WEB3
by BSCN
March 15, 2021
The greater the number of users of a particular product, the more value it tends to attain. This takes a good understanding and application of the “Network Effect” concept.
We live in a world where the use and adoption of cryptocurrencies are rising rapidly. With over 4000 cryptocurrencies available, there is always a fight for supremacy.
To make their projects the best and most sought-after, developers go the extra mile to incorporate innovative features/utility into them. That alone may not impact the sale or adoption of their cryptocurrencies as there is more to it.
It is the less developed cryptocurrencies that quickly gain traction. With unique characteristics, they take the market by storm. They win the hearts of cryptocurrency enthusiasts in the process, and subsequently, their value increases. How does this happen? One sensible answer to this question is the network effect. Let us explain how this phenomenon affects the entire market.
A network effect refers to how the number of individuals using a particular product affects its value. As the number of users of a specific product increases, the value tends to increase as well. The network effect is also referred to as network externality.
Whenever a new user adopts a given product, such a product’s value or utility tends to increase. A user’s adoption will increase the product’s value for pre-existing users and draw other people’s attention. The process by which users’ addition to a product increases its value is referred to as the “total effect.” The addition of users that causes non-users to have an interest in having the product is known as the “marginal effect.”
One of the largest and best explanations of a network effect is the stock exchange. Network effects can be seen in the volatility of the stock market. Prices of stocks are heavily dependent on the demand of users. When users don’t show interest in a given stock, the price drops, attracting many investors in the process as it is traditional to buy the dip.
Upon investment, the number of users increases because the price steadily increases. However, a decline is seen when people begin to sell off because of the increased price. As such, prices eventually drop yet again. The network effect is observed when the activity of investors causes people to profit from the price increase.
As the number of users of a given product increases, market sales are affected positively. If the price of goods and services are lower than the value they bring, the number of consumers will increase rapidly. A network effect is generally perfect for the economy.
There are several ways businesses can leverage network effects to attract several users. Common tactics are rebates or discounts, free trials, etc. The adoption of Airdrops is a common way of attracting users in the crypto market.
The network effect may be problematic when the addition of new users causes the reduction of value. This is often seen in blockchain technology. It is expected that a good network should attract investors. However, when investors are attracted, instead of the network’s value increasing, it declines surprisingly.
Ethereum’s gas fees are a typical example. It was designed for users to bid on transaction throughput. This bid is used as payment to miners of Ethereum for verifying transactions. The addition of users into the Ethereum network led to an increase in gas fees. This is because users of the network tend to outbid themselves. As the gas fees increased due to bidders’ activities, many users are inclined to leaving the network due to the high cost of transactions.
This illustration is one big problem of the network effect: an increase in users of a given product could end up leading to a decline in its value.
Network effects are a beneficial concept that many organizations leverage for rapid growth. A network ensures that its products or services are sold effectively. Networks may have some side effects like congestion, as seen in the Ethereum network or even on the Internet. Many users can lead to a slower network. The network effect is generally a positive phenomenon. The impact of the network effect is readily seen in many sectors of technology and finance. Its impact is well established in crypto markets and can be a strong determinant in how well a cryptocurrency is adopted.
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