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On Metcalfe’s Law and Crypto Market Structures

A question that often gets asked, especially by folks that are just beginning to learn the ropes of the blockchain business, is around which coin will eventually survive. Will Bitcoin be the eventual winner, or will it be Ethereum, or might it be something completely different? Will it be a winner-take-all, or will the steady-state market structure be broadly an oligopoly?

The usual response from many of us grizzled, battle-weary, blockchain-debate circuit veterans is of course to commence the discussion somewhere around that old chestnut about the value of the network and moats, use cases, store-of-value/medium-of-exchange/unit of account paradigms, throw in some Austrian economics for good measure, talk about supply curves and monetary policies, talk about teams, mention Chris Burniske’s latest thoughts on this subject for good measure, and generally leaving the person that asked the question (and sometimes ourselves as well) far more confused at the end of the whole exercise, even if we wouldn’t call it completely pointless.

Given that a fair number of us, including yours truly, started their careers at the end of the last great tech bubble, it might be instructive to zoom out and take a more fundamental approach, one that is not necessarily rooted solely in crypto economics.

Long long ago, around 20 years ago to be precise, before Google, before Yahoo (but after Lynx and Gopher!) there was a battle royale among search engines. There were several contenders to the throne, including once-familiar names such as Lycos, Altavista, Infoseek, Inktomi and countless others. But once Google created a superior product, most folks just stopped using anything other than Google, and the rest is history. In the absence of any switching costs, a superior product rapidly ended the search engine wars, leading to the current virtual Google monopoly, although Lycos apparently came very close to winning that war.

Now let us consider the social network wars; An opportune time since it looks like in many respects we might be past peak Facebook, at least in its current avatar. There was Google’s own Orkut (which for some reason was extremely popular in Brazil and India), there was Friendster, and there was Myspace. But once Facebook built a superior product that appealed to users, that war was over too. Unlike in the search engine wars, the incumbents had positive network externalities going for them, which of course rapidly became negative network externalities as users started flocking en masse to facebook. There were switching costs as well, such as photos and messages digitally stored in these networks but even that could not stop the inexorable rise of Facebook. A superior product won in spite of switching costs and against incumbents. These incumbents benefited from Metcalfe’s law, but only as long as they did not have to contend with a superior product, at which point Metcalfe’s law worked against them.

Which then brings us to the situation with cryptocurrencies today. Clearly, these are early days, so product market fit is arguably still a work-in-progress for even something as foundational to crypto such as a Bitcoin or an Ethereum, and definitely so for pretty much every other cryptocurrency project. In the absence of a clearly superior product, Metcalfe’s law effects (for real user adoption) are yet to kick in on any large scale for most themes in blockchain (except arguably with bitcoin as a store-of-value) whether it be programmable computing or secrecy coins or prediction markets or indeed anything else (0x and the decentralized exchange market could arguably be an outlier contradicting this argument but it is still very early days!).

However, here is the rub. Let us use Ethereum as an example to flesh out the argument; Assume for a moment that, say Dfinity, or Cosmos, or Cardano, or any one of the numerous Ethereum challengers for the ‘programmable supercomputer’ throne manage to actually launch on the mainnet a product that is faster, cheaper and better than Ethereum. Drawing parallels from the earlier scenarios, one would expect Ethereum to fade away. However, the situation is not that straight-forward this time around. There is a third aspect at play here, which is the ‘balance sheet’ that the value of the tokens provide to the key stakeholders that have a vested interest in Ethereum. In addition to potentially acting as a floor in currency wars, this also enables these stakeholders to fund super sharp development teams around the world, engage with corporations to evangelize their project and generally give themselves a fighting chance to survive an all-out assault by the challengers.

