What Is a Network Effect?
A network effect is the phenomenon in which a new user joining a given network changes the value of that network for other users. For example, a given messaging platform will be more useful as more people join the network, thereby increasing the amount of people someone could communicate with.
Network effects are generally positive, meaning that a new user increases the value of the network for other users. Additionally, new users make it more attractive for other potential users to join the network.
Network effects exist in many industries. Social media platforms have very strong network effects. Matching platforms, such an Uber, depend heavily on their network effect to crush competitors. iMessage plays to the iPhone’s network effect, to prevent users from switching to other phones.
How Do Network Effects Apply to Bitcoin
Network effects have huge implications on Bitcoin’s utility as a currency and as a store of value. Like all major currencies, Bitcoin’s value depends on somebody else being willing to accept it as payment or buy it as an investment. As more people accept Bitcoin, it becomes more valuable to somebody looking to spend Bitcoin.
However, every other currency is also affected by network effects. This powerful phenomenon favors whichever product has the largest user base, regardless of the underlying utility of the product. This means that currencies that are well-established with large user bases have strong lock-in effects, incentivizing people to continue using them.
Bitcoin is intended to disrupt fiat currencies with several million users. More directly, many people expect Bitcoin to largely replace gold, a global store of value and one of the oldest currencies still in use. To compete with established currencies, Bitcoin must overcome the lock-in effect that they currently benefit from. This is why Bitcoin adoption has taken a long time, despite having much better characteristics of money than its existing competitors.
➤ Learn more about what makes good money.
What Does The Network Effect Mean For Bitcoin’s Future
The fact that adoption is being hindered by the lock-in effect of existing currencies is actually extremely good news for Bitcoin. The two main factors in its adoption are the underlying utility it has as a currency and the network effect’s impact. Bitcoin adoption has consistently been increasing since its creation in 2009. Every new adopter makes it more compelling for the next person to join the network.
Adoption is toughest in the earliest stages and gets progressively easier as every new person accepts Bitcoin. Since Bitcoin has already persevered through the hardest parts of the adoption curve, it would stand to reason that it should only be easier from here. Bitcoin is already widely used by many fortune 500 companies, billionaire investors, and retail customers.
➤ Learn more about Bitcoin's adoption curve.
Identifying Bitcoin’s current location on the adoption curve is difficult for many reasons. Many people can participate in the network anonymously. Conversely, they may publicly support Bitcoin without actually owning Bitcoin or verifying transactions. More importantly, these conclusions depend on what you anticipate to be the final equilibrium of Bitcoin once it is fully integrated into the global economy.
However, we do know that every person who follows the existing adopters creates a positive feedback loop, triggering more people to follow. Eventually, these users will reach a critical mass that pushes Bitcoin over the tipping point. In theory, this point will have a sufficient network effect such that it can trigger everyone to accept the currency in a rapid move, including everyone who has yet to make the transition.
➤ Learn more about why Bitcoin has value.
Key Takeaways
- Network effects make a product or currency more useful as more people join the network.
- Every additional Bitcoin adopter makes Bitcoin more valuable for everyone else involved.
- Bitcoin is battling the network effect advantage of older and more established currencies.
