Network effects are the phenomenon where the value of a product or asset rises exponentially with the growth of its user base. The value of network effects is clear on social media platforms. The more people that use Facebook, for example, the more valuable the platform. Facebook’s scaling strategy played into this – they built network effects by launching into a pre-existing community (Harvard), grew into other university communities and then released their offering country-wide.
Blockchain and platform businesses, similarly, rely heavily on a strong community to survive. But no blockchain-based business has yet had the disruptive impact of platform economy equivalents. This article will examine why.
The Market Power advantage
Platform and blockchain businesses are not dissimilar. Both use a two-sided business model, rely on network effects to disrupt and are based on the democratising principle of creating a fairer, more sustainable landscape for consumers and businesses. Airbnb, for example, connects renters and hosts. The strength of their product relies on the participation of their users and they democratise the holiday rental market by enabling people to:
- Travel at lower costs
- Make money by renting out their space
- Access a wider choice of rentals
Blockchain business, Ripple, alternatively, enables fast, low-cost cross-border payments using their native token, XRP. The strength of its network, like with Airbnb, relies on the number of people using it. Ripple democratise the cross-border payments market by enabling people around the world to exchange money faster and at lower costs than they would be able to do with centralised alternatives.
The most significant difference between blockchain and platform businesses, however, is that blockchain technology is decentralised.
An MIT study explained that centralisation has a knock-on effect on market power. Market power “arises when users or customers have few comparable alternative options for sources of the good or service being provided.” This enables businesses to raise prices, charge transaction fees, sell user data etc. and monopolise the market. Although network effects and market power are not mutually inclusive, network effects are much more difficult to build without market power. A business that is able to build both (e.g. Amazon) has the potential to monopolise their market. But on a permissionless, decentralised ledger where market power does not exist, building network effects can be very difficult.
Residing outside the mainstream
One of the selling points for blockchain is transparency. All transactions are visible and verified on a public ledger and smart contracts create a highly secure and automated experience for users. An example of this in practice is BeefChain, the startup disrupting the beef industry in Wyoming. Farmers tag cows and upload their information onto the blockchain, enabling themto record the journey of their produce from pasture to plate. BeefChain enhances trust for both distributors and consumers alike by ensuring that premium prices are charged for premium beef only. This boosts the chances of BeefChain attracting users and building out strong network effects. But this example is niche, as are many of blockchain’s strongest use cases.
By nature, blockchain’s level of transparency is more valuable to some use cases (e.g. social impact projects, risk mitigation and operational efficiency) than others. A fashion online marketplace, for instance, does not get the same value from blockchain as BeefChain where the transactional process takes place from birth to butcher. Generally speaking, therefore, platforms tend to build network effects with a consumer-based audience whereas blockchain businesses must attract governments, NGOs, businesses etc. The blockchain potential, therefore, may be more powerful, but it is a slower burn than its platform equivalents.
Has blockchain taken off?
The lack of popularised blockchain use cases is no coincidence. Whilst early iterations of the platform economy emerged after the creation of the internet, blockchain emerged almost two decades later in 2008. Blockchain businesses, as a result, face two major obstacles: people’s allegiance to centralised platforms and establishing the relevance of using blockchain technology in certain use cases (e.g. a blockchain-based ride-sharing app). Management consultant agency, Boston Consultant Group (BCG) argued, “Just as it took a while for organizations to figure out how to turn the power of the internet into productive avenues for growth, it is taking time for today’s businesses to understand how to marshal blockchain’s capabilities into tangible and sustainable sources of value.”
The volume of different blockchains onto which applications can be built has highly saturated the blockchain market – and of those use cases that are live, fewer have found their product/market fit compared to their platform equivalents. BCG asserted that for a blockchain business to stand out against its centralised rivals, it “should identify ways in which technology and blockchain-specific capabilities could create meaningful value.”
Despite some structural similarities between platforms and blockchain-based businesses, the value of their respective network effects differs. Blockchain offers its ability to create trust and transparency, automate transactions, and validate/document items – but its disruptive potential is most relevant to niche, highly-specified, more utopian use cases. For platform businesses, network effects typically take marketing spend to start and come hand-in-hand with market power, an element that cannot exist in a decentralised framework.
Paybase Head of Partnerships, Nick Fulton asserted, “Blockchain businesses consistently underestimate the power of network effects. The value proposition of most blockchain businesses is not the ground-breaking technology but the network that they have managed to build. Once harnessed correctly, building strong network effects will be the catalyst to a blockchain business’s market disruption.”
Most important to remember is that we’ve not seen the blockchain giants emerge yet – the equivalents of Uber, Amazon, Deliveroo etc. Therefore, whilst platform network effects may appear stronger today, as blockchain technology develops, its network effects could become even more powerful. “Given the enormous value that network effects can create,” BCG asserts, “blockchain use cases that deliver such effects have the potential to be true disruptors.”