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Cardano's success depends on the network effect

Published 10.1.2023

Fiat currencies have the largest network effect in the world. In most countries, usage reaches 100%. Users generate a huge number of transactions, which reinforces the network effect of banks and money-transmitting services. Services with a strong network effect are very difficult to compete with, as users like to stay with a service that is reliable and to which they are accustomed. The social networks with the largest number of users are the most attractive to other new users. It is almost impossible for newcomers in this area to get a foothold. If they are to succeed, they need to come up with something fundamentally new. Cardano, and by extension all blockchain networks, face a daunting task. How to get a strong network effect in a world where the cards are dealt?

TLDR

  • The network effect can be considered as the intrinsic value of blockchain networks.
  • Cryptocurrency holders who continue to use fiat currencies essentially maintain their 100% network effect.
  • Storing value is not the primary purpose of blockchain networks and without the growth of a direct network effect, they may disappear.
  • Internet users must take back power and control over the networks they use.
  • The network effect can grow due to the greater versatility of the Cardano platform.

Why isn't the network effect of blockchain networks growing?

Cryptocurrencies are sometimes said to have no intrinsic value. What is the intrinsic value of Microsoft or Facebook, for example? Aren't they just IT companies with a large group of programmers? The social significance, which is reflected in the high market capitalization, is based on the network effect. A large number of users is the basis for the success of the technology giants. Fiat money is even better, as governments essentially require citizens to use it. Before the advent of blockchain networks, fiat money had no competition. Few things in the world can boast a 100% network effect. Blockchain networks will only succeed if their network effect, the number of users, grows. This can be considered their intrinsic value. Digital assets and transmission networks will only have the value that reflects the network effect.

The network effect cannot be copied. It is possible to copy the idea and create something similar, but the tricky part is convincing people to change their habits and learn to use the new technology. For that to happen, the new thing has to be many times better than what people are used to using.

Blockchain networks have succeeded in creating the perfect monetary policy. There will only be 45,000,000,000 ADA coins in circulation on the Cardano network and no central authority can change that. However, the high volatility will not allow people to use ADA instead of fiat currencies for current payments. People do not perceive ADA as better money as it does not perform the function of a medium of exchange. This is a problem since the direct network effect has no chance to grow. There is no reason for merchants to accept ADA as people will not use volatile coins for payments.

The direct and indirect network effect

The network effect can be divided into direct and indirect.

The direct network effect is associated with the interaction between users. Paying for goods, receiving a paycheck from an employer, borrowing from a bank, insurance or saving are all acts that require direct network interaction between users. In other words, it was necessary to use the network to transfer value. Obviously, for interaction to occur, both participants must use the same network and the same money.

ADA coin holders form a group that reinforces the indirect network effect. This group uses the Cardano network to buy and sell ADA, but for nothing else. Staking is about the interaction between the network and users, so it does not reinforce the direct network effect. This group of people may like Cardano's monetary policy and believe in the success of the project. They expect the number of new stakers to grow. Unfortunately, the indirect network effect is not as important to Cardano's success as the direct one.

Only direct use of networks can have a positive effect on further adoption. People around you will not use Cardano unless they see that it performs a useful function for you. Businesses will not start using Cardano unless they see that it has a significant number of Cardano wallet users. Merchants won't accept ADA unless people make it clear that they want to pay with it.

The number of coin holders may reflect a certain potential. If there are 100M stakers, some larger merchants may start to accept ADA. But if ADA users won't spend, others won't join knowing that people may continue to spend fiat currency.

Cryptocurrency holders who continue to use fiat currencies essentially maintain a 100% network effect of fiat. It's a bit of an ambivalent behavior, as on the one hand, they express a desire for change, but on the other hand, they are still existentially dependent on fiat currencies.

Unless the direct network effect of the Cardano network grows, the chances of success will be low. There is some possibility that people will start to see cryptocurrencies as stores of value and continue to use fiat currencies. In that case, bitcoin will mainly succeed if it proves to be economically sustainable in the long term. PoS blockchains like Cardano are 99% more energy efficient than Bitcoin, so they can easily exist for several decades. However, we don't think cryptocurrency adoption can continue to rise without growth in direct network effect. The indirect network effect works much like a belief. People are united by the same ideas and beliefs. Adoption based on the indirect network effect may reach a few tens of percent, but probably not more.

