Research Summary
The report explores the concept of public blockchains as network technologies, emphasizing the role of network effects in determining their value. It highlights the nonlinear relationship between user adoption and network value, suggesting that blockchain tokens may yield outsized returns during certain growth phases. The report also underscores the relatively low current adoption of public blockchains compared to mainstream internet applications, suggesting potential for significant token price appreciation with increased adoption.
Key Takeaways
Understanding Network Effects in Blockchain
- Networks and Value: The report explains that the value of a network to a user depends on the number of other users, a concept known as “network effects”. This is particularly relevant to blockchain technologies, where the value of individual tokens often accrues based on the size of the network.
- Nonlinear Relationship: The report highlights a nonlinear relationship between user adoption and network value, due to the exponential increase in possible connections as the number of users grows. This suggests that each additional network participant can significantly boost network value, especially during the early stages of network growth.
- Network Effects in Practice: The report provides evidence of network effects in the crypto industry, showing a positive correlation between the number of daily active users and market capitalization for various blockchain protocols. It suggests that market capitalization rises more than proportionately with the number of users once a network reaches a critical mass of around 650,000 participants.
- Implications for Investors: The report suggests that understanding network effects can help investors anticipate outsized token returns as network adoption grows. It notes that the number of users of the largest blockchain networks is still very low compared to mainstream social media platforms, indicating significant potential for growth.
- Risks and Limitations: The report cautions that positive network effects can be offset by network congestion, competition among blockchains, and the potential for network effects to work in reverse. It also notes that user adoption needs to reflect non-speculative use cases for networks to have sustained value.
Actionable Insights
- Consider Network Size: Given the importance of network effects, investors should consider the size of a blockchain network when evaluating potential investments. Larger networks may offer greater potential for token price appreciation.
- Monitor User Adoption: Tracking user adoption can provide insights into potential network value. Rapid growth in user numbers could signal an upcoming phase of outsized token returns.
- Assess Network Scalability: The ability of a network to handle increased usage without significant increases in user costs (e.g., transaction fees) is crucial for its ability to benefit from network effects. Therefore, investors should consider the scalability of a blockchain network.
- Understand Competitive Dynamics: The competitive landscape among blockchains can impact their potential to benefit from network effects. If users can easily switch between networks, it may be harder for any one network to dominate the market.
