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How Important are Bitcoin’s Network Effects?

https://www.aier.org/blog/how-important-are-bitcoin%E2%80%99s-network-effects

In this article by Max Gulker, he explains how network effects play a role in the success and value of Bitcoin. Currently, there are two main forms of cryptocurrency: Bitcoin and Ethereum. Due to network effects, one form may outgrow the other, as one company grows in users, it may become more valuable. Additionally, as more sellers accept Bitcoin or another cryptocurrency, the value will also increase. In most network effect examples, a dominant company or product comes out on top while the others slowly lose market share. Cryptocurrencies are different in the sense that there are no fixed costs associated with starting to use/own them. For example, Facebook is the dominant social media platform but Instagram, Snapchat, and Twitter are still thriving, smaller, more specialized platforms. Gulker predicts that Bitcoin will become the main form of this digital currency, but there is nothing stopping businesses from accepting all forms of cryptocurrency.

In class we learned about network effects and information cascades where people tend to copy the decision of others. This is usually the case with fashion, media, voting, and many other examples. People tend to “follow the crowd” where if there are two similar restaurants – one that’s pretty full and the other that’s empty, it would be rational to go to the restaurant with more people. This is known as herding, where people make decisions sequentially and every person’s decision depends on the previous decisions made. Within these decisions made, there are two categories of effects: informational and direct-benefit. Informational effects involve imitating the decisions of others – i.e going to a popular restaurant. On the other hand, direct-benefit decisions are when the product/service is better with more people – i.e fax machines, or any form of social media.

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