Crypto & NFTs: Network Effects in Web3

Crypto & NFTs: Network Effects in Web3

In the world of cryptocurrencies and non-fungible tokens (NFTs), network effects play a crucial role. Unlike traditional web platforms, the network effects in Web3 are natively layered, meaning that every project combines multiple forms of network effects. However, these network effects are weaker and less defensible compared to their Web2.0 counterparts, at least for now.

One example of network effects in Web3 is the Ethereum blockchain. The addition of more nodes increases the capacity and value for buyers of the Ether token. As more token buyers enter the network, the value of the Ether token increases, making it more valuable for nodes to validate transactions. This creates cross-side network effects on a two-sided interaction network, where token buyers can also be validators and vice versa.

However, this network structure also poses challenges. Firstly, there is a unique form of negative network effect. Beyond a certain point, the addition of a token buyer decreases the value of the network for all other token buyers. This is because blockchains are identity agnostic, and the identity of each node does not matter to other nodes or token buyers. Each new node adds less incremental value to the network as it scales.

Secondly, there is a risk of commoditization. Unlike Web2.0 platforms like iPhone or Salesforce, Web3 does not have a matching or app store component. Additionally, the underlying product in Web3 is primarily the Ether token. These factors have led to a wave of new Layer 1 blockchain protocols, such as Cardano and Solana, as competitors try to become "large enough" to compete with Ethereum.

Another aspect of network effects in Web3 is the emergence of decentralized autonomous organizations (DAOs). DAOs can be described as "group chats with a shared goal and money." They create another form of interaction network, where identity influences defensibility. The importance of user identity in DAOs depends on the scale of the network.

One example of a Web3 project that combines multiple network effects is Axie Infinity. Axie Infinity combines four different network effects, including the Axie Marketplace, which reinforces the interaction network effects of the game. The Axie Marketplace is highly defensible due to the differentiated nature of its supply, making it the go-to destination for buying in-game items.

However, it is still unclear how the value and utility of Web3 projects will evolve. At the earliest stages of a technology cycle, experimentation and evangelism always precede utility. Many projects are still experimenting with the capabilities of Web3, and the long-term winners with stronger and more defensible network effects will only emerge after this phase of experimentation.

To evaluate the potential of Web3 projects, several questions need to be considered. How do users interact with others? Does the addition of a user increase value for all users? In what way does every new user affect value and are there any limitations? How does defensibility change as adoption grows? These questions are crucial in understanding the potential of Web3 projects.

In conclusion, network effects in Web3 are natively layered and currently weaker compared to Web2.0 variants. However, the addition of more nodes can increase the value of the network. It is still unclear how network effects in Web3 will evolve, but projects that combine the capabilities of Web3 with stronger network effect layers could be the biggest winners of this era.

Actionable advice:

1. Understand the different forms of network effects in Web3: Familiarize yourself with the various ways network effects manifest in Web3 projects, such as cross-side network effects and interaction network effects. This will help you identify the potential value and defensibility of a project.

2. Consider the scalability and commoditization risks: As Web3 projects scale, consider how the addition of new users impacts the value of the network. Be aware of the potential for commoditization and competition from other blockchain protocols.

3. Stay updated with the latest developments in Web3: The Web3 landscape is constantly evolving, with new projects and protocols emerging. Stay informed about the latest trends and developments to identify potential opportunities and risks.