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What is Network Effect?

What is Network Effect? How to use Network Effect to invest in Crypto?

What is Network Effect? What types of network effects are there? How to use Network Effect to find investment opportunities in Crypto?

Some of the top Crypto projects have grown very fast and strong based on positive network effects. In this article we will learn all about Network Effects:

  • What is Network Effect? What types of network effects are there?
  • Why network effects can create huge value projects in the Crypto market?
  • How to apply Network Effect to find investment opportunities in Crypto

What is Network Effect?

Network effect is an economic effect, describing the phenomenon that an increase in the level of use of a product or service will increase the value of the product to other users. So:

  • A positive network effect will help a Crypto project do little work.
  • A negative network effect will make it very difficult for projects to create attractiveness for their products.

Network Effect Simulation

For example, Ethereum has created a strong network effect, specifically:

During the 2017 Bullrun, a lot of Smart Contract platforms came out with the promise of better technology than Ethereum, but most of those projects didn’t work when the market entered a real downtrend.

In contrast, the Ethereum community and developers are still there and building. They analyze the problem Ethereum is facing, then come up with a solution to fix it and plan to do it.

In addition, in the builder, toolkits that support Protocol & dApp building are developed more and more, making Ethereum gradually become the standard for the development of Protocols & dApps, in the context of other smart contracts. not ready.

Thus, we can see the Network Effect of Ethereum:

As more and more developers use Ethereum to develop applications.

Later developers can take advantage of the predecessor’s work, building other useful applications.

⇒ Stimulate more developers to build on Ethereum.

Classification of Network Effects

Network effects can be divided into three main categories, and their dynamics vary depending on the application. A product or service can have many different types of network effects:

Direct Network Effects

The direct network effect describes an increase in consumption that leads to a direct increase in value.

For example, Uniswap v2 standard AMM is a great initiative to liquidate any ERC20 on Ethereum without a Market Maker. In this model there are two important components:

  • The LP (Liquidity Provider) provides liquidity, in return the LP receives a portion of the transaction fees.
  • Swappers are traders on AMM, in return they will have to pay a fee of 0.3%.

Here, it can be seen that, if a user participates in an LP position, they will directly create more liquidity for the trading pair, and help the swapper to trade at a lower price. This is a live network effect.

Indirect Network Effects

Indirect network effects describe how increased use of a product increases the production of increasingly valuable complementary goods, leading to an increase in the value of the original product.

Example: After Uniswap V2 has been operating for a while, the team released Uniswap V3 which is an upgrade of V2, it has all the advantages of V2 and adds many other features to improve the capital efficiency of LP. , including the following key features:

  • Centralized liquidity gives LPs granular control over the price range to which their capital is allocated.
  • Flexible fees allow LPs to be appropriately compensated for taking on different levels of risk.
  • V3 Oracles is capable of providing time-average pricing (TWAP) on-demand for any time period within the last ~9 days.

Uniswap V3 features are utilized by several projects to build other DeFi products.

Nếu chỉ xét riêng V3 thì hiện tại đã có hơn 43 dự án hoạt động trong nhiều lĩnh vực khác nhau như LPs Position Management, Trading Tools, Liquidity Mining, Capital Efficiency,…

In addition, there are also indirect network effects arising from the Build on top Uniswap V3 projects that increase the applicability and availability of V3.

Two-sided Network Effects

A two-way network effect describes an increase in usage by one user group that increases the value of a complementary product for another distinct set of users, and vice versa.

For example, in DeFi we can find the double sided network effect from the Dex Aggregator.

When many users use Dex Aggregator such as Coin98 Exchange, 1Inch, Paraswap,… the following stories will be created:

  • Generate more transaction fees for DEXs.
  • Increases income for Liquidity Providers and Market Makers.

Indirectly encourage new accounts.

These in and of themselves help improve the user experience by creating a richer source of liquidity.

The Power of Network Effect in Crypto

An intuitive way to understand why network effects are so powerful is that we can look at their effects in terms of the relationship between value and cost.

This picture shows us that the power of the network effect lies in the fact that the cost of maintaining the network does not increase as rapidly as the value of the network.

Value increases as the size of the network increases ⇒ Exponential Value – Cost increases Linearly.

In crypto, we have seen strong influence of Network Effect such as:

  • Bitcoin’s Network Effect stems from many people seeing it as a store of value, thus encouraging miners to secure the network despite Bitcoin’s technological shortcomings compared to other alternatives.
  • Ethereum’s Network Effect originates from developers implementing applications, each developer becomes a lego block that other developers can leverage their work to create other useful applications, through over time it makes Ethereum gradually become the standard for the development of Protocols & dApps.

The robustness of the network effect can be seen more clearly at application levels, in particular the development of AMM.

Most current DeFi users will mostly know Uniswap V2 and V3, but what about Uniswap V1?

In essence, Uniswap is a protocol to trade tokens in a decentralized and permissionless manner on Ethereum. The first version of Uniswap was launched in November 2018 and did not attract many users.

In May 2020, Uniswap launched the second version of the protocol called Uniswap V2 enabling ERC20 – ERC20 liquidity.

And Uniswap V2 entered a period of parabolic development and quickly became the most popular application on Ethereum. It has also become a standard for AMMs and many protocols are built on top of Uniswap v2.

In general, Uniswap V1 takes about 1 to 2 months to reach $100M total trading volume, but V2 only needs about 1 month to reach $1B Total trading volume.

How to apply Network Effect in Crypto analysis & investment

Crypto is a very fast changing market, a bull run can end in a few months, trends can start and end in 1 to a few weeks, but mixed in there can be long term trends that last. up to five units, such as smart contract platform project groups, DeFi,….

So how to detect the Super Trend in the multitude of Trends appearing on the market?

Now we can apply our knowledge of Network Effect to analyze and consider, whether that sector can create a positive network effect?

Ask the question: Does the increase in user usage of the protocols in that sector increase the benefits for other users?

If the answer is yes, there is a high chance that you have found Trends with long-term potential for development in the future.

Once you have an overall understanding, you can start looking in more detail, digging deeper to consider the sub-category in a large category, for example in DeFi there are many sub-category such as:

  • DEX ⇒ AMM, Orderbook, Hybrid Model,…
  • Lending ⇒ Money Market, Yield Optimizer,…
  • Derivative ⇒ Perp, Option, Synthetic,…

Once you’ve identified the sub-category you want to explore, you can dig deeper and dig into the details of the projects within it to find high ROI investment opportunities.

Learn more about each sub-category in DeFi at: What is DeFi? Overview of investment potential & opportunities in DeFi


Above is the basic information about Network Effect, as well as how to apply Network Effect to Crypto analysis and investment.

If you have other questions related to the above topic, please comment below so that idolmeta.net can help you right away!



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