What is a network effect?
A network effect is a externality caused by an increase in use of a technology. A network effect can be positive, when it causes an increase in the value of a technology, or negative, when it decreases it. An example of a technology that created a lot of positive network effects is the Internet. In the beginning, it was used only by the military community, therefore, it had a limited user base. As more users were gaining access to this technology, more websites were created, and more people were able to communicate with each other by the Internet. That increased the Internet value. However, the increasing use of the technology can also cause a negative externality, such as a decrease in speed that occurs in some websites when they receive many visitors. That would be an example of a negative network effect.
Bitcoin network effects
Trace Mayer, an Austrian economist and Bitcoin expert, lists 7 network effects that happen with the increasing adoption of bitcoins. All these effects happen simultaneously, and have the potential to increase the value and the number of users of that cryptocurrency, in a retro-feeding virtuous cycle. Here is the list:
- Speculation
It happens when the people buy bitcoins aiming to sell them for a higher price in the future. They can also buy bitcoin as a safe have investment, like gold. The facilitators of the speculation process are the exchanges, which enable trading bitcoins for another currencies, and the wallets, which provides a safe storage of the bitcoins.
- Merchants
Because speculators have bitcoins, companies start to accept bitcoins. Thousands of companies, such as Dell and Microsoft, already accept bitcoins as payment currency. Bitpay is an example of a platform that facilitates bitcoin payments.
- Consumers
Because many companies start accepting bitcoins as a payment currency, the people start using bitcoins to buy their products. An example of a service that allows buying products with bitcoins is Purse.io. This platform allows buying Amazon products by trading bitcoins for gift cards. Purse.io enables saving 15% off Amazon with bitcoins.
- Miners
The increase in value of bitcoins attracts miners, which ensure the correct functioning of bitcoin transactions among users. Today, bitcoin mining network is the network with the biggest processing power of the world. That turns the bitcoin transactions extremely safe.
- Developers
The companies tend to develop softwares that are compatible with the safest blockchain protocol, and with the ones with more users. Therefore, Bitcoin tends to attract the best and biggest tech entrepreneurs to its blockchain.
- Financiers
When Bitcoin rise in popularity, it starts to gain financial tools like other currencies, like futures, puts and calls. Financial institutions become interested by the technology, offering loans and investment in bitcoins. The Winklevoss brothers Bitcoin ETF is an example of that.
- World reserve currency
Every government in the world have international reserves in US Dollar, which is the current world reserve currency. Because Dollar is the most used currency in the world, it is used to precify commodities in the global market. The countries also maintain these reserves to be able to export without paying conversion fees. Maybe one day bitcoins could be used as world reserve currency. One small scale example of bitcoin being used as reserve occurs by the Liquid protocol. This sidechain allows exchanges to trade bitcoins among them, keeping a bitcoin reserve for these trades.
Conclusion
Considering all these factors, one may ask: will another cryptocurrency overcome Bitcoin network effects? Trace Mayers consider this highly unlikely, due to the fact that Bitcoin was a first mover that accumulated these effects a lot earlier and in bigger scale than any other cryptocurrency. If the Bitcoin positive network effects will surpass the negatives ones, which according to part of the Bitcoin community, threaten the future of the cryptocurrency, only time will tell. But the future of Bitcoin looks promising.
References:
http://www.investopedia.com/terms/n/network-effect.asp