Bitcoin: Network Effects
Understanding the different nfx at play
Bitcoin is a sleeping giant and I think most people underestimate it’s current size and its potential for being a top world currency. Over the next decade, we’ll witness Bitcoin devour weaker currencies from developing countries before possibly flipping the larger currencies like the Japanese Yen, the Euro and the U.S. Dollar.
Bitcoin’s 9,000,000% rise over the last decade to $20k was due to many of it’s unique attributes such as — artificial capped supply, first mover advantage, deflationary monetary policy, and its decentralized network. But, one of the main reasons for Bitcoin’s exponential growth is its network effects. A network effect is a phenomenon whereby increased numbers of people using a good or service exponentially increases the value of the good or service for everyone using the network. Think of the telephone or internet. There’s not much value to these networks when one person is using the network, but as soon as others join the value explodes as users can connect, assemble, share, trade, etc.
Anyone in the world with an internet connection can buy, save and send bitcoin. It’s unstoppable and digital nature makes it the most accessible currency on the planet. Money itself has always had inherent network effects because of money’s necessary core properties — store of value, median of exchange and unit of account. Money was one of the first technologies to facilitate network effects among human beings. However, Bitcoin is a technology invented to be a better money by drastically enhancing these properties by being a digitally first censorship resistant money.
There are different types of network effects that vary in value for the growth of the network but each act like a defensive moat to help promote continuous growth of the network. Some of the core network effects for Bitcoin are below.
Direct Network Effects
Yes, bitcoin is a digital asset, but it’s secured by actual physical infrastructure through mining operations and chip manufactures. Billions of dollars are being invested into mining operations all over the world and there are machines built specifically for mining bitcoin, Application Specific Integrated Circuits or ASIC Miners. This equipment continuously gets better and more efficient overtime, and ultimately increases the security of the network making it the most secure computer network in the world.
- This physical network effect is similar to Comcast laying down fiber optic cables for faster internet connection.
Bitcoin is an open source protocol that can be used anywhere and by anyone. This protocol can be used to integrate into businesses and for engineers to build on.
- This protocol network effect is similar to how we use email, fax or plug in an ether net cord for faster internet.
Bitcoin can be used to store value over time, send value without any third parties for a very low cost, and travel all over the world without having to disclose how much money you’re traveling with. Bitcoin holders are able to earn interest on their bitcoin by lending it to borrows and borrowers are able to use bitcoin as collateral for a loan through platforms like BlockFi. Another personal utility is peace of mind. Bitcoin is completely separate from our existing financial system and can’t be manipulated by a central bank or government.
- This personal utility network effect is similar to Facebook’s messenger and what’s app communication tools.
Bitcoin has developed a very loyal and exuberant user base. People go to Bitcoin meetups all over the world to meet other fellow Bitcoiners and connect about the technology. Bitcoin has inspired artists, digital artists and an entire meme cultural. There’s bitcoin chat groups, blogs, Twitter accounts and YouTube channels. This only increases the awareness around Bitcoin and ultimately increasing the value of the network.
- This personal network effect is similar to the user activity on Facebook and Twitter.
Two sided Network Effects
As Bitcoin gains in popularity and value it attracts marketplaces for speculators to buy and sell bitcoin for an expected return. More exchanges and on/off ramps have been built around Bitcoin for this reason which then attracts more users. Some of the larger marketplaces are Coinbase, Cash App, Binance, Kraken and Gemini.
- This network effect is similar to our traditional financial services industry that allows us to trade stocks like E-TRADE and Robinhood.
Bitcoin is a new technology and as with new technologies their user interfaces are not great, however this has changed over the years. It’s moved from a niche hobbyist item with a clunky user experience to a cleaner and more useful user experience that allows for wider adoption. Platforms like Liquid, Lighting and Zap are second layer solutions that allow for faster transaction times and settlement for smaller amounts of bitcoin. The mobile wallet infrastructure is massively better today than it was just 3 years ago, Trust Wallet, Strike, and Coinbase Wallet. This is still the beginning of Bitcoin and we have a long way to go, but development is happening at a rapid clip.
- This network effect is similar to Apple’s iOS and Google’s Android operating systems.
Bitcoin is a blockchain and a blockchain is simply an immutable data structure keeping track of all transactions between participants. This data structure is a profound invention as it can never be changed by one third party. This is less valuable for developed countries with a sophisticated banking infrastructure, but amazingly important for the “unbanked” in developing countries with corrupt governments and zero access to financial services. Now, these “unbanked” individuals can download an app to be there on own bank via Bitcoin and never have to worry about stolen funds or thwarted payments again. As Bitcoin and the blockchain ecosystem evolves, soon machines and bots will be able to access and operate from these data structures to drive increased value to users. Think of trading bots and the internet of things; micro transactions will be possible allowing for people to be paid to eat healthy and exercise, along with smart fridges alerting Amazon to send more milk because you just ran out.
Social Network Effects
If bitcoin’s price continues on it’s trajectory and makes new all time highs, it will cause immense amount of FOMO from non-participants trying to buy bitcoin. This will only exponentially increase as other currencies are printed into oblivion creating capital flight to safe haven assets like bitcoin, gold and silver. We are already seeing this with technology stocks in the marketplace. People are parking their money into technology stocks at all time highs with crazy expensive P/E ratios simply because they perceive them better stores of value than cash.
Bitcoin was invented for a purpose and it’s characteristics represent a certain belief system. Free money without any government manipulation. Bitcoiners have a hard core belief in free money. They’ve opted out of our current financial system and have held bitcoin through extreme volatility risking their savings. Belief causes action.
- This network effect can be seen in religion by people going to church every Sunday or not eating pork. It can also be seen in this newsletter. I’m writing about Bitcoin everyday to increase awareness around bitcoin and encourage others to participate.
Great goods and services spring new words into existence which further increase the value of the network by strengthening the conviction of the network users and by on-boarding new users. “HODL” is a word that has been created and widely used in the community to express ones belief in Bitcoin and to encourage others not to sell during extreme volatility.
- This network effect is similar to how we use Uber and Google. “I’m going to Uber there.” “Just Google it.”
After researching Bitcoin’s network effects and combining it’s open sourced transparent code and fixed artificial supply, it’s clear why Bitcoin has been the best performing assets over the last decade. Right now Bitcoin’s market value sits slightly under $200B, but is already bigger than Warren Buffet, Goldman Sachs, UBS Group AG, Boeing, and New Zealand’s GDP. Here’s a link comparing Bitcoin to the market cap of world’s fiat currencies. Bitcoin is quickly eating everyone’s lunch and we’re just getting started.
Who’s next on the menu?
***This is not financial advice. Investing in bitcoin and cryptocurrency is extremely risky. Please do your own research. The ideas and news presented in this newsletter are my personal opinions and meant for informational and entertainment purposes only.