Crypto & NFTs: Network Effects in Web3 - The Audacity of Copying Well

Crypto & NFTs: Network Effects in Web3 - The Audacity of Copying Well

In the world of web3, network effects play a crucial role in the success and value of projects. Unlike in web 2.0, where network effects were primarily focused on user adoption and engagement, web3 projects have layered network effects that combine multiple factors.

One of the key characteristics of web3 network effects is their native layering. Each project combines various forms of network effects, creating a complex web of interactions. For example, the addition of more nodes in a blockchain network, such as Ethereum, increases its capacity and value for buyers of the Ether token. As more token buyers join the network, the value of the Ether token increases, incentivizing more nodes to validate transactions. This creates cross-side network effects on a 2-sided interaction network, with the ability for users to switch roles as token buyers can also become validators and vice versa.

However, this network structure also presents challenges. One challenge is the existence of negative network effects. Beyond a certain point, the addition of a token buyer actually decreases the value of the network for other token buyers. This is because blockchains are identity agnostic, meaning the identity of each node does not matter to others or to token buyers. As the network scales, each new node adds less incremental value.

Furthermore, the risk of commoditization is also a concern in web3. Unlike in web 2.0 platforms that have matching or app store components, web3 lacks an underlying product other than the native token. This has led to a proliferation of new layer 1 blockchain protocols, each competing to become large enough to compete with established protocols like Bitcoin and Ethereum. The ease of creating new protocols has resulted in a sea of competing tokens, potentially diluting the impact of network effects on defensibility.

Another challenge in evaluating web3 network effects is the uncertainty surrounding their value and utility. At the early stages of a technology cycle, experimentation and evangelism often precede utility. Many projects are still in the experimentation phase, trying to understand the capabilities of web3. Stronger and more defensible network effects are likely to emerge once this experimentation phase is over.

To evaluate the potential of web3 projects, it is important to consider how users interact with each other, the impact of adding new users on the value of the network, scalability limitations, and how defensibility changes with adoption. Projects that combine the capabilities of web3 with stronger network effect layers have the potential to be the biggest winners of this era.

In the world of traditional businesses, there is a different perspective on copying. Successful companies like Apple and Google have shown that copying well can be a powerful strategy. Rather than being deterred by naysayers, these companies focus on doing what is right for their own company. The ultimate constraint, however, is the attention of the end user. A product must fulfill the user's needs and desires to be successful.

One example of successful copying is Instagram's implementation of Stories, which was originally pioneered by Snapchat. Instagram recognized that Stories provided users with an opportunity to present the best version of themselves and created a feedback loop driven by likes. Snapchat, on the other hand, gave users permission to be themselves by starting with ephemerality, appealing to a younger audience looking to escape the prying eyes of adults.

The key to successful copying is not just replicating features but figuring out what else can be leveraged. Cloning a product's features does not offer useful differentiation. Instead, companies should identify other aspects that can be leveraged to create a unique value proposition. For example, Google may have copied the iPhone's UI for Android, but its success came from leveraging its advertising-based business model to offer the operating system for free.

Copying well also involves understanding the motivations of users. Instagram's implementation of Stories removed the motivation for Instagram users to try out Snapchat. The difficulty of getting users to adopt a new product is amplified when it requires a network. However, once a product reaches a certain threshold of user adoption, the network effect becomes a massive accelerant, making it harder for competitors to catch up.

In conclusion, network effects in web3 projects are complex and layered, combining multiple forms of interactions. While weaker and less defensible compared to web 2.0 network effects, web3 network effects have the potential to evolve and become stronger as the technology cycle progresses. Evaluating the potential of web3 projects requires considering how users interact, the impact of adding new users, scalability limitations, and defensibility. Additionally, copying well can be a successful strategy in traditional businesses, but it requires leveraging other aspects of the product to create differentiation. Understanding user motivations and the power of network effects is crucial in both web3 and traditional business contexts.

Actionable Advice:

1. In web3 projects, focus on creating strong and defensible network effects by combining multiple forms of interactions. Consider how users interact, scalability limitations, and the impact of adding new users on the value of the network.
2. When copying, don't just replicate features. Identify other aspects of the product that can be leveraged to create a unique value proposition. Understand user motivations and leverage network effects to make it harder for competitors to catch up.
3. Embrace experimentation and evangelism in the early stages of a technology cycle. Stronger and more defensible network effects are likely to emerge after this phase. Stay informed and adapt to the evolving landscape of web3.