What Is the Network Effect in Crypto?

We all have heard about the famous Internet companies like Google, Facebook, and twitter. One of the most important ideas behind their success was the network effect because it helps to improve user experience and add more value for its members.

While this concept has been applied in the technology era, it can also be applied to the crypto world like Binance (first decentralised exchange platform), Bitcoin (digital currency), Ethereum ERC20 token standard and many others. 

The competitive environment of the Web3 business is significantly impacted by network effects. Network effects can make it more difficult for new, technologically advanced competitors to enter the market, allowing existing projects to keep their competitive edge and grow.

What is Network Effect?

The "Network effect" is a phenomenon that describes how increasing the number of users or participants increases the value of a good or service.The internet serves as a demonstration of the network effect. Since the military and a few research scientists were the only people who really used the internet at first, there weren't many users.

However, as more people had access to the internet, more material, information, and services were created by users. A result of website development and improvement was an increase in the number of people who connected and conducted business with one another. As internet traffic grew, the value it provided increased, creating a network effect.

What are the types of Network Effect?

Direct and indirect network effects are the two main categories of network effects.

     Direct Network Effects 

They are those in which more usage is advantageous to all other users. Consider the telephone as an example. In the past, only a small number of individuals had telephones in their homes, and in order to access the network, those people's homes had to be physically connected to one another. 

As technology developed, more and more people were able to purchase telephones, increasing the value of the entire telephone network. As a result, as the user base grew, so did the value and utility of the current network. 

     Indirect Network Effects

Indirect network impacts are more difficult to define. The expression refers to other benefits that come along with the initial network impact. For instance, the source code for many Cryptocurrencies is available.

When the project has a significant network effect, many qualified developers will be more likely to audit the code because there is high value (including self) at stake.

The network already has a lot of value, so there is additional value that results from it. We eventually reach the dominant leaders who create significant network effects over their rival organisations as a result of this effect's accumulation.

How the Network Effect Works?

As more individuals engage, the experience may improve. However, as new participants want to take use of the network, the network effect may also promote more participation. 

Network effects are prevalent in social media. For instance, Twitter becomes more beneficial to the general public when more people submit material on the site, such as links and media. For networking sites like Facebook, YouTube, and Instagram, the network effect has produced exponential growth rates. 

The use of social media platforms by individuals has had numerous network effects. Companies wishing to advertise their goods and services race to join these sites as more individuals sign up and engage in order to take advantage of the trend. 

The number of advertising grows, increasing the revenue for social media platforms. The websites develop as a result and can now provide the user with new services. 

Example of Network effects

Today, network effects can be seen across a wide range of product categories. One of the prevalent examples is social media, where users commonly register for services used by the social networks they already belong to. As a result, people are motivated to sign up for the same platforms, which gives a select few providers monopolistic positions. 

The development of a social network platform's critical mass will be difficult for new enterprises. Why? The established network effects of the industry leaders have given them a significant competitive advantage.

Network Effects in Cryptocurrencies

Network effects are an important consideration when discussing blockchain and cryptocurrencies. For instance, Bitcoin has a strong network effect and characteristics that the majority of users find appealing. 

Consider how Bitcoin miners uphold network security without worrying about liquidity. Even if a technologically superior project with a similar use case to Bitcoin suddenly surfaced, switching to it might not be the best course of action. 

Despite the possibility of significantly higher payouts, Bitcoin may not always have the same liquidity issues as other cryptocurrencies. Particularly in the case of Bitcoin, the unique traits and characteristics of BTC make it challenging to replicate, which encourages users to stick with it over time. 

It is questionable whether any smart contract projects have so far effectively produced a significant network effect that places them as the market leader, even though network effects may be considerable in the Decentralised Finance (DeFi) field.

Bottom line

In a wide number of economic sectors, including cryptocurrency, network effects are pervasive. According to the theory, as new members sign up, they add value to the network. 

Building blockchain and cryptocurrency networks can benefit from research into the characteristics that produce network effects. They could accelerate the scaling of new currency and token companies by participating in the design process.

Network effects are a crucial factor in the acceptance of new technology and the dissemination of ideas, whether it be through social media, money, or play-to-win games. They are also one of the main factors supporting the success of communication and value networks in Web3.

Although it is impossible to predict which protocols will be able to accumulate long-lasting network effects, projects that successfully integrate network economics to their business model will probably have a higher chance of acquiring and keeping an economic adverse effect on the business.

So that's all about the Network effect and their impact on blockchain technology and crypto industry. If you like the blog and find it interesting and informative please do share with your friends and colleagues.