Most successful Internet-era companies have thrived on network effects (the product becomes more valuable as more people use it).

Today’s leading companies and startups are heavily influenced by network effects, such as:

1. E-Commerce: eBay, Etsy, Amazon, Alibaba
   

2. Rideshare: Uber, Lyft

1. Social Media: Facebook, Twitter, Instagram, YT

Network effects & the power law play an even bigger role in the Web3 space due to composability, open-source standards, and tokens. We can see network effects in many sectors of Web3 already, as explained below:

Blockchain Layer

At the blockchain layer, Ethereum, Tron, & Solana hold >70% of the TVL market share.

Bitcoin, Ethereum, and Solana hold 76% of the market share by price.

In the Ethereum Layer 2 space, Arbitrum One, Base, and OP Mainnet hold over 75% market share.

Application Layer

In liquid staking space, Lido holds > 62% market share.

In the decentralized exchange (DEX) space, Uniswap and Raydium hold over 70% market share.

In lending markets, Aave, Justlend, and Spark have more than 60% market share.

Similar to many successful companies in the Internet era, many Web3 projects that dominate their markets have two or three-sided network effects, as explained below.

Blockchain Network Effects

For blockchains, more users → more developers → more apps, → more users → flywheel.

For DEXs, as more users → more Volumes → more LPs → reduces slippage → more Users, → flywheel.

For lending markets, as more users → more borrow/supply assets → stable markets → more suppliers/borrowers → flywheel.

For Liquid Staking Tokens (LST), as a token’s market share increases → more DEXs, lending, and yield DeFi products support it → makes the LST more usable → attracts new users → increasing liquidity → flywheel.

In Web2, building a product around another company’s product or APIs can be risky. The main company might close access to the API and develop the product in-house.

For example:

1. Twitter closing its API access.
2. Facebook removing group API access.
3. Pebble lost to Apple Watch.
4. Clubhouse lost to Twitter Spaces.
5. Slack pending loss to Microsoft Teams.

In Web3, apps are composable and immutable, allowing other projects to build on top of them without trusting the team. This creates even more network effects at a much bigger scale than web2.

Importance of Tokens in Creating the Network Effects

In Web2, users find it difficult to leave the system due to economies of scale and extensive network effects; however, the dynamics are different in Web3:

Building a competitive edge is hard in web3, bc

1. User data and identity are public, making it easier to build and “vampire attack” existing products.
2. Switching costs are lower, leading to more competition.
3. It’s easier to create a substitute (forks).

Tokens enable projects to solve these issues and cold start & supply problems.

A platform becomes sticky when users develop a genuine preference for it. In Web3, this can stem from owning the platform’s token, which fosters a sense of belonging and investment in the platform.

As users grow with the platform or app, their identity becomes closely tied to the projects they support. This is evident on Crypto Twitter, where people from different ecosystems passionately argue in favor of their own.

Considerations for Builders & Investors

1. Which network effects are defendable?
2. Who gives value and who takes value from the network?
3. Which users bring strong network effects and grow the network quickly?
4. Will network effects apply to the token or the platform?
5. Are the network effects local or global?
6. Who to incentivize and who to charge a fee?

Conclusion

Network effects are crucial for any platform to have a competitive advantage. Blockchains become essential as important applications are built on top of them, incentivizing the maintenance and development of platforms or tools.

Reference:

1. https://a16z.simplecast.com/episodes/network-effects-moats-the-business-of-web3-eWugU00I
2. https://online.hbs.edu/blog/post/what-are-network-effects
3. https://www.growthepie.xyz/fundamentals/total-value-locked
4. https://dune.com/LidoAnalytical/Lido-Finance-Extended
5. https://www.coingecko.com/en/all-cryptocurrencies
6. https://defillama.com/categories

Disclaimer：

1. This article is reprinted from [chandan]. All copyrights belong to the original author [chandan]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.