The Rise of the Crypto “Network Effect”

5 mins read

Listen to this article:

Network Effect is a concept that describes the exponential impact of new user growth on the value of a business ecosystem. Applied to the world of cryptocurrencies, it reflects how the value of blockchains is predicated on the number of users and transactions within the network. 

Network effects are generally favorable, meaning that a boost in users increases the value of the network for other users. Moreover, new users are often a signal for other potential users to join the network. 

Because network effects are a part of many industries, crypto and blockchain startup projects can stand to benefit from discoveries in this space. By way of example, platforms like Amazon, Facebook, and Twitter place a heavy reliance on network acceleration to ward off and demolish competitors. Apple’s iMessage is an example of a network effect tool that prevents users from migrating to other mobile devices. 

A “Bit” of a Network Effect

Network effects have a major impact on Bitcoin’s utility both as a currency and a store of value. As is the case with other major currencies, the value of bitcoin is largely tied to others being willing to accept it as payment or purchase it as an investment. In other words, as growing numbers of people worldwide embrace crypto, it begins to hold greater value to those seeking to spend it. 

For these reasons, Bitcoin as the world's most established crypto has a strong lock-in effect. This has fueled its continued use and growth despite now being among over 12,000 cryptos worldwide. With over a million users, it is disrupting the prevailing ecosystem of fiat currencies. 

In maintaining its market advantage though, Bitcoin, which has been consistently increasing since its launch in 2009, must continue to expand beyond its first-mover position. 

For Bitcoin, adoption was toughest during the early years following its inception. 

Now having weathered myriad storms during the adoption curve, it stands to reason that future growth should be easier from here. Evidence of this is seen in the fact that Bitcoin is already widely used by numerous Fortune 500 companies, billionaire investors, and retail customers. 

According to the laws of network effects, every person who follows existing adopters and influencers ignites a positive feedback loop, sparking waves of other people to follow. At a certain point, these users will reach a critical mass that pushes Bitcoin over the tipping point. 

All of this will in turn trigger broader mainstream acceptance of crypto, including those who may be on the fence in terms of making the transition. The broader benefit from this greater demand usage is a boost in the value of not only Bitcoin but the entire crypto ecosystem. 

The 2021 Global Crypto Adoption Index by Chainalysis found that worldwide crypto adoption jumped over 880% in 2021 with P2P platforms being  the primary driver of cryptocurrency use in emerging markets.

In a new book entitled “The Cold Start Problem,” prominent VC advisor and investor Andrew Chen takes a deep dive into the power of network effects by examining the evolution of tech companies like Uber, Tinder, LinkedIn and numerous others. His main thesis: 

“When launching a new product, service, or creative endeavor, one often faces what the author Chen calls a ‘cold start problem.’  In other words, like trying to start a vehicle’s engine on a frigidly cold day, it's hard to gain traction and momentum when there are few or no existing users.” 

Chen defines Network Effects as:

“….. the ability to attract new users, or to become stickier, or to monetize, become even stronger as its network grows larger.”  

His reason for writing the book are captured here: 

“the inner workings of network effects, while often touted as being semi-magical, are often poorly understood.”

Chen continues: 

“The term ‘network effect’ has almost become a cliche. It’s a punchline to difficult questions, like ‘What if your competition comes after you?’ Network effects. ‘Why will this keep growing as quickly as it has?’ Network effects. ‘Why fund this instead of company X?’ Network effects.” 

Published in late 2021, Chen’s book was eagerly anticipated among startup and venture capital communities given his role as a general partner at Andreessen Horowitz along with board membership with startups that include Substack and Clubhouse. 

Throughout the book, Chen, who played a prominent role in the growth and ascension of the rideshare service Uber, focuses on the role that networks play in igniting successful tech companies. He uses network effect case studies involving Facebook, Uber, Airbnb, Dropbox, Slack, Instagram, Reddit, TikTok, YouTube, and Twitter to deliver his message. 

“Network effect describes what happens when products get more valuable as more people use them,” he writes. One example he uses in the book —how a telephone is useless without a strong network of users. In other words, phones become more valuable the more people you know that have a phone.”

One big takeaway from “The Cold Start Problem” is Chen’s concept of “atomic networks” or niche markets. He cites companies like Bank of America which launched the first credit card in 1958, exclusively in Fresno, California to 60,000 residents. Notes Chen in his book: 

“To build a massive successful network effect, I argue that you must start with a smaller, atomic network. And use the success in the first set of networks to tip over to the next set of small networks. I’m not convinced this step can be avoided.” 

The book, which is a robust 387 pages— explores five stages of businesses that Chen encapsulates as part of his “Cold Start Theory. These are the cold start problem, tipping point, escape velocity, hitting the ceiling, and the moat.

In the end, the Cold Start problem delivers a clear message that can be applied to how crypto projects begin building a network and community for their business. 

The book offers poignant examples of how some of the most successful leaders and companies of our time distinguished themselves from competitors that often collapsed. Those in product, startup, and investing ventures will find Chen’s book of particular interest. 

 

You may also like

Recent Articles