Unleashing blockchain’s full potential: Leveraging network effects
The cryptocurrency market is known for its volatility and can be a risky place for those unprepared to navigate its ups and downs. However, for those willing to take the time to understand the intricacies of the crypto world, the potential rewards may outweigh the risks. Investors need to be aware of where the true value lies in order to make informed decisions. It’s all about knowing where to look.
Finding certainty in a speculative market
The crypto world is still young, with many new cryptocurrencies constantly emerging and fading. Exchanges have allowed investors to easily trade cryptocurrencies, but this also opens the door to unethical practices such as price manipulation, wash trading and spoofing. Unfortunately, this can lead many investors to inaccurately value a blockchain solely on its cryptocurrency price.
But this is not the correct approach. While cryptocurrencies and blockchain are often used interchangeably, they are distinct entities. This is especially the case for blockchain’s that power smart contract platforms and serve as a foundation for a wide range of applications and innovations. As such, the value of a cryptocurrency and the value of a blockchain should not be conflated.
The duality of blockchain and crypto: Separating function from currency
A blockchain is not a traded commodity, but rather a technology. Comparing the value of a blockchain to the price of its cryptocurrency is like comparing the value of a car to the price of its gasoline. The price of gasoline may fluctuate and influence the cost of operating the car to some degree, but it doesn’t capture the car’s overall value — its make and model, its performance and safety features, and its potential resale value.
Similarly, a blockchain has far more value than its cryptocurrency price — its network effects, its ability to facilitate transactions and support applications, and its potential for long-term growth and adoption.
The engines of ecosystem growth
Blockchain’s that provide such effects are known as Layer 1 (L1) blockchains and serve as the foundation layer for decentralised networks.
Unlike application layers (DApps), tokens and scaling solutions that operate on top of them (L2), L1 blockchains do not rely on other blockchains to function. Instead, these “on top” technologies inherit the security of L1 blockchains and contribute to the networks through transaction fees.
As infrastructure providers, some L1 blockchains host thousands of applications and process trillions of dollars’ worth of transactions across a wide range of industries and use cases — like the Ethereum blockchain and Bitcoin blockchain. Other L1 blockchains include Solana, Cardano, Avalanche, Polkadot and Algorand, to name a few.
But tracking the activity streams of L1 blockchains can be challenging due to the sheer number of users and services involved. But the public nature of blockchain networks means that anyone can access them with the right tools. For instance, on-chain analysis platforms can be used to track ecosystem activity and identify the growth trajectories of a blockchain over time.
This is important as it can help us measure the balance between pratical usage and speculative investing in a blockchain. By tracking metrics such as the size and diversity of its user base across various use cases, the increasing number of DApps, developer activity and the general usage of its native asset (i.e., to deploy smart contracts, locked in DeFi products, or used as a store of value), we can gauge how much value is being created by genuine demand, as opposed to speculative price predictions on exchanges.
Understanding a blockchain’s value creation
There are two primary models for measuring value creation: linear and network effects.
Linear growth models involve each additional unit producing the same amount of value. This is often seen in businesses that sell a single product. As more units are sold, profits increase in a linear fashion, but there is no additional benefit to other consumers purchasing the same product.
On the other hand, network effect models involve each additional unit growing exponentially in value. Blockchains, with their vast network effects and role as a “backbone” for decentralised economies, fall into this category. As more users join the network, more value is created for all participants. This is because more developers create more applications, which in turn attracts more users and increases the overall utility and activity of the network. This increased value and activity ultimately drive up the price of the blockchain’s native cryptocurrency.
Blockchains that achieve a positive network effect can lead to an exponential rise in value but achieving this is no easy feat. It requires significant resources and the ability to navigate regulatory barriers and limitations. As an investor, it’s important to consider whether a given blockchain initiative has the capacity and resources to accomplish this.
Additionally, blockchains can be affected by negative network effects, such as network congestion and high gas fees that drive users away to cheaper alternatives. As new scaling solutions emerge, it’s important to assess whether developers are taking these challenges into account. In this regard, a blockchain’s flexibility is key to demonstrating its future worth.
How does a Layer 1 blockchain position itself for long-term success?
Blockchain technology has the potential to revolutionise various industries, but its true value lies in its rate of adoption. To achieve this, a dedicated team of developers, users and businesses must work together to improve and advance the technology. This collaboration drives innovation within the L1 blockchain, leading to scalability improvements and increased implementation in various business practices globally.
There are several key factors that will contribute to its long-term success:
- Foster a dedicated and active community of developers, users, and businesses that are committed to driving innovation and improving the technology’s adoption rate
- Continuously increase the number of daily active users, which will fuel blockchain activity and transactions across the network
- Develop and offer a wide range of applications and add-on solutions that appeal to a diverse array of industries, leading to increased network effects and user growth
- Secure support from various organisations and research and development (R&D) teams to help drive its development, scalability and real-world usage
- Achieve and maintain a significant share of the market, demonstrating strength and positioning against competitors
- Experience a steady increase in the volume and value of processed transactions, indicating growing user activity and overall utility
- Implement strong security measures to prevent breaches, vulnerabilities in smart contracts and hacks, which are essential for maintaining the reputation and reliability of a blockchain
Concluding remarks:
Instead of solely relying on historical price patterns, investors should consider the true disruptors in the industry — those who have proven to be reliable and can weather market uncertainty — and examine which blockchains support entire Web3 economies, facilitate trillions of dollars in transactions and enable users to access thousands of applications. Without them, none of these functions would be possible.
In a rush to discover the next big thing, it’s important to remember that true value often takes time to develop and flourish. As businesses begin to leverage the capabilities of blockchain to generate tangible and stable revenue streams, speculation will naturally wane.
But as with any market cycle, timing and intelligence in your selection process is everything. While it can be risky to put faith in the predictions of futurists, it might be more productive to look into what has already proven to be reliable.
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Disclaimer
This document is purely for educational purposes and has been issued by Sygnum Group. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication. It does not constitute an offer or a recommendation to subscribe, purchase, sell or hold any security or financial instrument. It contains the opinions of Sygnum Group, as at the date of issue. These opinions and the information contained herein do not take into account an individual‘s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes personalized investment advice to any investor. Therefore, you must verify the above and all other information provided in the document or otherwise review it with your external advisors. Some investment products and services, including custody, may be subject to legal restrictions or may not be available worldwide on an unrestricted basis. The information and analysis contained herein are based on sources considered as reliable. Sygnum Group uses its best efforts to ensure the timeliness, accuracy, and comprehensiveness of the information contained in this document. Nevertheless, all information indicated herein may change without notice.