Blockchain networks are designed to transfer value. They don't just exist to store value. We have gold for that and we don't need a digital analogy for that. Only a direct network effect on the order of tens of percent can cause a revolution in the financial world.

Weak points of the Internet

On the Internet, everything important happens through centralized entities. All major social networks have a CEO. All commercial banks have CEOs. Fiat currencies are controlled by central banks. The transfer of fiat currencies is handled by companies that have CEOs.

What is most interesting about cryptocurrencies is that it is possible to create functionality over which their creators will not have permanent control. Creating a service that no longer requires any control is impossible. However, it is possible to create a service over which users will have control. The blockchain network has no CEO. In the Cardano network, pool operators and all delegators are important. By decentralizing the network consensus, the team loses control of the network.

The team has no influence over Cardano's monetary policy, censorship of transactions, or control over who will use the network and what applications will be created on it. It is even possible for the team to hand over control of project management to the ADA holders.

No centralized entity can create value without retaining control. Blockchain makes this possible and that is its greatest strength if people understand the meaning of decentralization and want to use services that don't have a CEO. If you have ADA coins in a Cardano wallet, you have full control over them. You also have the confidence that you can send the coins to anyone at any time and no one can stop you from doing that because the network consensus is in the hands of thousands of pool operators and over a million stakers. You can even be one of the stakers yourself and directly influence the production of blocks.

The financial world, and with it other IT giants, will change fundamentally only if the balance of power on the Internet changes. Internet users must take back power and control over the networks they use. But first of all, they must start using them so that the network effect can grow at the expense of the current networks.

The Cardano network effect is not only ADA dependent

Cardano is a smart contract platform, so the network effect is not just based on the transfer of ADA coins. Greater versatility is important because with greater utility there is a greater chance that the direct network effect will grow.

Cardano's direct network effect grows with every token, NFT, and stablecoin sent. Every direct interaction between users is important regardless of what specifically is being sent. The use of apps also increases the network effect since it is a direct interaction. The success of a decentralized exchange increases the overall direct network effect of the Cardano network.

Stablecoins are very underrated in terms of direct network effect growth. While the future of payments with volatile assets is uncertain in the next 10 years and no major changes can be expected, there is no major barrier to the use of stablecoins. Merchants can hold stablecoins for longer periods of time without the risk of a sudden change in the exchange rate.

Smart contracts make it possible to create a stablecoin such as Djed. Through greater versatility of platforms, it is possible to solve problems and allow people to use digital tokens more widely.

Decentralized Digital Identity (DID) is another capability that will allow people to use Cardano without having to deal with volatility. In order to use DID, users must learn how to use the Cardano wallet. Once DID is used by the order of hundreds of millions of people, it will become interesting for companies to tap into this potential. Firms may even be interested in starting to use DID and thus take an active role in the adoption of the technology. For example, Fortune 250 company Dish has moved in this direction.

Many people believe that cryptocurrencies are competing with each other for what will be used for paying first. The reality is that cryptocurrencies have so far failed to fundamentally undermine the importance of fiat currencies. It is possible that blockchain networks will compete with each other on the level of the number of wallets. The wallet is the gateway to the world of cryptocurrencies, and versatility may be the feature that influences success.

It is realistic to imagine that people will continue to hold ADA coins, but at the same time send stablecoins to each other and use DeFi and DID. A stable direct network effect may stabilize the value of ADA and this may lead people to start paying with ADA. However, this is a wild idea and we will have to wait a long time before it is confirmed. Utility isolated from volatility may be the key to higher Cardano adoption.

Conclusion

For fundamental changes to take place in our society, business models and people's behavior must change. Blockchain is the technology that will make this possible. However, the existence of the technology itself is no guarantee that change will happen. People need to start using Cardano in order to grow the direct network effect.

Feel free to send some HOSKY tokens to your friends. People need to learn how to use Cardano wallets. It can be a challenge for a significant portion of the population to learn the basic rules associated with self-custody. Having a few HOSKY in your wallet carries minimal risk. Once people become more confident in using it, they can use the Cardano wallet for stablecoins and ADA.

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