Web3 network effects

Network effects refer to the phenomenon where the value of a product or service increases as more people use it. Network effects will be an important way to retain users in a Web3 network and stop everyone from easily migrating to other competing networks. Network effects are also important due to the role they could play in sustaining a higher rate of demurrage due to the difficulty for other networks to gain enough traction because of the existing network effects that the most adopted network has achieved.

Approaches for creating network effects

Token asset adoption

A large amount of token based assets being created and used on a single network could create a network effect where people continue to use that network due to easy access to assets they want to own and use.

This approach is only somewhat compelling as the technology for interoperability keeps improving and these networks are commonly open and permissionless. It will likely become increasingly easy to migrate an asset from one network to another if there was an incentive to do so.

User adoption

Global adoption of a Web3 network where many people use and rely on that network could create a network effect due to the ease, trust and familiarity of using that network. It could take a large amount of effort to incentivise and convince people to use another network if the existing one fulfils their needs.

This approach is only somewhat compelling as increasingly automated solutions could emerge that take advantage of using the most cost effective networks. Even a small community of people might be able to benefit from another network where the incentives are better aligned for their use cases. New technologies such as AI agents could even handle this adoption of new networks, for example if people wanted to use the cheapest network possible that is still secure an AI agent could handle this request in the background.

User application data

As a Web3 network grows the number of protocols and applications that exist on that network should grow with it. User data that is stored in these protocols and applications could represent another potential network effect as this usage data helps to strengthen the connection between the user and the network.

This approach is not massively compelling as if the protocols and applications are open source and permissionless their data should be self sovereignly owned. This would make it easy enough for people to migrate their existing data to other applications if there was an incentive to do so. People may even use their data across multiple networks at once if they wanted to.

Group application data

Applications that involve groups of people could create a more sticky environment as it often can require a consensus from that group of people to migrate to another network. Each of the users in that group could rely on the data that is being created and managed in the existing application. Example group applications could be collaboration tools or group communication.

This approach is slightly more compelling than single user applications as a group of users often need to act in unison rather than a single user independently making a decision themselves about which network to use. However it still would be unlikely that it will be very difficult to migrate to another network due to the open and permissionless nature of these emerging networks. The exact same application and data could be copied across to another network along with some better aligned incentives.

Commerce adoption

A growing number of businesses that accept a network's own coin or token based assets for buying goods and services could create a network effect of adoption for conducting commerce.

This isn’t very compelling for creating a reliable network effect as businesses could accept the same token but from other networks or they could accept other forms of money entirely along with the ones they already do. They don’t rely on other businesses to also do this for them to take any initiative by themselves. It is however worth noting that businesses would likely be concerned with whether these alternative forms of money are sufficiently reliable and stable. These factors could reduce the speed of adoption until any emerging network has proven itself to be reliable.

Identity credentials adoption

Self sovereign identity solutions could become widely adopted within a Web3 network and the credentials people use in their wallets could help with making the network more sticky.

This isn’t a very compelling approach as self sovereign identity wallets should enable people to move their credentials to other wallets, this is assuming the data is truly self sovereign! This means other networks and wallets should be able to gain adoption fairly easily due to the open and permissionless nature of this emerging identity technology.

Identity connection data

Each identity wallet could have connections with other wallets such as peer reviews, endorsements, friend or professional based connection information or even collaboration history. The data that exists between each identity could create a network effect that makes it difficult to move to other networks.

This is only somewhat compelling as self sovereign identity solutions can work across multiple networks as the standards can be universally adopted and integrated. Identities and credentials can migrate to other networks. Decentralised identifier (DID) implementations are tied to specific blockchains. Some users may decide to replace any existing DID’s they’ve used in a renewed credential, however this still could introduce a level of risk or complexity to handle these migrations. So this factor could add some degree of network effect that could limit the people that are willing to migrate to other networks.

Mediation services adoption

Web3 technology can be used as an effective tool for removing middlemen for many different services. But this doesn’t negate the importance of third party mediators from being involved when something goes wrong. An example could be a marketplace where the buyer puts their money into an escrow contract and the seller receives the funds after some form of proof of delivery. The buyer might want to contest this exchange and say the item was not delivered. This is where a mediation service could be used to try and resolve the problem. Building up a network of mediators could create a certain level of stickiness for using one network over another as it would take time to build up this community of mediators.

This approach is only somewhat compelling as although there is increased value from having a growing amount of mediators on one network it doesn’t prevent mediators from being signed up and available across multiple networks. Protocols that handle this mediation process could also work across multiple networks which would remove most of the friction of being able to use one network over another.

Financial liquidity

A large amount of deposited liquidity being used productively in a network can create a much more sticky financial market due to the efficiencies that a large volume of liquidity can create. Financial liquidity could also be locked up for a period of time to generate higher yields such as in loans or token exchange based protocol incentives. These incentives would only strengthen the network effect as it should reduce the speed in which liquidity can be removed from the network.

Financial liquidity could represent a highly effective network effect as each individual would be contributing a certain amount of liquidity into the network. If only a few people tried moving towards another network they would not easily be able to compete with the most dominant network that already has the largest amount of liquidity. The largest network should have the most efficient markets which makes it more desirable to use the financial services available in this network.

Most promising solutions

Financial liquidity is the most compelling solution for creating network effects for a Web3 network that is competing as a digital asset network. Liquidity provided by a wide range of users can create a more sticky and highly efficient financial market for facilitating financial activity such as token exchanges. Larger financial markets could be difficult to replicate due to the efficiency and scale achieved from a globally adopted network.

The other approaches identified above were not massively compelling on their own. This was mostly due to the open and permissionless nature of Web3 networks that make it easier for people to migrate to other networks. However, a combination of these approaches do still represent a fairly compelling network effect. In combination these approaches could result in a higher overall complexity and cost to migrate to other networks, making it less compelling to switch to another network without a good enough reason to do so. The more these approaches stack up on top of each other the better the incentive has to be for people to migrate to another network.

If these factors are effective in combination it could help with sustaining a higher rate of demurrage that is effective at maintaining a higher velocity of network money circulation. This can be effective for generating income for the ecosystem and that income could make it difficult for other networks to compete with the progress and ongoing development that is achieved by the dominant network. Sustaining a sufficiently high rate of demurrage through a network coin tax could help to reliably improve the network and fund other important public goods.