The value of a network

You’ve probably heard this before, one of the most common objections to crypto is that people don’t get it.

They say something like, “Is it money? Is it a commodity? Is it something else?”

The answer, usually, is, “Yes.”

Cryptocurrencies can function in a lot of different ways. That’s why crypto can get confusing fast when we compare it to old models of how we understand systems of value exchange.

Today’s popular financial tools aren’t the most efficient way of handling transactions. They work the way they do because we are comfortable with them. Our current money system is based on decades (centuries even) of hand-me-down knowledge and layered behavior.

But financial systems based on crypto or blockchain more broadly are valuable in a different way. One of the main value propositions is that they can function like an information network and a value network combined.

The current internet is an information network, but it doesn’t have a built-in money or value layer.

It’s like having a postage system that doesn’t allow people to mail checks or cash. What if every time you got a bill in the mail you had to go to the bank to resolve it, instead of just responding through the mail?

That’s sort of how the internet works now. To handle financial transactions, you need third-party tools like credit cards or payment services.

But one of the use cases for crypto is that the technology allows for native payments, right from within the same infrastructure you use to connect to the internet, such as a web3 wallet or a smart wallet.

In other words, crypto isn’t a new kind of money, a new kind of digital commodity, or a new something else. It functions as all those things, while also growing in size (users) and value (market cap) because of network effects.

To distill this idea even more: New digital assets are valuable because they are networked services that can behave in lots of ways, such as digital cash or digital commodities.

Why are networks valuable?

Networks are valuable because they allow people to coordinate and collaborate. A good network creates rules or agreed-upon operating systems so that information exchange or engagement with the network is predictable and somewhat standardized.

If you think about it, the idea that networks have inherent value is nothing new.

After all, people naturally join networks of all different kinds to get things done.

The school you went to is a network, the bank you use is a network. Your phone company? Same thing. We also coordinate in social networks like neighborhood groups, churches, or sports teams.

Networks native to the internet are different. Probably the biggest and most obvious reason that internet networks are different than previous networks is the sheer scale and scope of operations.

Internet scale breaks down previous limitations imposed by infrastructure or geography.

Granted, the URL experience can’t replace the value of IRL (in real life) experience for most things. But as we’ve seen over the past 20 years, URL networks can also create utility by enabling applications and services not previously available.

Besides the obvious example of internet scale, another thing enabled by digital networks is the “network effect.”

The network effect kicks in anytime the network becomes more valuable when someone joins.

Think about a legacy network, like a phone company. It doesn’t matter if I use Phone Company A and you use Phone Company B because we can still call each other and there’s no real difference when having a conversation.

Now consider a social media network. These networks become more interesting as more people join them and as more people invite friends, family, and co-workers.

So there’s a natural incentive to grow the network (it gets more interesting) and the more interesting the network gets, the more people will join.

In other words, the network effect is like a powerful flywheel that drives growth and adoption and is mainly made possible by internet scale.

Relating this to cryptocurrencies, it’s important to understand that when you buy crypto you are essentially buying into the network.

You might be buying into the network as a way to speculate that the network will become more valuable over time.

• Or you might be buying into the network because it is easier to send value across the internet, using crypto as a payment system.
• Or you might buy into the network to perform some kind of decentralized financial transaction, like liquid staking, which is something that’s not even possible via traditional finance.
• Or you might buy into the network because you need assets to cover transaction fees on any of the activities above.

The point is, you are buying into a network.

It gets easier to understand the value of an internet-native financial system once we start thinking about the internet as a network of networks.

How to value a network?

Ok, on to the trillion-dollar question: How do you come up with a valuation for a blockchain or crypto-enabled network?

As new networks become more important and more pronounced in everyday life it becomes increasingly more important to find adequate ways to value these growing networks.

People often use an overall market cap or total value locked (TVL) when trying to value crypto networks.

The only issue is that these metrics only reflect market values. And while market values are really important, they don’t tell the full story of the value of the network.

If our main premise is that crypto is more than money or more than a commodity, then we need some other ways to find a valuation for these networks.

And it turns out, there are already multiple systems or tools for trying to value networks. Many of them are outdated and don’t fully capture the full potential of the internet. And none of them fully capture the dynamics of a crypto-powered network.

As an example, here are three of the more well-known network valuation methods:

• Sarnoff’s Law: This network valuation model was made popular when network TV and other forms of mass media broadcast were king. The basic premise is that the value of the network can be derived from the number of network participants. It’s a simple measurement that equates overall value with popularity.
• Reed’s Law: This valuation method is more applicable to the age of the internet. It says that the value of networks, like social media networks scale exponentially (not linearly as in Sarnoff’s Law).
• Metcalfe’s Law: This valuation method is also helpful for understanding the dynamics of massive, permissionless networks like the kind enabled by crypto and blockchain technologies. The idea is that a network grows in value proportionally to the number of connected users. Specifically, the value can be calculated as a square of the number of total users. The exponential scaling captures the network effect idea explained above. An internet-based network becomes more valuable as more people join and use the network.

The interesting thing about the network valuation models that exist so far is that they might not adequately express all of the growth dynamics built-in to cryptocurrencies and digital assets.

It will be interesting to see if new valuation models are created to fully capture networks with a built-in money layer.

Moving past “Is crypto money?”

If you’ve made it this far, congratulations.

The main takeaway is that it is helpful to think of crypto or blockchain systems as a networked fabric and not so much as solitary threads.

In other words, while crypto acts like money, it’s way more than that.

So even when market cycles are going up and down, and prices feel like they are all over the place, it’s helpful to think of different crypto-based systems as new kinds of networks.

One of the key value propositions of a crypto network is that a money layer — or a way to easily exchange value over the internet — is baked in.

But it’s also important to consider a whole bunch of other factors when looking at the potential of the network, which we will get into in later issues, but the main point, for now, is that crypto is more than just what’s captured in the market cap.