Achieving Network Effects on an Open Network

When it comes to building a business, there are two primary value-growth models – linear growth and network effects. With a linear growth model, the value of a product or service stays the same after it’s been used by a customer. However, the value of a product or service grows as more people use it in a network effects model.

In theory, network effects sound great: exponential growth, faster momentum, and a loyal customer base clamoring for a product or service. In practice, network effects are hard to achieve for mainly two reasons: 1) one needs to achieve critical mass before they start to activate, and 2) scaling too quickly can expose cracks in the foundation of the business.

But if an entrepreneur can address these two challenges, the magnification of network effects can have outsized impact for the users. We’ve seen how social media networks and online marketplaces grew from limited functionality (i.e. getting to meet people at college at Facebook, buying textbooks at Amazon) to becoming industry leaders paving the path forward because they were able to hit critical mass.

Success requires: substantial resources and talent, a solution that builds user trust and adoption, effective leadership, and a strong network. On October 7, 2020, the board members of the Stellar Development Foundation participated in a roundtable to discuss how exactly do you go about achieving that success. You can rewatch the roundtable in the video below or read on for a recap!

SDF CEO Denelle Dixon is joined by Jed McCaleb (Co-founder and Chief Architect at SDF), Keith Rabois (General Partner at Founders Fund), Lin Hua Wu (Chief Communications Officer at DropBox), Ronaldo Lemos (Chief Scientific Officer at Institute of Technology & Science of Rio de Janeiro) in the video above. Together, they discuss the implications of network effects and share their expertise on how to accomplish this value-growth model in blockchain. They also explore the potential of building on an open network like Stellar.

What Strategies and Tactics are Useful in Building Network Effects?

To gain a critical mass of users, user adoption and trust are of utmost importance, especially in industries like finance or healthcare where the user is entrusting the business with sensitive information.

Rabois suggests that in order to build this credibility, businesses can employ several tactics:

• Invest in design. Precision and polish matter and gives users more confidence in a product or service if there is someone to care for the small details.
• Take advantage of marketing data pre-launch. Conducting an alpha or beta phase can yield valuable information on what potential users like or dislike.
• Using the media and borrowing credibility through partners. By collaborating with them, a product or service gains credibility.

This goes hand-in-hand with Wu’s suggestion that businesses should identify which power users and influencers to engage with. The word of an advocate goes a long way, so it is worth either paying or incentivizing these communities.

Wu also identifies the signs of when a business is ready to grow:

• When the business doesn’t have enough supply (because customers are buying it up),
• Targets are overachieved easily,
• Risks are mitigated and the business feels in control.

Once those conditions have been met, scaling successfully becomes possible resource-wise, product-wise, or market-wise.

Network Effects in Blockchain

Depending on what the product is, network effects can work against the business in early stages unless it can attain critical mass – otherwise, the product or service can’t take off and be useful. “This is what we’ve been seeing in crypto,” McCaleb says regarding network effects in blockchain.

However, just because there’s struggle doesn’t mean there isn’t opportunity.

Lemos comments that in much of the developing world, citizens do not trust incumbent services like traditional banks or state agencies. If people could find services that are easy to use, transparently and ethically designed, and affordable, they will jump at the opportunity to use them.

Blockchain can fulfill that need. For starters, it is a system of“trustless trust,” giving people confidence in blockchain because there is little room for human error or manipulation. It can tap into the huge market for KYC-compliance, since state-government issued ID can be inefficient and not scale well with next-gen services.

Developers also have plenty of room for innovation on blockchain while establishing protections for users. Many regulators favor innovation and can design positive institutional frameworks via regulatory sandboxes. This paves the path for blockchain to achieve network effects without discouraging participants due to overt restrictions.

What Network Effects Look like on Open Networks like Stellar

Monopolies have arisen as a result of network effects, but are network effects antithetical to open source? Not necessarily. Having a universal open network as a foundation to build products and services upon means everyone is encouraged to plug in without fear of extremely mature competitors.

So what happens if users are already happy with what they have? Why explore services provided by blockchain if they already have what they need.

McCaleb argues that while some people are content with the status quo in certain parts of the world, others are not. He reiterates Stellar’s focus on serving the developing world, since many communities are underserved by existing solutions. This means that if a product or service were able to achieve network effects on an open network, it could mean uncapped potential for those who need it most.

Don't miss out on the Stellar Development Foundation's Q3 in Review. On Thursday October 15 at 9:00 am PT, SDF CEO Denelle Dixon will lead the call to share a major announcement about the Stellar network, in addition to the strategic highlights from the Stellar Development Foundation and Stellar network over Q3 of 2020. She will be joined by SDF leaders and a special guest. Register now →

You can view all upcoming Stellar events here.