Network effects and cryptocurrencies
Network effects are an important consideration when it comes to cryptocurrency and blockchain.
Miners support network security and have great liquidity to sustain their operations. But let’s say another network is launched that aims to serve a similar use case as Bitcoin. Miners may get higher rewards but won’t have the same liquidity to exit their positions. They could take a gamble and hope that liquidity will improve in the future. Or, they could just keep mining bitcoin with relative certainty that they’ll be able to remain in business. This is how a network effect operates. Even if the alternative would be technologically superior, or bring in more rewards, it wouldn’t necessarily make sense to switch.
With that said, this isn’t only a result of Bitcoin’s network effects. Thanks to its fair launch, Bitcoin has inherently unique properties that would be extremely difficult to replicate in the first place. Think of this example more as a thought experiment.
Network effects are an important aspect to consider in the Decentralized Finance (DeFi) space as well. If a product, service or even smart contract builds up a massive advantage, that may be difficult to overcome for other projects. However, DeFi is in its very early stages. Many would argue that no product has achieved a network effect that makes them a decisive winner yet.
Negative network effects
Negative network effects work in the opposite direction. This means that each new user subtracts value from the network instead of adding it. This is also an important consideration when it comes to the design of blockchains. Good design should dictate that each new user should add value to the network. Why? This helps the network achieve scale. However, if each user subtracts value, that will lead to network congestion.