The History of Non-Fungible Tokens (NFTs) and the Dynamics of Network Effects

The History of Non-Fungible Tokens (NFTs) and the Dynamics of Network Effects

In October 2017, a Vancouver-based company called Axiom Zen launched CryptoKitties, a game that allowed users to collect and breed digital cats on the Ethereum blockchain. This innovative concept quickly gained popularity and introduced the world to the concept of non-fungible tokens (NFTs). While ERC20 tokens were suitable for many functions on Ethereum, they were not ideal for creating unique tokens. As a solution, the ERC721 standard was invented, which allowed for the creation of non-fungible tokens.

Before CryptoKitties, there were other examples of unique digital items being traded on the blockchain. The Rare Pepe Meme Directory, for instance, had "experts" who certified the rarity of Pepe memes. This peculiar example highlighted the demand for unique digital assets. In fact, one could argue that Colored Coins, which were bitcoins that were part of the "Genesis transaction," were the very first NFTs. These coins were unique and distinguishable from regular bitcoin transactions.

As the popularity of trading rare pepes on Ethereum grew, two creative technologists, John Watkinson and Matt Hall, decided to create their own NFT project with a twist. They developed Cryptopunks, unique characters generated on the Ethereum blockchain. Interestingly, Cryptopunks did not follow the ERC721 standard as it had not been invented yet. Instead, they can be described as an ERC721 and ERC20 hybrid.

The ERC721 standard, where ERC stands for "Ethereum Request for Comment," was purpose-built to be the technical standard for non-fungible tokens on the Ethereum blockchain. Unlike ERC20, which focuses on fungible tokens, ERC721 tracks ownership and movements of individual tokens in the block, allowing the chain to recognize non-fungible tokens.

The first project to utilize the ERC721 standard was CryptoKitties, which gained significant attention and led to the spin-off of a company called Dapper Labs. Dapper Labs secured $15 million in funding from top investors, including a16z and Google Ventures. This showcased the true potential and power of NFTs.

While NFTs gained momentum in the digital collectibles space, another concept called network effects was also gaining prominence. Network effects refer to the value a platform or product gains as more users join and interact with it. Andreessen Horowitz highlighted the importance of understanding the value proposition driving network effects and how they evolve over time.

For founders, it is crucial to identify whether their network effects are weak or strong and pay close attention to their evolution. As a platform iterates and introduces new value propositions, founders need to understand how these changes impact network effects and product-market fit.

The dynamics of network effects also depend on the nature of the platform's inventory. The more differentiated the inventory, the more important it becomes for the platform to curate and match content effectively. This not only enhances the overall defensibility of the platform but also strengthens network effects over time.

When attracting incremental users, founders must consider whether these users are network "contaminants," "neutrals," or "contributors." Incentivizing the desired users and disincentivizing undesired ones is crucial for sustainable growth. Curation mechanisms play a vital role in screening and removing bad inventory or users, ensuring the platform maintains its quality and appeal.

Additionally, understanding the competitive landscape is essential. If another platform has a similar network to yours, there is always a risk of them entering your market. Their existing network gives them an advantage, making it easier for them to penetrate your space. Being aware of this existential risk is crucial for founders to stay ahead and continuously innovate.

In conclusion, the history of NFTs showcases the demand for unique digital assets and the evolution of technical standards to support them. The success of projects like CryptoKitties and Cryptopunks has highlighted the potential of NFTs and attracted significant investment. However, it is equally important to understand the dynamics of network effects and how they can shape the growth and sustainability of a platform. By focusing on value proposition, curation, and user incentives, founders can harness the power of network effects and build thriving ecosystems.

Actionable advice:

1. Understand the value proposition driving your network effects and how they may evolve over time. Continuously iterate and adapt to new value propositions and layers of product-market fit.
2. Curate and match content effectively, especially if your platform offers differentiated inventory. Strong curation mechanisms enhance defensibility and strengthen network effects.
3. Pay attention to the incremental users you attract and classify them as network "contaminants," "neutrals," or "contributors." Incentivize the desired users and disincentivize undesired ones to foster sustainable growth.

Sources:

• "The History of Non-Fungible Tokens (NFTs)"
• "The Dynamics of Network Effects - Andreessen Horowitz"