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Author: Admin | 2025-04-28
Originally published: March 2021One of the most powerful things to look for in an investment is a network effect.A network effect is an attribute of a company or other system such that as more people use the network, the network becomes exponentially more valuable for each user. It’s one of the strongest economic moats that a system can have against competitors.This article takes a look at how bitcoin derives its value from its network effect, why that network effect is difficult for a competitor to displace, and what some of the risks are to be aware of so that investors can continue to assess the health of the network.Rather than being about the short-term, this is about longer-term fundamental analysis on the protocol. In the short-term, bitcoin can move up or down significantly based on sentiment and broad macro factors.Network Effect ExamplesBefore I dive into details on bitcoin, we can isolate a few examples of different networks.Telephone: One-Sided NetworkOne of the early examples of a network effect was the telephone. A single telephone is useless, but as more and more telephones began to exist, the telephone became one of the most important inventions of its era.And we can mathematically derive why the telephone network gets quadratically more valuable as more people use it, rather than just linearly more valuable.If there are two telephones or “nodes” on the network, there is only one possible connection between them. If there are three telephones (A and B and C), there are three possible connections (A to B, A to C, and B to C). If there are four telephones, there are six possible connections. If we jump to ten telephones, there are 45 possible connections. With 100 telephones, there are 4,950 possible connections.Where “c” represents the number of connections, and “n” represents the
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