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Bitcoin, Bitcoin Cash, and Understanding the Mania of Network Effects

Through my work with Cornell Blockchain, every week there are three things I look out for.

First: The news of the week – a combination of political, technological, and innovation that the blockchain space has undergone. Examples include China’s ban on ICOs, Ethereum’s Devcon 3 releases of Casper protocol upgrade, and companies like IBM, Mastercard, Square, or more announcing different projects.

Second: The market prices and major movements. This is pretty straightforward, usually a 1-week look at the top 5 or 6 by market cap coins, and also checking to see any major ICOs that have raised capital.

Third: Understanding how these two go together.

That last part is something I usually never even get to touch. Because it’s so hard. Through the couple of years I’ve been following the space, there have been moments from the news that I have believed MUST affect the price, but they don’t. And also, the opposite. These little things absolutely devastating prices.

I think it’s interesting because the fundamental problem is a disconnect between information. There is so much going on, but the vast, vast majority of people who hold cryptocurrency do not understand at all what they are doing, and are not on top of the news. Therefore, markets are slow to react, and only huge headlines – even if they don’t mean anything, do a lot. For example, when Jamie Dimon called bitcoin a fraud, markets plummeted for a couple weeks. Absolutely crazy! The technology (blockchain) was undergoing incredible upgrades, governments around the world were adopting blockchain and bitcoin solutions, but still the price was dropping. Why? Network effects and the lack of information.

The truth is, Jamie Dimon is an incredibly influential figure. When he speaks, people listen. There’s this interesting thing in networks about how people trust others, and this just causes a huge chain reaction. Jamie Dimon calls bitcoin a fraud. Major newspapers, most who don’t understand how the technology or the space¬†jump on that, people read these newspapers and thus the market plummets, leading others to sell.

Bitcoin cash, a hard forked version of Bitcoin Blockchain was created in August as an alternative to bitcoin. After settling around the low 300s for months, it recently skyrocketed to almost 2000 with the cancellation of segwit¬†2x and the incompetency of the Bitcoin Gold Fork. Bitcoin, on the other hand, fueled by confidence and the upcoming release of CME futures is absolutely riding the bull market. I’m really quite lost on how the value and where it came from – and then I stumbled upon the influence of power laws and network effects as an explanation.

MetCalfe’s Law, therorizes that the value of a network is proportional to the square of the number of nodes on the network. expressed as V = C * N^2, where V is value, C is a constant, and N is the number of users or nodes. This model is seen to hold for Facebook and Tencent.

So, looking at these bitcoin forks, what will the value be?

Well, according to Metcalfe’s Law, is a network loses 20% of users, the original network’s value is reduced to 64% of the original, and the new network is only worth 4% – combining for 68%. Interesting enough, this is because conneected networks with extensive adoption have an incredible synergistic effect. The Sum of the part is worth less than the whole.

Looking forward – I still wonder if that rule holds at all for something so volatile, so speculative as the cryptocurrency markets. The rule really has not held so far, with the incredible rise of crypocurrencies as a whole at an incredible rate for the past few months. Will a crash come? How far will things go? Only time will tell and, if according to many, Bitcoin is the most bubble of all bubbles – good luck when it pops.



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November 2017