The cryptocurrency network effect and why 'we're still early'
Updated: Jan 7
On 3rd January 2022 it was 13 years since the first genesis block of Bitcoin was mined by the infamous Satoshi Nakamoto. The cryptocurrency poster child has become a teenager. Over more than a decade the narrative backing the leading cryptocurrency has changed several times from being digital cash, to a cheap peer to peer transactions network, and in recent years it has firmly planted itself as a censorship resistant digital gold and a genuine hedge
against out of control fiat currency inflation around the world. The overall cryptocurrency space has evolved and is slowly starting to mature. Although the past year has seen the space exploded, I will explain why the cryptocurrency network effect has only just begun and why the often over used phrase 'we're still early' is to some extent very true.
The value of a telecommunications network is proportional to the square of the number of connected users of the system (n2) - Metcalfe's Law
What is a network effect?
Metcalfe's Law characterises many of the network effects of communication technologies and networks such as the internet, social media networking and now most recently cryptocurrency and blockchain technology.
A network effect happens when the number of people using a product or service increases, which also increases the value of the product/service. In recent years with the rapid increase in social media, this is the perfect example of a network effect. The more users that a social media platform has gained, the more valuable it has become. The value of Facebook is testament to this.
How does a network effect work?
As a consequence of the network effect it has the ability to increase the value of a product, whether the quality of the product improves or not. If a competitor enters the space with a better product, it may be hard for them to compete because they don't have the established network effect that a larger, established competitor does.
Take Instagram, it is a platform used by millions of people for sharing photos and different informational posts. Its value is derived because so many people use it. If there were only 10 users there wouldn't be an inherent value because their friends or their favourite actor wouldn't be on the platform. There simply isn't much use for a social media app if there are no people to interact with. This is why large social media platforms grow faster, and stay bigger than the rest. The more users a social media platform has, the more it makes sense for somebody to join.
Network effect and Bitcoin
Bitcoin is the most established and recognised cryptocurrency, as such it has experienced a large network effect. 13 years into the digital revolution, although many would argue that there are more technologically advanced coins or tokens than Bitcoin, by virtue of the large number of users, is one reason it is has become the most valuable.
If you dig into the tech behind Bitcoin you will realise that the miners and individuals running nodes that conduct the mathematical calculations that both verify transactions as well as maintains network security are another example of Bitcoin's network effect.
In essence Bitcoin miners could opt to mine another cryptocurrency that is attempting to compete with the top tier coin, and in doing so there is the possibility that they could receive better compensation. However, this would most definitely be a gamble as there would be no guarantee that a new and unproven project will stand the test of time, like Bitcoin has. Given that the Bitcoin network is well established, there is a high probability that miners will be able to mine for Bitcoin well into the future, and in fact their rewards are likely to be worth even more in the future as a direct consequence of the increasing number of users of the Bitcoin network.
Network effect problems
Although having an increased number of users has the ability to add value to a product, it can also be detrimental. For example, if there are too many people using a product on the internet it has the potential to cause congestion on the network resulting in it becoming slow or unusable. This can hinder the user experience, and may result in them using a different product.
The quality of users can also cause a negative experience with a product. If a large number of people using a social media platform for example are making the experience negative for other users, those users may want to leave and find another platform to use.
The Ethereum blockchain, which is the most established smart contract network in the crypto space has suffered from these problems. The network has become a victim of its own success. Due to network congestion and the slow implementation of network upgrades users have been expected to pay exorbitant fees, primarily due to the explosion of DeFi and NFTs.
Up until recently the number of Ethereum transactions per day had been growing steadily. With an increased interest or increased optimism in Ethereum could lead to greater transaction occurrences as the audience for the underlying token grows.
As interest in cryptocurrencies increased and cryptocurrency market caps reached peaks during the 2017-early 2018 crypto boom, daily transactions also increased to a peak of 1.35 million transactions on January 4, 2018.
Ethereum transactions per day is at a current level of 1.209M which is down from 1.234M one year ago.
