BITCOIN DOES NOT HAVE MUCH NETWORK EFFECT
Most people think that Bitcoin [Legacy] (BTC) has the most Network Effect. Even Tom Lee from Wall Street attributes his rising price predictions to network effect. Roger Ver talks about BTC’s network effect.
They are mostly wrong. BTC does not have much network effect.
DEFINITION OF NETWORK EFFECT
According to Wikipedia:
“A network effect…is the positive effect…that an additional user of a good or service has on the value of that product to others. When a network effect is present, the value of a product or service increases according to the number of others using it.”
The keyword is “using”, not buying or owning. Another key word is “network”. It is related to networks.
Wikipedia gives these examples:
“The classic example is the telephone, where a greater number of users increases the value to each. A positive externality is created when a telephone is purchased without its owner intending to create value for other users, but does so regardless. Online social networks work similarly, with sites like Twitter and Facebook increasing in value to each member as more users join.”
Again, the key is “users”, not owners. If four billion people create and own profiles on Facebook, but do not share photos and do not message each other, Facebook will have no network effect and have little value.
To leave Facebook for another social networking site, you need to convince your 300 friends to go with you, because of the “usage”. To leave gold or any coin, you do not need to convince anyone to leave with you.
Fax machine is another good example of network effect. By itself, it is useless. The more people that have them, the more useful they become.
Network Effect does not relate to the price. If there is less supply than demand, the price of a telephone may go up, but this is not correlated to network effect.
Network Effect does not relate to ownership. Seven billion people can buy and own telephones or fax machines (and drive up the price). But, if every one of them is disconnected, they are all useless and have no network effect.
Network Effect relates to usage and interaction.
Millions of people can buy and store gold, which will drive up the price, but there is little to no network effect. My gold does not network nor communicate with your gold, to increase the value of your gold.
So, contrary to popular believe, BTC has little network effect, because most people buy it to speculate or HODL, like they do with gold. They do not use it, by spending it.
The more BTC buyers there are, the higher the price goes. That’s mostly it. Most BTC owners stay home, and do nothing. Facebook users are out of the home, interacting with each other.
HOW TO INCREASE NETWORK EFFECT
When people spend their currency and people accept this currency as payment for goods and services, then the network effect goes up. As an example, the more merchants that accept your currency, the more valuable your currency becomes. The more people that spend their currency, the more valuable it is for a merchant to accept that currency, by implementing Bitpay, etc.
This is one of the factors for the value of the U.S. dollar. Out of all the currencies in the world, USD has the most network effect. It is used and accepted in more countries than any other currency.
In its initial years, BTC was taking market share from fiat currencies. During this time, it was increasing its network effect. In the past year, the trend is reversing. SatoshiDice, Yours.org and Bitmain switched to Bitcoin Cash. According to Businessinsider:
“Out of the leading 500 internet sellers, just three accept bitcoin, down from five last year.”
Why is BTC losing market share to fiat? According to Businessinsider:
“when they do try to spend it, it often comes with high fees, which eliminates the utility for small purchases, or it takes a long time to complete the transaction, which could be a turn-off.”
BTC has transformed from a currency to store-of-value (by design by Core/Blockstream which wants high fees). As a store-of-value, like gold, it can continue increasing in price. Crypto fans salivate at the thought of taking market share from gold, which is worth $7.8 trillion worldwide. However, this is not where the real prize is. This is chump change compared to money, which is worth $80.9 trillion worldwide.
This is why the most successful crypto-currency will become more valuable than the most successful crypto-store-of-value.
The key to getting network effect for a crypto-currency, is to get people, such as merchants, to accept that cryptocurrency as payment. If you want to send a fax, but there is no machine willing to accept it, then your fax is useless and worthless.
There is a significant side benefit whenever a merchants accepts a coin. It is providing free advertising for the coin.
Try to imagine a world where more merchants accept ABCcoin than any other coin, and growing. As a consumer, will you get some ABCcoin? Likely you would. If you’re a merchant, will you accept ABCcoin? Likely you would. Like Facebook, this trend will likely continue growing. The bigger the network effect, the more attractive it is, and the more people that will want to join. Once it starts, there will be a compounding and self-reinforcing effect that will be hard to stop, unless ABCcoin does something stupid, such as make it too costly for merchants to accept it.
WINNER TAKES ALL (OR MOST)
Once the majority of merchants in the world accept ABCcoin, it will be extremely difficult for another coin to compete. Let’s say you’re a merchant that accepts ABCcoin and you see that most merchants accept ABCcoin and most consumers have ABCcoin. Are you going to go through the hassle of accepting another crypto-currency? Unlikely.
When something dominates a space with network effect, it is nearly impossible for a competitor to compete. You can build a website with superior technology to Facebook, but you will likely fail to get people to leave Facebook to come to your site. Google+ tried and failed. Similarly, this can happen with crypto-currencies.
Once the value or market cap of the crypto-currency matches that of the crypto-store-of-value, the owners of the crypto-store-of-value will likely migrate to the crypto-currency, because the crypto-currency will be serving both functions: currency and store-of-value.
APPRECIATING VALUE DOES NOT HAVE TO DETER USE
Some argue that crypto holders will spend their bad money before their good money. That is, they will spend their fiat because their crypto is appreciating in value. That is not necessarily true.
Merchants will likely offer discounts to purchases made in crypto, due to savings from not paying fees to credit card companies and not suffering from chargebacks.
Let’s say a person wants to maintain a certain balance of ABCcoin. When he sees the merchant’s discount, he will likely pay in ABCcoin and then replenish his ABCcoin holdings by buying more with fiat.
Let’s say that you are a merchant accepting ABCcoin. If you can use your ABCcoin to purchase from another merchant, regardless of discount, you likely will.
If you want to send money to another country, you will likely use crypto, instead of paying the exorbitant bank wire fees.
If more people start receiving their salaries in crypto, they will spend their crypto.
As it stands today, the coins that have the most network effect, though they still do not have much, are Ethereum, Bitcoin Cash, Dash and Monero. I may have missed a coin and this list can easily change.
In my opinion, the ultimate winner will be the one which can get the most people, merchants, retailers, businesses, etc., to accept the coin and to do it the quickest. If you want your coin to succeed, this is what you must focus on.
Below is a very rough stab at listing the competitors.
Strengths: Brand awareness. Low fees and fast confirmation times.
Weaknesses: Misperception and confusion in market place. (Read Bitcoin Divorce — Bitcoin [Legacy] vs Bitcoin Cash Explained for clarification.)
Strengths: Brand awareness. Low fees and fast confirmation times.
Weaknesses: Perceived to be a platform for smart contracts, not money. Slow.
Strengths: Low fees and fast confirmation times.
Weaknesses: Perceived as Bitcoin’s silver (another store of value).
Strengths: Very low fees and very fast confirmation times. Optional privacy.
Weaknesses: Low brand awareness and perceived centralized ownership/control/instamine
Weaknesses: Low brand awareness, high fees. Cannot scale.
Will Bitcoin [Legacy] win due to its brand awareness? Will Bitcoin Cash beat out Bitcoin [Legacy] with its cheaper and faster transactions? Will Bitcoin Cash beat out Dash with its better brand awareness? Will Dash win with its very low fees and very fast transactions? Will Monero win because of privacy?