Metcalfe's Law & Network Effects
Why does Twitter or Uber have value? Not from a traditional financial perspective, but actual value for the participates in the network? Twitter works because you can interact and receive information from millions of accounts, or start Twitter fights with them if thats your thing. How useful would Twitter be if there were only 5 accounts? Or how useful would Uber be if they only had 2 drivers in the entire city. Not very.
Metcalfe’s Law
So what is Metcalfe’s law?
“Metcalfe’s Law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system (n²), or n(n − 1)/2, where n equals to number of nodes.”
Thats the long and convoluted academic definition, but Metcalfe’s law can be summed down to “The more people in a network, the more valuable the network becomes.” The cool part is that exponential growth is built in to this law. Lets say a network has 10 users and we want to find out the Network Value, so lets do some math with the formula:
(n²) = Network Value
(10²) = Network Value
100 = Network Value
The value of this network becomes 100. What if 1 more user comes in?
(11²) = Network Value
121 = Network Value
1 extra user made the value jump by 21 points! If we add another one, then it does a 23 point jump to a Network Value of 144! It can be summed up as each marginal user raises the value more than the previous user.
This helps explain why tech companies and crypto have exponential gains in their stock or coin and why copying pasting doesn’t work well. Anyone can create a Facebook clone, but it won’t have the users needed, making it worthless. Litecoin may be a “faster” fork of Bitcoin, but it doesn’t have the users and network effects of Bitcoin, which helps explains why its marketcap is lower.
The value of the network isn’t driven by P/E ratios or linear financial analysis, or even slightly better tech. The system grows exponentially with more users onboarded. This creates a feedback loop where future users will be driven to the strongest network, growing it faster, while making it more useful at the same time. This feedback loop allows the price to grow exponentially.
Applying Metcalfe’s Law to Crypto
The higher the growth and acceptance of cryptocurrencies, the more that the growth will push crypto higher. Compared to 2013, in 2021 crypto has a massive amount of use cases that will continue to push the growth of the industry. Lets look at a few of them:
DeFi is having impressive growth year over year with more and more wallets interacting with the system. It’s currently taking the baby steps needed to replace traditional financial services. The more lending & borrowing and money locked into DeFi the better the experience is for everyone and the more efficient it becomes. An example would be trading on Uniswap, having billions of dollars of liquidity would incur less slippage than a few thousand dollars. It also makes it harder to manipulate, which is a net gain for the ecosystem.
NFTs shot into the mainstream with collectables, art, and in game assets. An entire ecosystem with digital collectibles with many participants is a stronger system than a couple of people having NFTs. This is only the tip of the iceberg on what NFTs will be capable of and expect a lot of crypto onboarding of younger normies from NFT exposure.
Institutional demand for cryptocurrencies has grown massively this year. It use to be unheard of for famous legacy investors to talk about crypto in a positive light. Now many such as Paul Tudor Jones and Ray Dalio are now stating that crypto is a legitimate asset class. Each time someone from TradFi gives their stamp of approval, it makes it more likely that another big investor will take a look into the ecosystem. As more get in, then additional services and businesses are created serve this niche. A net positive for crypto. Big banks and insurance funds are starting to get into the action as well.
Even governments are starting to adopt crypto as legal tender for their country. El Salvador was the first one to do it, and now it seems that Paraguay is on the verge of following in their footsteps. It took 10 years for the first country to adopt Bitcoin as legal tender and it only took 1 month for the 2nd country to attempt legislation at this. The network effect of countries adopting crypto will accelerate as more countries jump in.
In Conclusion
While in the short term the prices can fluctuate, there is no doubt we’re at an inflection point where so many new participates are entering our ecosystem. The more that crypto is used, the more useful it becomes to interact with other people within the network. Each marginal user is growing the value of our ecosystem until it’s a runaway train thats impossible to stop.
Captain BTC
(This is for educational purposes and does not constitute financial advice)
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