Created 21h ago, last updated 14h ago
Blockchain network effects — you ’ ve credibly never heard of them, and so far they ’ ra super important for mooning or nuking your coins. While the bull scat was active and kick, a few unvoiced questions were asked. VCs were felicitous to spray and pray investments across blockchains. But in the bear grocery store, hard questions will be asked of the Bitcoin and Ethereum networks :
The utility comes from solving user problems. The more user problems a blockchain can solve, the more newfangled users will flock to it. That is why we are looking at network effects today :
- What is a network effect and why does it matter?
- How do network effects apply to crypto?
- A case study of Bitcoin network effects.
- A case study of Ethereum network effects.
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What Are Network Effects and Why Are They Important?
Our trusted cognition encyclopedia, Wikipedia, defines net effects as follows :
“The phenomenon by which the value or utility a user derives from a good or service depends on the number of users of compatible products.”
In homely English, this means : the more people use something, the (exponentially) more useful it becomes. For case, one person owning a telephone is useless ( they ca n’t call anyone ). Two people are dependable because they can call each early. Three people already yield two potential persons to call and three connections in total. And thus on .Network effects determine the success of new technology. The more people use a phone (or a social network or crypto), the more useful it becomes. A subset of network effects is The more people use a call ( or a social network or crypto ), the more utilitarian it becomes. A subset of network effects is Metcalfe ‘s law which quantifies the network effect of communication technologies like the internet or social media. We can distinguish between one-sided and two-sided networks and between direct and indirect network effects. A one-sided network would be the telephone. Each drug user uses the engineering with the same goal : to communicate with person. The exponential emergence of connections in a nonreversible net can be seen below : source : hypertext transfer protocol : //www.lynalden.com/bitcoins-network-effect/ A two-sided network would be a marketplace like Amazon, Uber, etc. It connects add ( vendors or drivers ) with demand ( buyers ). It besides grows exponentially : Direct network effects immediately result from network growth, i.e., more telephone owners resulting in more people being easily to reach. Indirect network effects happen when at least one group benefits from the growth of another group. For example, the more accredit calling card operators there are, the more competitive the market and the lower recognition card fees are. Credit card users benefit from both frictionless payments and low ( or zero ) costs. ultimately, to determine the strength of a network effect, we have to look at the problem the technology solves and the market it addresses. For example :
- Problem solved: direct and fast communication
- Market addressed: everyone between the age of 3 and 100.
- Credit cards
- Problem solved: instant payments
- Market addressed: everyone between the age of 18 and 100.
- Social networks
- Problem solved: online socialization (debatable, of course)
- Market addressed: initially people between 14 and 34, now nearly everyone.
New technology normally starts in a niche market and propagates to other markets if it is accepted. For model, social networks like Facebook initially appealed to a bantam recess ( campus students at Harvard ) and finally propagated to virtually anyone .
A Case Study of Bitcoin Network Effects
Let ‘s assume that we could hypothetically give each person a Bitcoin address. Would that mean that we have reached the utmost network impression for Bitcoin and therefore hyperbitcoinization ?if everyone had a Bitcoin address, network effects would obviously grow. not necessarily. The answer to “ Is Bitcoin money ? “ is a yes, but Bitcoin still lacks enforce demand like decree currencies have through taxes. however, If we look at current trends for the network, we can observe some interesting trends. The number of Bitcoin addresses with smaller balances is growing. here are the Bitcoin addresses with at least 0.01 BTC and at least 0.1 BTC :
however, the number of Bitcoin addresses with big balances is shrinking. here are the Bitcoin addresses with at least 10 BTC and at least 100 BTC :Bitcoin is becoming more common among smaller wallets but less popular for storing value. That is at least true for . That is at least true for non-custodial storage, since these bigger balances may hold coins at exchanges or in derivatives. If we look at the number of transactions, we can see that growth is stalling : The count of transactions and the sum size of transactions have gone by and large sideways since the 2017 talk through one’s hat run. therefore, Bitcoin’s network effects as a payment network and store of value are currently stalling. This could be due to several factors. For exemplify, Bitcoin ‘s excitability may lead investors to the termination that it is not such a good shop of value after all. alternatively, they may be holding custodial coins or Bitcoin-related products like Grayscale BTC. On the payments side, the net can lone process 120 million transactions per class. large-scale network effects will lone be possible with scale solutions like the Lightning Network however, to determine the potency of Bitcoin ‘s network effect, we need to look at its total addressable market. In other words :
- What is the maximum amount of wealth looking to be stored in BTC?
- How many people want decentralized P2P payments?