Network effect solutions
Frustrated Ethereum users have opted to start using alternative blockchains that offer faster and considerably cheaper transactions. Time will tell whether they will be able to become genuine competitors to Ethereum and achieve their own network effect.
One such project however that plans to launch in the next couple of months called PulseChain, which I have written about previously, could add a new dimension to the network effect in the crypto space. Please be sure to read this article as it is full of interesting information about both Ethereum as well as this new blockchain. However in summary:
PulseChain is a new blockchain that is due to launch during the first quarter of 2022. It is a fork of the Ethereum blockchain. As a consequence of the similarities between PulseChain and Ethereum all data on one will be compatible with the other although it will have a faster throughput, it will move to a proof of stake validator mechanism and the transaction fees will be pennies as opposed to dollars.
On the day that PulseChain main net launches, instead of it being an empty blockchain, it will contain all of the data from Ethereum (smart contracts, addresses, transaction history and states). In other words, a snapshot of Ethereum will be taken and loaded onto PulseChain.
Effectively this means that everything any address owns on the Ethereum blockchain (ERC-20 and NFTs), the same address will own on PulseChain. No action from the users perspective will be required; the tokens will be received into their wallet that they own the keys to.
This will be the biggest airdrop to ever occur since the genesis of blockchain technology and given that Ethereum has already succeeded in creating a significant network effect already, but has been met with problems, is it not conceivable to think that PulseChain could literally pick up the mantle and enable that growth to continue?
The crypto network effect has only just started
Let's now take a look at the growth of the mobile phone network and by way of comparison see how much growth potential there could be for cryptocurrency as a way of demonstrating why the crypto network effect has only just started.
The chart below shows the growth of mobile phone subscriptions, in millions, since the mid 1990's, which has quite clearly gone exponential over time.
And this chart shows the growth in the number of mobile phone units sold in millions since 2007.
Globally it has got to the point where the network effect within the telecommunications sector has grown to there being over 6.6 billion smart phone users.
And the numbers are forecast to keep increasing.
Now let's look at the cryptocurrency space. As of 2021, although cryptocurrency has seen significant growth in adoption, there were still only 300 million cryptocurrency users worldwide.
Cryptocurrency adoption from 2014 to 2020 has however resembled that of the internet from 1990 to 2000, the same years when the online boom was looked at with skepticism and a bubble in the market formed that would eventually burst. But from the collapse rose several behemoth corporations that are now household names.
The speed at which interest in cryptocurrencies have gained momentum has certainly started to surprise many people. 2021 saw countries adopt Bitcoin as legal tender; the world's richest man put Bitcoin on his companies balance sheet; the total value of the cryptocurrency market surpassed 3 trillion dollars; and Wall Street appeared to do a complete 180 degree turn in its views on the asset class that they for so long held in great contempt.
In August 2021, Crypto News Australia reported that global adoption had increased by an incredible 880% over the previous year, and the number of active addresses reached its peak on November 10 – the highest level since May.
The number of users and institutions now engaging with crypto and DeFi related products and platforms has also risen considerably.
Yes, we are still early!
As a way of finishing I will leave you with 3 charts that should be self explanatory in helping you appreciate the potential growth ahead for the cryptocurrency market as a whole, and as such you should definitely get a sense that we are definitely still early in this technological revolution.
Unfortunately far too many new investors are deterred from entering the space by seeing the 5 digit price attached to one Bitcoin, even though you could actually buy just a fraction of one coin. The crypto space is however so much more than just Bitcoin. Scratch the surface and you will see that there are literally hundreds of new, exciting and innovative projects being worked on by some of the brightest minds that aim to disrupt a wide range of business sectors in the very near future.
If you spend some time educating yourself (and I am more than happy to help you in that regard🙂), you do your research correctly, and you make sensible investments with a long term time horizon, there is no reason why anyone shouldn't be able to achieve life changing wealth as a result of the cryptocurrency network effect.