Bitcoin’s price and ecosystem benefit from network effects.
As more users join, demand pressure increases the price of bitcoin, which in turn attracts more buyers in a self-reinforcing cycle. Similarly, user growth creates a larger market with more liquidity, incentivizing businesses to provide more services, integrations and security, which then encourages new users to join the more robust ecosystem.
Understanding this network effect is important when considering Bitcoin’s place within the greater financial world.
Legacy financial systems also benefit from network effects to a degree, as increased user growth enables expansion of financial services, fostering more user growth. As more customers adopt Visa credit cards due to their widespread use as payment options, more merchants are incentivized to integrate with Visa to access customers, thereby enabling more Visa card adoption.
Network effects are a powerful driver for growth.
However, not all network effects are the same[1]. Each network has its own value proposition, potential growth rate, structural limitations, and barriers to entry and exit. Metcalfe’s Law[2] posits that the value of a telecommunication network is proportional to the square of its nodes. As more users (nodes) join such a network, the number of possible connections increases exponentially, providing an ever-growing incentive for new users to adopt that network.
Although Metcalfe’s Law has limitations beyond communication networks, it still helps illustrate the exponential power that network effects have in our increasingly interconnected world.
A less-discussed phenomenon of network effects is their decline potential. Just as the increase in the number of nodes can add value to a network exponentially, so too can the decline in the number of nodes reduce the value of the network exponentially.
Social giant Facebook has leveraged network effects in its growth, as each additional Facebook user added exponentially more
