Network Effect

Table of contents

   1. What is Network Effect?
   2. Does the network effect really have an economic value?
   3. Types of network effects
   4. Network effect examples
   5. Network effect and Bitcoin

Have you ever wondered what would happen if people stopped using Bitcoin? Certainly, its value will decrease and may reach zero, since it is no longer used by many people. Sure, other factors come into play, but since there are so few users, it has little value as a service.

What is Network Effect?

Network effect is an economic effect whereby new users add value to the network by entering the network. This in turn motivates new users to join the network, add more value to it, etc.

Network effects are important to consider when it comes to cryptocurrencies. Money and blockchains ultimately organize people, so the more people use the network, the more benefit it can provide as a service and therefore when you find networks that not many people use it is better to avoid investing in them.

Does the network effect really have an economic value?

The phone is the quintessential example of the network effect. In the early days, very few people had phones in their homes. Furthermore, their homes must be physically connected to each other to use the network.

As technology matured, more and more people could purchase a telephone, which in turn increased the value of the entire telephone network. As the number of users increases, so does the value and usefulness of the entire network. As more people join, more value is added to the entire network. Increased use has led to exponential growth.

Types of network effects

In general we can consider that there are two main types of network effects - direct and indirect network effects.

Direct Network Effects: This is what we just discussed above in the phone example.
Indirect network effects: These refer to the additional, complementary benefits that result from having a network effect in the first place. For example, the open source Electrum wallet.

The increased use of software will prompt more skilled developers to proofread the code since there is a lot of value at stake (including their own). This added value comes from having so much value in the network in the first place. This effect begins to multiply, and we reach dominant leaders who are building significant network effects over their competitors.

Network effect examples

Network effects can have an impact on a number of different product categories. One such obvious medium is social media, where users tend to join services used by their pre-existing social networks.
The same applies to Ebay and Amazon with online sales, Google with Internet search, AirBNB with online leasing, Microsoft in enterprise operating systems, and Apple with iPhone.

Network effect and Bitcoin

Bitcoin has some highly desirable characteristics, as well as a strong network effect.
Miners support network security and have a large liquidity to maintain their operations. But let's say another network is launched that aims to serve a similar use case for Bitcoin. Miners may get higher rewards but will not have the same liquidity to exit their positions. They can take risks and hope that the liquidity will improve in the future.

At the current stage, the influence of the network has a major role in the growth of some cryptocurrencies and an insane increase in their price in a short period.

Sources

Code:

https://academy.binance.com/en/articles/what-is-a-network-effect
https://online.hbs.edu/blog/post/what-are-network-effects
https://www.applicoinc.com/blog/network-effects/
https://www.nfx.com/post/network-effects-manual/
https://www.youtube.com/watch?v=aoeal3ljnqw