Blockchain startups adopt free pricing to drive up valuation
As blockchain technology disrupts a variety of industries from finance to supply chains, the valuation of the technology and subsequently the prices charged for their use have become a topical issue. A blockchain is a public distributed ledger, that is immutable and highly secure through the use of cryptographic encryption. In short, a blockchain is a large network of stored information that is immutable and verifiable by the stakeholders in the network. A blockchain uses a mechanism of consensus in order to verify the validity of transactions and claims on the blockchain. The two most common consensus mechanisms are proof of work (PoW) and proof of stake (PoS.) Irrespective of the consensus mechanism used, a blockchain is as secure, and consequently valuable, as its size. Therefore, the higher the number of users and blockchain transaction volume, the more the valuation of the blockchain.
An example of this is the Byzantine Fault Tolerance consensus. A challenge in a blockchain is that because of its distributed, multi-user design, there is the possibility of faulty nodes. However, a blockchain could not work if the entire network was compromised if even one node was faulty. In a consensus mechanism, like those discussed above, all the nodes vote on each block to determine the validity of the block and therefore admit it (or not) onto the blockchain. The Byzantine Fault Tolerance Theorem states that the network can only be compromised by 1/3 of nodes being faulty or malicious in both PoW and PoS. The larger the number of nodes there are, the harder it is to compromise the network, as one would need to compromise a very large number of nodes in order to get to the 1/3 percentage. FYI, the Byzantine Fault Tolerance Theorem arose from the Byzantine general’s problem which we have discussed in class in relation to mixed Nash Equilibria.
With the growth of blockchain technology, many new startups and companies are beginning to offer blockchain-as-service. So in order to ensure that the blockchain is secure enough, new blockchains and blockchain startups need to get a large number of users on their blockchain. How do they then reach this critical point? Similar to the network effects of a social network, a blockchain is also dependent on people’s expectations of the users of the blockchain. It is a positive feedback loop, the more users are expected, the more users enter the blockchain and vice versa. However, to get the fraction of the population needed to make the blockchain a success, network expectations matter, and there is an incentive for blockchain startups entering the market to manipulate their price to lower the lower threshold beyond which the company will be successful. This is why startups that offer blockchain-as-a-service, such as Topl, charge initial users next to nothing to use and transact on their blockchains. The result? The typing point of users beyond which the blockchain is successful is much lower and the blockchain gains a higher valuation when they go public.
However, the valuation of blockchain is a complex topic and involves a variety of factors beyond blockchain volume. However, given that volume is one of the key requirements in the valuation of a blockchain, there is an incentive for startups to offer the service at negligible prices, and then increase the price in the future and begin making revenue once the blockchain is large enough or the blockchain goes public. One cannot monetize on something that has no value. Therefore, by offering the blockchain for (practically) free, the blockchain becomes more valuable and companies can then sell their use at a higher price.
https://www.etftrends.com/crypto-channel/analyzing-bitcoins-network-effect/
https://www.topl.co/solutions
https://medium.com/loom-network/understanding-blockchain-fundamentals-part-1-byzantine-fault-tolerance-245f46fe8419