Posted: 08.07.2021 | 02:53
What is Network Effect?
The network effect is that a product becomes more valuable as more people use it. An economic impact that identifies a product or service for which additional users add value to the network. When there is a network effect, each new user adds value to the product by entering the network. This in turn encourages new users to join and add more value to the network, etc. encourages.
A good example of the network effect would be this phone. In the early days of technology, very few people had a telephone at home. In fact, their homes had to be physically connected to use the network. But as technology improved, more and more people started buying a phone, which increased the value of the entire phone network. As the number of users increased, the value and utility of the entire network increased. This has created a positive feedback loop where more people join, more value is added to the entire network. Increased usage led to exponential growth.
Network Effect Types
There are two main types of network effects, direct and indirect network effects. Direct network effects are the network effect for the telephone example above. Increased usage in direct network impact adds value for all other users.
The indirect network effect, on the other hand, refers to the additional, complementary benefits that result from the network effect. For example, many cryptocurrencies are open source. A project with a strong network impact can push talented developers against moderating the code, as it gains too much value and is compromised. This added value is due to the fact that there is so much value in the network in the first place. This influence begins to escalate and dominant leaders are reached who exert significant network effects on their competitors.
Network Effect Examples
Today's examples of the network effect exist in a number of different product categories. One of the most obvious is social media. This encourages people to join the same platforms and thus a few services become monopolistic.
Another good example of network effects is car sharing. The network effects Uber or Lyft have built over the years make it hard to compete for newer services with a smaller user base.
The same is true for Ebay and Amazon with online sales, Google with internet search, AirBNB with online rental, Microsoft with enterprise operating systems, and Apple with iPhone. In fact, Wikipedia is a good example of an open source project that has had a significant network impact.
Network Effects and Cryptocurrencies
Network effects are a major consideration when it comes to cryptocurrency and blockchain. Bitcoin has some highly desirable features and also has a strong network effect.
Miners support network security and have great liquidity to continue their operations. If another network is launched that aims to serve a similar use case as Bitcoin, miners may receive higher rewards, but they will not have the same liquidity to exit their positions. This is how the network effect works. Even if the alternative is technologically superior or brings more rewards, it doesn't necessarily make sense to switch.
Network effects are also an important consideration in Decentralized Finance (DeFi). If a product, service, or even smart contract is a huge advantage, it can be difficult for other projects to tackle.