As some wise man said, money does not solve all problems, but it solves 99% of all problems; In this case money buys the incumbent (typically the beneficiary of an early, successful ICO) network externalities, developers working to improve the protocol, corporations willing to experiment with the protocol and eventually, as a result, wider user-adoption for the protocol and in-built switching costs. This still might not amount to much if the challenger has a product that is radically superior, but in this day and age of GitHub and open collaboration, eventual success almost always boils down to agility in implementation, both from a technology and a marketing perspective. An incumbent is therefore on high ground, well-positioned to absorb any blows from a challenger, assimilate their best ideas and go back to the market with an improved offering. It might not be long before we start seeing ‘protocol M&As’, especially involving well-funded projects funded by leading VCs (now that the ICO train has left the station, at least till the newer, more-improved version, possibly wearing a fresh coat of paint that says ‘STOs’ roll in). M&A exits are part and parcel of the VC playbook, and could end up becoming a win-win for all parties involved in crypto projects as well. The incumbent large project has one less competitor, possibly better tech; The VCs have a quick exit (although the actual returns could vary depending on the nature of the transaction) and the team that gets acquired will also have an exit under their belt and in some cases, if they are lucky, they also get some additional cash or crypto, which will tide them over whilst they cool their heels and figure out the next thing to do while making a fist of it with trying to work for the acquirer.

Therefore, there is no easy answer to who will win the crypto-wars. Bitcoin, Ethereum and most of the early thematic pioneers (such as Zcash, Monero etc with secrecy coins) will probably be around for some time. Tokenization ( and the biggest utility here is indisputably financial) has added an additional layer of complexity this time around that was absent in the earlier iterations of the big technology wars that have defined the internet era.

Meanwhile in Crypto Wonderland….

“Lawmaker Introduces Bill to Promote Crypto” A South Korean lawmaker has reportedly introduced a bill to promote cryptocurrency trading and the development of crypto exchanges. The ‘Digital Asset Trading Promotion Act’ includes a comprehensive plan for establishing a guideline for promoting the development of virtual currency exchanges and blockchain technology, tax reduction and exemption, measures against hacking damage, and prevention of market disturbances.

“Coinbase OTC Platform” Major U.S. crypto exchange and wallet provider Coinbase has launched over-the-counter (OTC) trading for institutional customers. OTC crypto trading will allow institutional investors to conduct direct trades between each other. Christine Sandler, head of sales at Coinbase, commented that the move is taking place in conjunction with an increased demand for OTC crypto trading from institutional players, considering leveraging both exchange and OTC business as a “huge benefit” to their customers.

“Steemit Lays Off 70% Staff” Blockchain startup Steemit has laid off close to 70 percent of its staff, citing the prolonged bear market for cryptocurrency. In a video address posted to YouTube Thursday, Steemit CEO and founder Ned Scott said, “while we were building out our team over the last many months we have been relying on projections of basically a higher bottom for the market and since that’s no longer there, we’ve been forced to lay off more than 70 percent of our organization and begin a restructuring”.

“Foreign Investor Backs Out of Norway Investment” NTC Services AS, a Norway power consulting firm, revealed that a foreign investor had stopped a $116 million investment into a crypto mining facility which was going to be built in Norway’s Tydal municipality. The investor made the decision after hearing about the Norwegian government’s decision to exempt crypto mining centers from electricity tax subsidies. He decided to cancel the arrangement that took several staff-years to reach a balanced conclusion.

“Putin says U.S. actions driving the world away from the dollar” Smarting from sanctions and increased isolation following Russia’s latest flare-up with Ukraine, Vladimir Putin again took aim at the U.S. dollar’s global dominance. Putin on Thursday said that the U.S. and other countries imposing sanctions on Moscow were shooting themselves in the foot, or worse, and that it was evident that the world continues to chafe against the dominance of the greenback, which serves as the world’s reserve currency, fueling the hunt for alternatives.

Earlier, we opined about the possible tectonic shift away from the US dollar standardization.

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Ramani Ramachandran

Ramani Ramachandran (Ram) has close to two decades of experience across consulting, IT, product management, corporate development and investment banking across the US, Europe and Asia. Ram has a B.Tech from the National Institute of Technology, Calicut, a PGDM from the IIM Lucknow and an MBA from MIT Sloan.

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