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Currency relies on network effects for success. Much like the marketplaces it enables, a currency is only as useful as the number of participants willing to conduct business while utilizing it as a medium of exchange.
In that regard, currency is not special there exists an entire product class that relies on network effects for success. Products, such as multiplayer games whether League of Legends or poker rooms – cryptocurrency exchanges and social networks are only as valuable as their ‘liquidity’ the number of active participants.
I’ve seen network effects firsthand while I’ve worked for the world’s biggest poker companies and game publishers. The success of poker rooms depends on the number of players willing to play games at certain stakes.
In principle, one can have an amazing poker product the software of an actual casino but fail as a business because the number of players willing to play largely depends on the number of players already playing. Such businesses need to bootstrap the network before the poker room becomes a success by providing strong incentives for early players and potentially bringing in ‘house players’ to get the games going.
League of Legends is one of the most played games in human history. It’s easy for new players who are seeking competition at their level or stakes preferences to join the player pools. Over 100 million players enjoy the League of Legends platform, meaning, individuals joining the game will find their counterparties.
Network effects help users to connect with others who play similar roles or have complementary skill sets as themselves increasing their chances of success. Competing with League of Legends is extremely hard not just because of the product but because the user experience is deeply tied to the depth of the player pool.
Marketplaces are the ultimate network effect-dependent product. Consumers want to find their desired products at price levels comfortable to them. Some people will go on eBay and shop for a watch that costs $3,000, while others go on eBay to shop for a watch that costs $30.
Depth of liquidity defines one’s ability to interact with the network of participants providing various products at various price points.
In crypto, network effects create interesting scenarios. Raising capital in private sales depends on the private validation of a project. Public capital performs proportionately to private validation, which is measured by the amount of capital raised in the private sale. The entire sequence is ironic, considering the expected outcomes of network effects.
Essentially, the success of a medium of exchange (cryptocurrency), which depends on its acceptance and use by a sizable proportion of the public (network effect), is determined by a small group of private investors who initiate a chain reaction.
Network effects play a pivotal role in ensuring the success of our industry. Bitcoin’s resilience, both technically and economically, is attributable in part to network effects.
Crypto’s total market cap has grown from approximately $340 billion to $2.3 trillion in a year an almost 700% increase. This success is attributed directly to the volume of transactions and the number of market participants and projects in the space. Every new entity creates value by introducing more opportunities for interaction to other ‘players,’ further fueling the blockchain economy.
Macro factors have played a major role in the rise of cryptocurrency prices, but the importance of network effects can’t be understated. One new person joining the crypto ecosystem leads to a positive feedback loop that expands exponentially as more people join, creating an increasingly valuable industry with each additional participant and interaction point.
NFT marketplaces, DeFi, play-to-earn and the explosive growth of CeFi are all happening concurrently, with tremendous positive spillovers between the products.
Network effects are at the core of forming cities and sometimes entire industries such is the case of Silicon Valley, where a group of companies creates positive spillover effects for one another, triggering the creation of additional companies. The formation of companies triggers the inbound traffic of more skilled labor and the creation of more efficient marketplaces.
A lot of the realities around us in terms of employment, innovation and education are also driven by network effects and the resulting resiliency that’s created through an increasing number of participants.
We are seeing a similar global boom happening in the blockchain economy, as growing volumes and number of users draw opportunistic entrepreneurs, causing a spike in investor interest and availability of capital which is then used to attract talent that develops the next generation of products and services.
The 2020-2021 bull cycle thus far has been a blessing for crypto enthusiasts worldwide. We’ve seen true generational wealth form (and lost), and lives forever changed. The good times may eventually end, but one can hope with strong intentions we’re at the precipice of something special and era-defining.
One of the defining outcomes of this cycle was the fact that millions of new users have gotten their hands on both cryptocurrency and cryptocurrency-enabled products. This cycle has forever changed the fabric of finance and how we view money.
We’ve seen network effects take hold and drive financial products into the mainstream with successful IPOs, millions of users and billions of dollars in funding most being the product of previous bull cycles companies established between 2013 and 2017.
Time will tell what paradigm shifts and market leaders will be born as a result of the 2021 bull cycle.
Anderson Mccutcheonis, founder and CEO of Chains.com, an operating system for the cryptocurrency-enabled economy. Anderson is building a full-stack crypto-economy consisting of a marketplace, freelance platform and cryptocurrency exchange. He is also an investor and entrepreneur with an interdisciplinary technological and marketing background and a long history in the crypto space. A blockchain industry pioneer and an 8200 alumnus, he has founded Unicoin, Synereo (later HyperSpace) and is currently leading Chains.com.
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