Investors look for companies that have a “Network Effect” which is nicely summed up by Wikipedia:
a network effect is a characteristic that causes a good or service to have a value to a potential customer which depends on the number of other customers who own the good or are users of the service. In other words, the number of prior adopters is a term in the value available to the next adopter.
Startups who can harness a network effect, and move quickly in the market gain tremendous advantages over their competitors by providing an increasing amount of value to their users.
In 2008, Fred Wilson wrote about a “Second Order Network Effect” in which companies like Zynga were able to build their networks on top of social networks to increase the utility of their product and reduce their market friction.
Large corporations also benefit from an effect that Niraj Pant calls “The Ecosystem Effect” where they start to build out their own breadth of product offerings to dominate a market. (Example: Google building Chrome and Gmail.)
Blockchains have created a new paradigm along these lines that I’ve referred to as “Network Effect².” Where startups are no longer restricted to trying to build networks, or ecosystems within their own product offering, but can instead openly leverage the compounding value of deep, permission-less integration with other projects.
Take the game CryptoKitties by AxiomZen for example. In this game, players buy, sell and breed, digital cats — and according to DappRadar there is about ~25 ETH worth of turn over in the game each day.
But, since the cats are owned by the players, and their information is represented by the ERC-721 non-fungible token, these cats aren’t limited to AxiomZen’s world.
In fact, players have gone on to create their own games and new features for CryptoKitties including:
- KittyHats: Where players can buy, sell and trade, hats and other accessories for their cats.
- KittyRace: Where players can race their Kitties and bet on the outcome.
- KittyBattles: Where players battle their Kitties to gain skill, experience points and fur-filled glory.
- CatNip: The Tinder for Kitties.
These projects are all built using CryptoKitties but operate independetly. They don’t need API permission or a partnership, and they don’t need to create their own network from scratch. Instead they are tapping into an existing network on the Ethereum blockchain.
They are free to build and integrate in anyway they choose, something entirely unique to the blockchain.
This “Network Effect²” is a positive impact for both CryptoKitties and the new projects.
The new projects get:
- A day one audience with clear interest in their project.
- A reduction in what they need to build out.
- Assurance that they can’t be shut out by an API or platform change.
- They ability to hyper-focus on doing one thing better than anyone else.
- New features built out by the community without cost to them.
- A rapidly expanding marketing footprint.
- New ways to re-engage and re-enforce behavior among current players.
- Increased value of the ERC-721 assets.
- A low risk way to prototype and validate new feature concepts.
Blockchain’s help us unlock and secure value in markets that previously required trust, permission and risk.
If you wanted to build out a feature for your favorite online game, you’d previously need permission from that company, and you wouldn’t expect much compensation for it.
Now, you’re free to go and build that feature and benefit from the direct value that you create. That is a very powerful paradigm shift.
I think we’re likely to see an increase in companies who leverage the open value of a “Network Effect²” to create dominant positions in their market, as we shift from creating networks to creating these boundry-less cross-company ecosystems.