Network Effects and the Value of Emerging Cryptocurrencies

Cryptocurrencies have transitioned from niche assets to a central focus in contemporary economics. While Bitcoin and Ethereum often receive the majority of publicity and attention, there are still hundreds of new digital tokens that are released annually, and most claim some sort of unique technology or community benefit. In reality, most tokens will become worthless or part of the ever-growing background noise, while a select few will emerge as billion-dollar networks.

So why do some cryptocurrencies succeed and others fail? In most cases, the answer is not technology, but rather the economic principle of network effects — a good or service becomes more valuable the more people use it. Understanding network effects can help explain the success of Bitcoin, the volatility of meme coins, and the peculiar case of projects like Pi Coin.

The Economics of Network Effects

A network effect refers to the advantages that are given to a specific product as its user base grows. The telephone illustrates this dynamic best: the very first telephone was useless, but as additional people began to use the telephone, the value of the telephone grew — and grew rapidly. Social media tools derive their value when there are a sufficient quantity of users.

Cryptocurrencies follow a similar path. A digital token has, more or less, little value by itself. Rather, it has value based on how many people are willing to hold the token, trade it, or build services that use it. If only a few people will accept a coin for goods or services, then it is not of much use. But when it has achieved some degree of user adoption, then it becomes easier to use and trade, easier to add to applications, and begins to be accepted as a medium of exchange and store of value.

That feedback loop is why early user adoption is so vital in early cryptocurrencies. Once a coin, or token, reaches a dynamic tipping point, the network effect can take over and produce momentum that onboards and maintains value for the token. Conversely, coins that do not see an early wave of people to hold or to transact with the token, will not quickly find a way to remain relevant.

Bitcoin as the First Case Study

The escalation of Bitcoin's value provides a straightforward example of a positive network effect. In the beginning, Bitcoin was valuable to a few groups of cryptographers and libertarians. Over time, Bitcoin attracted miners, developers, exchange operators, and ultimately institutional investors. The more layers of adoption Bitcoin attracted, the more value it created, and therefore attracted even more participants.

Bitcoin also had a hard supply limit of 21 million Bitcoin programmed into its algorithm, which only strengthened the network effect with scarcity. Scarcity and incremental adoption further established the foundation for price growth and sustainability over the longterm. Today, not only is Bitcoin a speculative asset, it has evolved into a "digital gold," or a valuable store-of-value asset, based upon its overwhelming network of participants.

The Long Tail of Cryptocurrencies

For every Bitcoin, you have numerous projects that fail to catch any traction and generate any useful network effect. Or alternatively, many new coins launch with momentum only to soon stagnate on real user numbers and liquidity is very quickly lost. Eventually, without a material user base, exchanges delist, developers get bored and don't support the growing user base and the value begins to fall apart.

This model is reminiscent of the broader economics of digital markets. There are a handful of platforms that are generating the vast majority of engagement, while most users are either sub-scale or go out of business. As with social networks or e-commerce platforms, cryptocurrencies exhibit a "winner-takes-most" market mechanism.

Pi Coin and the Challenge of Adoption

Pi Coin serves as a noteworthy example of a network effects economics case. Unlike traditional cryptocurrency economics, which necessitate some way to incentivize users to obtain the currency (say through the use of hardware), Pi Coin launched in a mobile app, where users could "mine" coins without incurring substantial costs. Recognizing the need to build accessibility, and leverage viral growth, Pi's initial strategy aimed to attract an increasingly larger user base, where they could invite friends to join, form mining teams, and expand the user network through referrals.

From an economic perspective, the entire effort was to bootstrap network effects before there was any monetary value to the currency itself. By attracting millions of users, all over the globe, a community formed around the belief that the token would one day have some form of trading value.