The answers to these questions determine how big Bitcoin ‘s grocery store capitalization can become. so far, becoming a store of value is an indirect network effect. If enough capital is allocated to Bitcoin and/or enough transactions are processed, its market capitalization will grow. however, direct network effects would come from increased adoption. Adoption is unmanageable to quantify since we can not distinguish how much real economic action ( not speculation-related ) happens on the network. For increase network effects, Bitcoin needs more top-down adoption ( adoption as a entail of payment ) and bottom-up adoption ( a desire to pay in Bitcoin ). A dependable network impression is unlikely to happen before Bitcoin does not separate its base layer use case ( store of value ) from its L2 use lawsuit ( P2P payments ). This is because users that want to hoard coins ( SoV use case ) will not want to transfer their coins ( payments use encase ). At best, they would use the Bitcoin network as a settlement layer to transfer non-BTC-denominated values. TLDR:
- The number of Bitcoin wallets with a small balance (<1 BTC) is increasing, and the number of wallets with a bigger balance (>10 BTC) is decreasing.
- The more storage of wealth in BTC and the bigger the demand for decentralized P2P payments, the bigger the potential network effect.
- Bitcoin will need to separate its base layer use case (SoV) from its P2P payments use case (L2).
A Case Study of Ethereum Network Effects
Ethereum operates more as a bilateral network and is frankincense more comparable to an operating organization like io or Windows. Its main value pitch is “ a decentralize global calculator. ” however, Ethereum suffers from a problem. Since decentralization is a samara separate of its rate peddle, the phone number of nodes is necessity to the network ( since more nodes mean a more decentralize network ). But the marginal respect of each extra node decreases since the 10,000th node is not american samoa authoritative as the 10th. In other words, it doesn’t matter all that much whether there are 10 nodes or 10,000. however, being a node is lucrative and has become even more lucrative after the Merge, now that ETH can well be staked for concede. But the more ETH is staked, the less ETH there is for network usage. This could result in more expensive ETH ( see : the ETH Merge Trade ) and higher accelerator fees. But higher gasoline fees make the network less attractive to use. In other words, Ethereum paradoxically suffers from negative network effects because more demand for blockspace results in higher gas fees and slows down the network .positive network effects. For example, successful scaling of Ethereum itself and via Optimism, positive direct network effect, although it would have a negative indirect effect of reducing gas fees on the however, there are besides. For example, of Ethereum itself and via L2s like Arbitrum zkSync and Starkware would make the ecosystem more appealing to use. This would be a, although it would have aof reducing gas fees on the mainnet and thus burning less ETH .increased composability would be another direct positive network effect. The more furthermore, would be another. The more decentralized applications exist for Ethereum, and the more interconnected they are, the more appealing the ecosystem is to use .two additional problems. First, although it has a couple of experimental use cases like DeFi and decentralized gaming, it still lacks clearly defined non-speculative utility. Arguably, the point of most DeFi apps is “make more money from money” rather than providing a real alternative to existing financial services. Similarly, many play-to-earn games like suffer from negative network effects since too many players drive up the price of in-game assets and slow down the blockchain. unfortunately, Ethereum suffers from. First, although it has a couple of experimental use cases like DeFi and decentralized bet on, it hush. arguably, the point of most DeFi apps is “ make more money from money ” rather than providing a real alternative to existing fiscal services. similarly, manylike Axie, in fact, since excessively many players drive up the price of in-game assets and slow down the blockchain. Ethereum ‘s core “ product ” is decentralized blockspace, and its independent force is a talented and innovative developer community. therefore, there are many potential use cases of Ethereum, but most of them are experimental and inactive very limited by engineering. The size of the total addressable market for Ethereum ‘s value sales talk remains unclear. A classic operate system, like Windows, addresses every computer user, setting a high benchmark for Ethereum. still, it is uncertain how many users want to put up with technologically subscript products for the sake of decentralization. TLDR:
- Ethereum is liable to negative network effects: more blockspace demand clogs the network and increases gas fees.
- Scaling can increase Ethereum’s direct network effects.
- Ethereum’s real-world utility so far is experimental and limited by technological bottlenecks.
- A more tangible value pitch would allow us to define Ethereum’s total addressable market and its potential network effect more precisely.
Network effects will be a key factor in a potential future bull run. Switching costs for users are low – it ‘s easy to use other L1s rather of Ethereum, But how well-built a network is in terms of composability and scale will directly influence the count of users a blockchain has. The bear market is the perfect time for blockchains to zero in on the actual problems they are trying to solve. This article contains links to third-party websites or other content for data purposes merely ( “ Third-Party Sites ” ). The Third-Party Sites are not under the control of CoinMarketCap, and CoinMarketCap is not responsible for the message of any Third-Party Site, including without limit any link contained in a Third-Party Site, or any changes or updates to a Third-Party Site. CoinMarketCap is providing these links to you entirely as a appliance, and the inclusion body of any associate does not imply endorsement, approval or recommendation by CoinMarketCap of the web site or any association with its operators. This article is intended to be used and must be used for informational purposes alone. It is important to do your own research and analysis before making any material decisions related to any of the products or services described. This article is not intended as, and shall not be construed as, fiscal advice. The views and opinions expressed in this article are the generator ’ sulfur [ party ’ randomness ] own and do not necessarily reflect those of CoinMarketCap. CoinMarketCap is not responsible for the achiever or authenticity of any project, we aim to act as a neutral informational resource for end-users .