Most developers and investors claim crypto ventures can’t capture interest because they’re open-source codebase. The thought goes that if you develop open-source code, somebody comes along and copies it, luring away your users and any revenue potential. That doesn’t seem like a good base for a company.
But crypto networks adhere to a sustainable business model, and those who understand the dynamics behind valuable Web 2.0 marketplaces will quickly become familiar with it. Unlike marketplace companies, crypto ventures seek defensibility through network effects that allow fee streams and make users reluctant to turn to a competitive service.
What makes cryptos unique is its potential to expand on that familiar framework. The crypto networks’ principal innovation is their ability to develop network effects by encouraging users to share the value they generate.
Network Results, Exchange Costs, and Defensibility
The misconceptions surrounding cryptography and the capture of information are understandable. Open source code has allowed trillions of dollars to be produced by the tech companies that use it. But the communities that produce the technology usually didn’t have the means to capture any of the value directly.
That’s because there’s a major difference between open source libraries that can easily be replicated and networks that develop around running open-source code as a service. An open-source library is a blueprint for empty use. It is dead code until it runs as an instance and is filled with data forming a network or service, users, or both.
Many internet systems are constructed using open source libraries and are run as an instance or utility by businesses. The service is more valuable to every individual user with each new database entry or user and creates a network impact. That creates an implicit expense for consumers to migrate to a competitive new service. These costs of switching make it more difficult for the competitors to break through, creating defensibility. Imagine a Facebook clone with no friends or an Uber clone that has no drivers. It is why big platforms are getting bigger while the competitors are getting stuck.
If we create defensibility through network effects, switching costs become the basis for fees that businesses will start charging consumers, advertisers, or both. This model is feasible as long as the price for shifting to an alternative is below the switching rate.
Why Forking Does Not Eliminate Transfer Costs
Like Web 2.0 platforms, a well-designed crypto network is a live, running service, and it too can be the basis for strong network effects that create switching costs. Since crypto-networks rely on open source code, they can be copied more easily (or forked). But while code replication may be free, the social cost of coordinating all participants in the network to move to an empty room is not nil. Add to that the confidence and familiarity that comes with brand, lindy effect, and smart contract integration, and you have a recipe to consolidate an existing service, build its network effects, and generate switching costs.
The network impact of Bitcoin comes from more people finding it a value store, which incentivizes miners to protect the network. The network impact of Ethereum comes from developers distributing apps — each becomes a building block that can be assembled into higher-order services by other devs, driving increased use and demand for ETHs.
Uniswap, an automated token exchange, becomes more useful at the application layer with each new user because additional marketplace liquidity leads to better trade prices. Compound, a system for lending and investing in the money market, provides more favorable interest rates on loans as the liquidity lending rises.
In each case, initially, a fork from the original network will be technically equivalent but functionally inferior to the canonical instance. Because of lower liquidity, a Compound fork will give worse interest rates. For the same cause, a Uniswap fork will have inferior pricing. A Bitcoin fork is less likely to be used as a store of value or trading medium, and hence less likely to gain interest.
In traditional Web 2.0 platforms, this is the same basic defense principle: attract users, build network effects, and increase defensibility by switching costs. That cost of switching is the basis for extracting margins, usually in the form of a fee:
|Bitcoin||Fee per transfer||PayPal||Fee per transfer|
|Ethereum||Fee per function call||Twilio||Fee per API call|
|Compound||Fee per borrow||LendingClub||Fee per borrow|
|Uniswap||Fee per exchange||Coinbase||Fee per exchange|
As long as a company remains minimally extractive—charging a fee lower than the switching costs—its model is viable.
So, the business model is not what’s new in crypto. It is the one who profits from that.
The Differentiator: Cryptos Potential for Value Distribution
Crypto tokens are an invention close to that of packets of data. We can now transfer bits of value in the way we transfer bits of information: using an open standard, in very granular communications, instantly, to everyone, anywhere in the world! This means that valuable crypto services now have the unique opportunity to directly redistribute the value to the users who produce it.
Correctly built, efficient delivery of a fee stream will further entrench network effects by providing users with a direct economic incentive to participate, creating further defensibility, strengthening the fee stream’s viability. This is a virtuous loop that can create sustainable, user-owned networks due to their cooperative economic model that expands in size and defensibility.
Crypto networks, including Bitcoin and Ethereum, are the first on-scale services owned and run by the Group. But provided the right tools, many more entrepreneurs will use this new platform as a mechanism for spreading economic capital, creating network effects, and generating value for themselves, investors, and their user communities.
By making economic cooperation with consumers a primary feature of the product experience, entrepreneurs will be able to unlock broader, more efficient, and more defensible networks while at the same time allowing for more creativity — all thanks to the open-source framework of cryptos.
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