However, the key to the success of the Pi model depends on Pi Coin converting all those engaged users into some sort of economic value. Without liquidity and use cases established in the real economy and or exchanges, a vast network could turn out to be nothing more than a symbol. For those contemplating whether to engage with Pi coin, tutorials such as how to buy sell pi coin explain the process of engaging with Pi in its current for

The Double-Edged Sword of Network Effects

Though network effects are undeniably strong there are limits and risks as well;

Hype lead adoption: Speculation is capable of driving networks but most often it is at the expense of real utility. Speculation can lead to real bubbles that subsequently collapse, once the hype has faded.
Centralization risks of metnets: Once a large enough user base joins a network or platform (which is often the case in a metnet), you are more likely to find that it has been centralized around a few exchanges, platforms or other dominant players that have tendencies of monopolistic/oligopolistic behavior.
Switching costs: For the most popular coins, e.g. bitcoin and Ethereum, it becomes more and more difficult, once a user has adopted the dominant coin, to convince them to switch. In which, it becomes prohibitively expensive to build adoption Uptake of the pegged networks.
Regulatory failures: No matter how strong the networks appear to be to the user clusters as a whole, government policy can quickly change how it reshapes adoption. Either by implementing bans, taxes, or changing what a security is classified as, removing more options to engage the networks themselves.

Measuring Value Beyond Price

Economists are increasingly emphasizing that the value of cryptocurrency should not be based solely on price. Other metrics such as active addresses, transaction volume, developer contributions, and relationships with other projects give a better view into the health of the network.

To illustrate this point, a coin with increasing developer contributions and budding partnerships may have healthier long-term value than a coin whose price is surging but has no signs of real adoption. In this way, Pi Coin has millions of individuals participating in their app and that seems like an asset, but more importantly, will all those “participants” actually turn into meaningful end-user activity when trading opens up fully?

Implications for Economic Thinking

The emergence of cryptocurrencies upsets traditional economic models in various ways:

Reconceptualizing scarcity: Digital assets can create infinite copies - however, blockchain technology seems to propose "artificial" scarcity, leading to debate about what value really is.
Shifting trust: Traditional money states rely on trust that is state sponsored, whereas cryptocurrency states rely on decentralized consensus and shifting trust- the economics of trust are shifting as well.
Speculative behavior: The economics of behavior are more present in cryptocurrencies than in any other asset class. Herd behavior and social proof often drive adoption of digital assets faster than rational analysis.

Network effects connect all these themes; they show how value in digital assets doesn't necessarily exist as an inherent trait, but instead will be created, socially, state decoupled technological, and economically.

The Future of Emerging Cryptocurrencies

In the future, one of the primary challenges that the new coins will face is overcoming the adoption gap. Bitcoin and Ethereum have established themselves in the mainstream, and it will require something powerful (unique attributes, reliability with real problems to solve or viral growth models) to enable them to gain traction.

An example of a new coin is Pi Coin which is taking advantage of mobile access and community mining, but that is just an 'experiment.' Other cryptocurrencies are focusing on other areas of interest, such as decentralized finance (DeFi), and privacy and scalability. As with the once popular cryptocurrencies, the continued existence of these projects in the long run will eventually depend on their further developments and proving that their first day "hype" is legitimate, as from the get-go cryptocurrencies that can show movement and excitement will provide a signal to others to take notice.

Ultimately economists, institutions, and policymakers will need to remain keen observers. Network effects strongly suggest that cryptocurrencies will evolve in a similar trajectory; a couple, if even that, will take off in value and others will die off. It is not the same speculative exercise to think about; it is only a comparision of value destruction/creation with the efficiencies on existing digital networks in contemporary economies.

Conclusion

The role of network effects is a foundational principle for understanding why some cryptocurrencies become globally significant while others fade into obscurity. If Bitcoin's estate in cryptocurrency only demonstrates the benefits of loops of adoption, Pi Coin is more useful to illustrate the trials and opportunities for emerging entrants to create value through viral uptake.

To economists, the world of cryptocurrency does not just serve as a series of speculative assets, it is an ongoing experiment of how digital communities create value. The future of cryptocurrencies that emerge will not simply be determined by the code, but even more so by the networks they can build and sustain either by mobile-first approaches to users mining options or with shared technologies. Of course, the Amelia scenario of the Chase was greatly impacted by consumer trust in their payment systems.