockchain can be leveraged in novel ways. Outside of payments, one of the most compelling use cases for blockchain technology is the ability to record and secure arbitrary kinds of data.

Why Factom and not just Bitcoin?

There are several reasons why enterprise clients, especially those dealing with large amounts of data, would not want to record that data directly onto the Bitcoin blockchain:

  • Bitcoin’s 10-minute average block times create forced delays that slow down the securing of data (usually up to 60 minutes per entry for full confirmation).
  • Adding data directly to the Bitcoin blockchain is expensive and the cost is unpredictable. Bitcoin network fees are denominated in Bitcoin. Therefore increases in BTC-USD prices increase the USD cost to commit data to the Bitcoin blockchain.
  • The Bitcoin blockchain cannot currently support the number of transactions needed for record keeping. Bitcoin supports about 7 transactions per second (TPS). This is far too low for organizations that need to secure large amounts of data to the blockchain.
  • With Bitcoin, the entire ledger is needed to verify individual pieces of data. This is computationally expensive. Factom allows for data to be grouped and examined at the group level, reducing the computational and storage cost for an individual organization.
  • Using Bitcoin (the currency) has implications for enterprise users, both legally and financially. Some businesses, nonprofits, and other enterprise clients will not want to transact or hold cryptocurrencies. Not only would this present a financial risk (due to volatility), it may also present regulatory risk.

Factom was built to address these issues, especially when it comes to the needs to enterprise clients. Factom has its own protocol that allows for continuous time-stamping and securing of data. Because this data is compressed using merkle trees, even huge amounts of data entered into Factom chains can be secured onto the Bitcoin blockchain with a single data point. This greatly reduces both transaction costs and blockchain congestion.

In the Factom network, data is organized into specific groups, and each group can be tracked or examined individually (although grouping is possible in Bitcoin using colored coins, verification requires the entire ledger back to the genesis block). In Factom, users write to and read from groups that they’re interested in. This is extremely valuable to users, especially as the size of the overall data set grows. Users do not need to sift through a huge data set, most of which is irrelevant to them. They can simply identify the subset they are interested in and focus on that.

Factom also utilizes an innovative dual token system that accomplishes two things. First, it provides a way for individuals to utilize the Factom protocol without having to hold or transact cryptocurrencies. This is good for businesses for both financial reasons (due to volatility) and regulation. Secondly, it provides USD-denominated price stability by setting a network-wide price per kilobyte of data entered. This allows for enterprise clients to better estimate costs.

Factom Protocol Mechanics

Factom is maintained by two different groups of network actors: Federated Servers and Audit Servers. Federated Servers are the main nodes in the network, and they have the ability to actually write data to Factom chains. They are compensated for their work in Factoids. Audit Servers do not have the ability to write data onto chains, nor are they compensated, but they monitor the entire network, watching for accidental or malicious misbehavior on the part of the Federated Servers. Both types of the servers are ranked by a vote of Factom users. If one of the Federated Servers misbehaves and is voted out, the highest ranking Audit Server takes its place, becoming a Federated Server.

Factom users submit data by paying with Entry Credits, which are the secondary token of the protocol. Entry Credits are created by burning Factoids, and each Entry Credit entitles the user to enter 1kb of data into Factom. Users submit content along with a Chain ID, which is a piece of data that identifies which particular sub-group the content should be added to, and all of the servers on the network receive the entry. The Federated Server responsible for that particular Chain ID at that time adds the data into an Entry Block. Every 60 seconds, all of the servers assemble their Entry Blocks into a Directory Block, which consists of the Chain IDs of each chain that was updated during those 60 seconds, each paired with a hash of the Entry Block that contains the entry or update. Servers then rotate responsibility for a new subset of Chain IDs.

When the 10th Directory Block has been created, the hash of each individual Directory Block is taken. Then the Federated Servers hash those 10 hashes as the definitive anchor to be added onto the Bitcoin blockchain. One of the servers is randomly chosen to add the anchor root to the Bitcoin chain, and the entire process begins again.

The use of hashes, merkle trees, and chain IDs to compress and organize data means that very large amounts of data can be contained within Factom, identified by a very specific path, and anchored into the Bitcoin blockchain using a very small amount of data. This minimizes costs, provides all necessary flexibility, and maximizes network security.

Factoid (FCT) Token Mechanics

Factom tokens are designed in such a way that tokens increase in price as platform usage grows. 73,000 FCT are generated by the software, each month, to pay the Federated Servers. In order for Factoids to reach a price equilibrium (where there is neither inflation nor deflation), 73,000 FCT must also be burned each month in the process of creating Entry Credits. If demand is lower than this amount, and less than 73,000 FCT are burned, then the number of new FCT entering the system will exceed the number being burned, and inflation will drive down the price of each FCT. Conversely, demand that exceeds the number of FCT entering the system will cause deflation, and FCT prices will rise. Eventually, in each of these scenarios, the FCT price will reach an equilibrium that reflects overall usage of the platform. This means that the long-term price outlook for FCT is simply based on expected usage of the protocol. We are very bullish on this front, and thus expect Factoids to significantly increase in price.

Market Potential

Factom provides a very specific utility to enterprise clients, who need to secure massive amounts of data and documents. Paper records, which are still in use in many major industries today, are costly to maintain, store, organize, and audit. Digital data is a better alternative in many ways, but current structures leave this data vulnerable to hacks and digital tampering. Factom provides a solution that is not only more secure and less costly, but also allows for greater transparency and regulatory compliance.

These solutions are especially apparent for data that’s required by more than one organization; mortgage documents, supply chain verification, medical records, and other documents that are regularly audited are all examples. Because these documents frequently change hands among different organizations, each must independently audit the documents to ensure that they haven’t been altered or fabricated. That creates significant operational costs that are avoidable when using Factom.

Conclusion

We believe that Factom will become the de-facto second-layer protocol for securing data onto blockchains. While current development has focused on securing data to the Bitcoin chain, we are confident that Factom will be used not only to secure data onto many chains, but also to secure data from entire blockchains onto one another. This cross-anchoring will help ensure the security of the entire network of blockchains that will exist in the future.

While large industry players have been reluctant to adopt blockchain technology, often because of regulatory concerns, we believe that Factom’s dual token system will allow for easy and compliant integration of this technology. This will pave the way for enterprises to take advantage of Factom’s lower costs, which will further drive adoption.

Factom has a secure, well-designed protocol that offers cost savings and compliance advantages to industries that need it most. From an investment standpoint, the token mechanics are extremely compelling— increased usage of the Factom platform will result in higher prices for Factoids. For these reasons, we are currently bullish on Factoids.

 

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