Network effects in Blockchain ecosystems

Hayk Hakobyan
February 26, 2020

In a bid to link the fields of economics and finance to research and academia and particularly leverage on the power of digital technology, Massachusetts Institute of Technology (MIT) have recently established a Crypto-Economics Lab. In this regard, MIT Sloan's Christian Catalini collaborated with expert economist Joshua Gans of the University of Toronto's Rotman School of Management to co-publish a journal paper dubbed Some Simple Economics of the Blockchain. This is reportedly one of the very first academic papers to comprehensively describe and try to understand blockchain technology in economists' own jargon and point of view.  

To economists, the adoption of new technology is critical if it can help minimize or get rid of inefficiencies altogether, i.e. it must be able to guarantee better outcomes at both the macro and micro levels. If blockchain can help reduce the inefficiencies arising from the cost of networking, then it's very welcome. Such inadequacies are brought about by the market power of near-monopolistic internet behemoths like Facebook, Google, and Amazon. The phenomenon of market power for the big market players is caused by consumers not being able to find many comparable options for a product or service. Such a scenario gives more power to the big players to manipulate the market to their advantage by, for instance, raising prices at will. In the case of online commerce giants like Amazon or Google, they may choose to leverage on their market power by levying transaction charges, compelling their users to authorize the sale of their data to third parties in order to gain access to their services, etc. Minimizing the cost of networking and its associated inefficiencies is a great boon to the economy since it separates the benefits of what is known as network effects from the often disadvantageous effects of big-player market power to small and medium-size marketplayers.  

Network effects refer to a situation where the value of a good/service to the user goes up as the consumer base grows. For instance, Facebook is today much more attractive as a product than it was when Mark Zuckerberg and his co-founder colleagues launched it at Harvard in 2004. Being a social service, there are more users to connect totoday, thus making it much more useful to consumers. Network effects are useful if consumers can interact and connect on the same or interlinked network. That means segmented markets will be less attractive in this regard. But if consumers flock to the same service provider and leave all others out, the gained market power by that particular company can be abused.

Detaching market power from digital networks, therefore, enhances their efficacy to the economy. Apart from a reduction of networking costs, builders and users of alternative solutions will also not be elbowed out of the market by the big players. This ultimately raises the level of participation,translating to bigger network gains.  Blockchain technology is even better at solving this bottleneck because it enables its users to create highly-valuable assets that can take advantage of the power of network effects yet without being owned.  

A permissionless system like Bitcoin ensures that no single individual or entity can exert undesired control on the network.This tremendously reduces the abuse of market power.

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