What are Network Effects?

What are Network Effects?

What does Network effect mean?



Humans are social by nature. In illustration, our nature deems us to interact with others to achieve larger accomplishments through connectivity and collectivity. This is an example of network effects, which will be explored further in this writing, along with its origin and influence on us.

The Origin of Network effects

The term “Network effect” was first used in 1980 by Robert Metcalfe, a co-founder of Ethernet. The phrase was initially used to refer to the benefits of systematically connecting with other people, but then caught on to the appliance towards the field of technology, the internet, telephones, faxes, social media, and now, cryptocurrency. Network effects are phenomena that occur when a group of people within a network is enlarged by an increase in the amount of people included in it, resulting in the elevation of good and service costs. With additional users, the network is influenced by it and starts interacting with one another at an increasing rate, creating a network effect so strong and positive that competing networks would not be able to catch up.

Examples of Network Effects



A great example would be telephones. Telephones are devices that are used to maximize communication, meaning that if there were only one phone in the entire world, that phone would be rendered useless. For a network to be created, the tool, device, or means of communication would need to be used widely.



If we apply a mathematical calculation to the process, we’d be able to understand the bigger picture of how influential network effects are. If there were to be only 1 phone in existence, how would communication take place? If there were 2, 1 connection would be created. With 3, 3 would be created. However, with 100, there would be up to 4,950 connections and with 100,000 phones worldwide, there would be up to 4,999,950,000 connections.



This calculation is in accordance with Metcalfe’s law, which is employed to calculate the connections within a network. If “c” is the number of connections and “n” is the number of devices in the same network, the equation would be as follows:

c = 0.5 x n x (n-1)



If n is increased, the equation would be changed to: c = 0.5 x n2.



In contemporary times, network effects are found on the internet and social media platforms, which initially started out with only a handful of users. Nonetheless, as time progressed, more users arrived and started enlarging the network through interaction and information sharing, further preventing competing platforms from overtaking its dominant market stance. 



A pragmatic example would be Facebook, a well-recognized social media platform that has disrupted the internet since its arrival, ultimately eliminating its predecessor, Myspace, which was dominant in the U.S. market at the time.



Myspace was founded during mid 2003 with a peak of 100 million users and being valued at around 12 billion USD, or around 370 billion THB. Soon after, Facebook was founded in 2004 and accumulated a user count of around 1 billion in a short matter of time, whilst also approximating its market capitalization at around 800 billion USD or around 25 trillion THB. Though occasionally facing user privacy and security concerns, Facebook has still held its dominant position in the market as the top social media platform for over 17 years.

Why have Facebook users stayed?



The main reason lies within the company’s adaptation to mobile platforms. The invention of the Apple iPhone became the driving force behind Facebook’s business model, pushing it to grow even more exponentially, ultimately overtaking MySpace in the social media platform market.

You may be wondering; why hasn’t anyone been able to replace Facebook? Well, there has yet to be a new platform with features significant or unique enough to overcome the network Facebook has created, making it incredibly difficult for regular users to change platforms.



How do network effects relate to Bitcoin?



Much like Facebook, Bitcoin was created in a short matter of time but grew exponentially as well. It became a household name when it came to cryptocurrency, not only attracting traders, but also miners who became an integral part of the Bitcoin network’s large-scale connectivity, which provided immense computational power that has evidently resulted in a secure system that has become nearly impossible to attack or overcome.



Though the arrival of smart contracts and dApps have provided alternative use cases for the blockchain system, Bitcoin’s top dog position in the crypto market has still yet to be taken away. Its portion of the market is approximated at around 54.22% (as of April 15, 2021 on TradingView.)



Attempts to overtake Bitcoin have been made in the form of Bitcoin Cash (BCH), a network that is separated entirely from the Bitcoin blockchain (BTC). Soon after BCH was even Hard Forked into Bitcoin Satoshi’s Vision (BSV). Though both were created as solutions to Bitcoin’s issues and shortcomings, neither have yet to even eat away 5% from Bitcoin’s market shares. 



In exemplification, if one were to create a replica of a famous painting with identical colors, features and even use the same picture frame, the public would still value the “original” more and prefer it over copies and replicas. The same concept applies to Bitcoin, an open-source system which allows all users to implement their own coding to develop a new coin from Bitcoin itself. However, if the newly-erected versions were to not receive much popularity amongst the crypto community, Bitcoin would still be their go-to.

Conclusion



Network effects are found in our daily lives, they are shown through the internet, telephone connectivity, credit cards and much more. Its occurrence takes concern of the connectivity between people within a network. If the connection is recognizably strong, the transfer of information and work rate within the network would be equally strengthened, further attracting new users into the network as well. Behind Bitcoin’s growth and recognition is the network effect it has created throughout the years which has become evidently impossibly difficult to replace. Nonetheless, the matter of adapting to adjust systematic features for users is also integral to maintain regular users and draw in new ones as well.





Reference:



Harvard business school, Investopedia, Bitcoin market capital, Network effect กับบิตคอยน์

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