Why Bitcoin's Network Effects Are More Important Than Its Price

Date Published
May 20, 2022
Written by
Mitch Morse
Reviewed by

A network effect is what happens when people benefit from using the same platform, system, or rules as others. Because there is a benefit to being on the same page, more people join the same network. As more people join, they also get their peers to join. These peers get their peers to join, and so on. While a network effect typically starts slowly, it grows exponentially once it reaches a critical mass. 

While we often think about network effects in light of modern technology, network effects have existed for as long as humans have been around. One of the most important network effects is one that we all use: language. If each household used its own unique language, it would be incredibly difficult to communicate with anyone beyond the household. Because of these difficulties, we would quickly see certain households switching to another household’s language. Perhaps two households that do business together would agree to adopt one single language in order to make transacting easier. Eventually, entire regions would adopt the same language, so that all households in that region could seamlessly communicate with each other. Over a long enough time span, languages would tend towards a winner-take-all effect, as people using minority languages will face more difficulties than those using the majority language.

Network effects have been around for thousands of years, but the modern age greases the rails to allow for more rapid transformations. From the internet, to Amazon, to Twitter, the modern world is filled with network effects that pop up in the span of a couple decades or less. The flow of information is what allows a network effect to grow. By drastically increasing the ability for information to flow, the internet allows a network effect to go from nothing to globally available in the span of a few years. While language took centuries for winner-take-all effects to become noticeable, network effects today can reach billions of people in a small fraction of the time (e.g. Twitter, Amazon). 

Beyond the advantage of growing exponentially, network effects are also notoriously difficult to unseat. Because network effects are based on connections with millions or billions of people, those inside the network face a steep cost for switching to a different network. Switching from Twitter to a less popular competitor requires creating a new account from scratch. Even if a brand-new Twitter clone was created with one improved feature (e.g. 24/7 live customer support with zero wait times), few people would switch over. In order to unseat a network effect, one must deliver a vastly superior product whose advantages offset the pain that people incur for leaving the established network. Combine exponential growth with a natural hurdle for competitors, and we get a winner-take-all effect. 

Bitcoin, as a collection of interconnected global peers using the rails of the internet, has developed a rapidly growing network effect over the past 12 years. With the core ethos of Bitcoin being immutability, censorship resistance, and a hard-capped supply of 21 million units, Bitcoin is the ultimate store of value asset. The value stored in Bitcoin can be securely transferred across the globe in under an hour; the same cannot be said of real estate or gold. While gold and real estate do benefit from network effects, these assets are based in the analog world. Thus, the flow of information is far slower with gold or real estate than it is with digitally-native Bitcoin. Without even considering the full range of assets that people store value in, the global market caps of gold (~$10 trillion), real estate (~$300 trillion), and bonds (~$120 trillion) put us over $300 trillion in store of value assets. Bitcoin’s market cap is around $1 trillion. 

Bitcoin is the most secure computing network on earth. It is an asset which cannot be diluted beyond the disinflationary preprogrammed supply schedule. It has a globally liquid market, and it can be zipped around the world in under an hour. Someone holding Bitcoin can even distribute the security of their personal holdings across different jurisdictions using multisignature technology, rendering any eminent domain or physical attacks nearly impossible. In a nutshell, Bitcoin is orders of magnitude better than any other store of value asset. It does not require trust in a government or other entity, and it provides vastly superior optionality to those who use it to store value. The Bitcoin network effect has rapidly grown in its first 12 years of existence, and yet it only occupies a tiny fraction (less than 1%) of all store of value assets. As more people choose to adopt Bitcoin as their primary store of value asset, network effects will continue to accelerate. As is the case with any network effect, the early adopters will get their peers to switch to the superior network that allows for faster flow of information and increased optionality. These new peers will then get their peers to join the network and so on, as the winner-take-all network effects take hold in the global store of value market.

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