This is better than any viral growth

Understanding network effects and what that means

Gm

(Do you know why everyone in the crypto world wishes each other that? No? We’ll tell you that towards the end of this newsletter)

From being tagged “geek money” in 2009 to evolving into the “next iteration of the internet,” Web3 has had a wild ride… and a successful one. 

So, to kick things off in our first newsletter we’ll tell you exactly what makes web3 so special. And more importantly, for people who wish to move to the web3 world, why’s there some insane amount of money (and opportunity) flowing in the space. (wink, wink)

Yes, there’s some young dude who made a million dollars selling some dog related meme-coin but there are also some of the smartest minds of our time who are pouring in some insane amount of money in the space. 

So, why is everyone throwing money in web3 like crazy? 

Well, that’s because the tech on which products are built in this space operates on network effects and growth in any product is by default exponential, not linear. Once a network takes off— it can grow very fast and generate massive returns for participants of the network (NOT just investors 😱—more on this later)

70% of the value in web2 comes from companies who had some form of network effect built into their product—Amazon, Uber, Facebook, Google—you name it. 

So, what are network effects and what makes them so special? Is it the same as making a product viral? Is virality equal to network effect? How do web3 companies benefit from this? We’ll discuss that and how you can make money in this space in this newsletter😎

Without further ado. Let’s scoop it out. 

Understanding Network Effects IRL

Think of the telephone.

If only one person has it, it’s of no use because no one can connect with that person. 

If another person gets a telephone—the first (and the second) telephone all of a sudden becomes useful. The two people can now connect and communicate with each other. 

If two more people join the network, every telephone can connect to three other people. You can have 6 links now. 

As you continue adding more telephones, the value of the telephone increases for every user and telephone as a product itself becomes more valuable. (if everyone communicates with a telephone, you cannot NOT have a telephone)

But where are we going with this?

How everyone thinks about Network Effects

In any network, when every user who gets added to the network adds value to other users in the network (and makes the product more valuable in the process) it results in what is called a network effect.

Think of the Facebook network as an example. The more friends you bring on to the network—the more people you and your friends can chat with. Plus, more friends mean more content on the feed and more app time for Facebook.

The effect of any network is often calculated mathematically by Metcalfe’s law which states that “the systemic value of compatibly communicating devices grows as a square of their number”

Here’s a simpler version of that: If a network has 10 nodes at some point and that number grows to 20, the network’s value doesn’t double. It quadruples. 

However, the system has its limitations and is often painfully irrelevant especially when you want to map a strategy around network effects. 

That’s because it doesn’t consider the quality of user engagement, and the multi-sidedness of networks today with buyers and sellers, for instance.

Nor the difference between those who are “active” vs those who just signed up. 

Therefore a better model of understanding is the Allee curve and threshold. 

How can YOU think about Network Effects

Given by the pioneer of American ecology Warder Clyde Allee, the Allee curve dynamics state that social animals — like meerkats, sardines, bees, and penguins — benefit by living together. 

That’s because if one of the animals in the group sees a predator approaching, it can send alarm calls to alert the group and keep it safe. 

However, if for whatever reason the population declines and there are not enough animals in the group to warn others — everyone is less able to protect themselves, and the entire species is more susceptible to collapse. 

(The tipping point after which the animals are safe and can grow fast as a population is called the “Allee threshold” )

If the population grows too quickly, living in too small a space, then overpopulation negates their advantages — which causes the population to plateau. (called the “carrying capacity” of the network)

How does it relate to web3?

The technology metaphor of this is- if a protocol or application does not have enough users, the users will delete it. And the smaller the network, the more there’ll be inactivity which might lead to the collapse of the network. 

On the other hand if there are enough users on the platform, there’s a higher likelihood of users interacting with each other and even getting new users onboard. And the more the network grows, the stronger and more defensible it’ll become. 

However, growth cannot continue forever- after a certain point of exponential growth, there's overcrowding in the network.

You must have seen this when there are too many products in a marketplace such that finding the right one becomes a chore. Or when there are too many people in an engagement app which leads to too many messages, clutter, and spam. 

However, unlike what happens with natural forces, technological products can increase the carrying capacity of a network by upgrading the UI, continuously filtering out spam, adding features to personalize feed, etc. 

Alle’s curve though often not discussed from a business standpoint is a much better model to help us understand network effects. By borrowing these ideas, we can describe how web3 products might launch, scale, and defend markets through network effects.

(The idea first appeared in Andrew Chen’s book Cold Start Problem ) 

Closing ideas

The best part of network effects in web3 is that it generates returns for everyone participating in the network and not just a handful of people who own the product (like in the case of Facebook or any other web2 company out there)

That’s because there’s no centralized authority and everyone who participates in the network is also an owner of the network. (Participants in the network are called the “community members” and have rights to take decisions for the network)

We plan to cover this topic (“Community”) in the next few editions and help you understand what that term means and how it might very well revolutionize the way we interact with brands.

So, stay tuned and subscribe to the Unhashed newsletter. 

PS: We are itching to know something about all of you who read these pieces. So, please comment below and tell us something about you (where are you reading this from, what you’re working at, and your favorite ice-cream maybe?)

PPS: Now, to our first question… why does everyone say gm? 

It’s certainly no surprise that gm stands for ‘good morning’ but because crypto has a global community and it’s morning for some part of the community at all times, gm has just become crypto’s global standard for wishing each other a nice day irrespective of the time. Easier than tracking multiple time zones and wishing people accordingly, you see. Smart work! 

And well, the sun never sets for the crypto empire. 😎