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Cryptocurrency and Network Effects

https://nakamotoinstitute.org/mempool/appcoins-are-snake-oil/

 

The cryptocurrency market has been notoriously volatile, with currency values skyrocketing and plummeting drastically. The most notable frontrunner of cryptocurrency is BitCoin, and its explosive success has attracted others to join the game with their own digital currencies such as LiteCoin and even Dogecoin. The latter example here is a humorous way to call attention to crypto’s way of becoming so suddenly popular that it is essentially a pop-culture fad. However, the battle of the currencies and the extreme rises and falls also exemplifies how network effects can have large-scale consequences  for society and their wallets.

If we were to model the adoption of cryptocurrency in terms of network effects, all the participants in the global economy would be nodes, and we can call cryptocurrency the new technology that is introduced into the system. Currently nodes use some form of currency other than crypto (e.g. the American dollar, yen, krona, etc.), which is largely determined by the nationality of the nodes to which each node is connected; if most of the people and businesses you would interact with and exchange currency with are using one type of currency, you would also use it for convenience in purchasing or selling goods and services. The adoption of cryptocurrency is atypical of the usual technology adoption we have been discussing in class since participants do not have to entirely choose between one currency or another, but rather can have their total amount of investment in multiple currencies. This can lower the the threshold for entry into adoption of the currency for individuals, since the potential risk is low if you do not invest much, even if the threshold for full adoption remains quite high. However, the monetary value of a cryptocurrency is also determined by how many users it has, with more users making it more valuable. As a result, this could decrease people’s thresholds for initial and full adoption of the currency as it gains more initial adoption, since there is an added value to switching of potentially increasing the value of your assets over time, and we may see more switches.

The crypto introduction is slightly more complicated than this since much of its popularity and purchases are motivated by investors attempting to make a profit. The main strategy for investments is to buy low and sell high, so how would that effect the budding crypto market? People may adopt the currency just to sell it at a higher price for their desired currency. These participants are not exactly true adopters of the currency, however, give the appearance that they are, and thus increase the perceived value of the currency, and get others invested by pushing them above their thresholds. However, once these investors sell, this creates a cascade of selling as potential adopters and investors alike dip below their thresholds and opt for more useful currencies or cut their losses. These potentials for large gains which lower adoption thresholds and the fear of loss of value and convenience which again raises them leads to these volatile spikes and dips in usage of cryptocurrency. As a result, I anticipate that there will not be a cryptocurrency revolution as some have speculated, since the connections people have of users of domestic currencies in their social networks will likely remain dominant.

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