What Is A Network Effect?
A network effect is a phenomenon whereby a good or service becomes more valuable when more people use it. Network effects are often studied in the context of technological adoption. The best-known example of a network effect is probably the telephone system: the value of a phone increases as more people have phones and can be called. Other examples include social networking sites, email, and payment networks.
Metcalfe’s Law
One important model for understanding network effects is Metcalfe’s law. The law states that the value of a network is proportional to the square of the number of nodes in the network.
The network effect is one of the main reasons why Bitcoin has become so successful. The more full bitcoin nodesWhat Is A Bitcoin Node? A bitcoin node is any computer that runs the bitcoin software, enforces the bitcoin consensus rules, and validates bitcoin transactions and blocks. Bitcoin nodes are... that exist, the more decentralized the blockchainWhat Is The Blockchain? The blockchain is the public record of bitcoin transactions, which are organized into blocks that are all chronologically linked to one another. Because every block is... becomes. The more bitcoin miners that exist, the more decentralized and secure the network is. The more people that use bitcoin as a store of value, the stronger the bitcoin monetary network effect becomes.
For example, if there are 100 nodes in a network, then the value of the network will be “10,000” (100 squared).
Gresham’s Law
Gresham’s Law is an economic theory that states that bad moneyWhat Is Money? Money is a tool that enables humans to perform 3 basic functions: store value, exchange value, and account for value. In order for money to perform its... drives out good money. The theory is named after Sir Thomas Gresham, who observed that when two different types of coinage were in circulation, the more valuable coins would quickly be hoarded, leaving only the less valuable ones. This phenomenon occurs because people are more likely to spend the less valuable coins, saving the more valuable ones.
As a result, the circulating supply of good money becomes depleted, while the circulating supply of bad money increases.
While Gresham’s Law was originally formulated with physical currency in mind, it also applies to economic systems more generally. For example, in a networked economy, businesses with a strong network effect will tend to drive out those with a weaker network. This is because the former will be able to offer better prices and services due to their larger network of users. In the context of cryptocurrency, this means that Bitcoin, which has a stronger network effect than all of the altcoins, is likely to always be the dominant form of digital money.