In the cryptocurrency environment, network effects are extremely important. For example, if a big number of new users join a blockchain network, the underlying service is likely to be more useful.
So let us find out what is network effect?
What is network effect?
A network impact is an economic phenomenon in which an increase in the number of users of a product or service increases the network's value.
The emergence of a network effect incentivizes new customers to join the network, thus increasing the value of the underlying product or service.
As the number of users on a network grows, so does the value of the whole network.
The telephone network is a textbook example of a network effect, in which increased use contributed to lower costs, thus raising the network's overall value.
Which cryptocurrency projects are leading the market in a specific sector is determined by a variety of factors.
The relevance or success of a promising or creative technology can not be determined solely by its users.
Numerous examples exist of ventures that were technologically inferior but nevertheless managed to gain a large market share.
The availability of a project at a specific time is more important to users!
Essentially, this is where network effects come into play.
There are various types of network effects.
Network effects can be divided into two categories:
Direct network effects
Indirect network effects
The telephone network, for example, has a direct network impact, where increased use adds value to all other users.
Increased use from one set of users adds value to another set of users in an indirect network impact.
Due to a strong network impact, many cryptocurrency projects are open-source, and developers prefer to audit the underlying code.
This increased use is due to an established network impact, which decides which cryptocurrency ventures become market leaders in a particular field.
Cryptocurrencies and network effect
Network effects are a critical consideration of blockchain and cryptocurrency.
Bitcoin, for example, has a clear network impact and features that appeal to the majority of users.
Consider how BTC miners protect the network's security while ignoring the issue of liquidity.
Even if a technologically superior project comes out of nowhere that serves a similar use case to Bitcoin, converting to it isn't always the best option.
Miners will receive slightly higher incentives, but they will not have the same liquidity as BTC.
The unique features and characteristics of Bitcoin, in particular, are difficult to recreate, which encourages users to stick with it over time.
Despite the fact that network effects may be relevant in the Decentralized Finance (DeFi) space, no smart contract projects have arguably achieved a strong network effect that makes them a market leader so far.
Network consequences that are harmful
When new users join the network, they have a negative network impact, which means they take away value from the network. A negative network impact is exemplified by Ethereum gas fees.
Ethereum gas fees rise as the number of users bidding on gas fees to be charged to Ethereum miners rises.
Closing words
Network effects, which affect the value of cryptocurrencies in the same way that they affect the value of different economic segments, have an influence on the value of cryptocurrencies because new users add value to the network.
Developers can speed up scalability by taking network effects into account when developing blockchain networks.
