The network effect is the key to success
Would it be an email service useful if only you could use it and nobody else had no idea what that is? Definitely not and you would not probably care much about it as well. If you could write an email to your friends and family then the utility of the service would be significantly better. What if you could write to whomever you wish? Then the email service would become one of the most important services in the world. As you probably know, it happened. To exchange information quickly and cheaply on longer distances is a commonality nowadays but it was a revolution a few decades ago. People started to use electronic email communication and basically left the traditional mailing services that became slow, unreliable, and expensive.
Is email the predominant service today? Hard to say. The email service has a lot of competitors like chat services or social networks. Some people are daily on Facebook or Twitter but check their inbox once a week. It can be faster to send a direct message via a messenger than to send an email. People can choose from many different services based on their preferences. There is no ultimate winner. Evolution is a mother of progress. There will probably never be a single winner for a longer period of time.
Once we mastered sending information via many different protocols and added security features to ensure private communication between counterparties, we were able to transfer value in a digital manner as well. Money was digitized, or in the jargon of cryptocurrencies, tokenized. We do not need to use physical banknotes or coins. We are able to pay electronically. Hence, we can exchange digital value for physical goods. We have digitized not only money but many other assets. You can own gold digitally. In the case you trust a third party you can own and spend gold or Tesla shares via the Internet.
Adoption of technologies takes time. Users must trust new technology and they need to learn how to use it. Sometimes, there are some economical barriers. The best technology is such that it is for free and easy to use. A few early adopters start using technology and when it shows up that it is useful and beneficial others gradually join the group of users.
The network effect is a phenomenon whereby the increasing number of users has a direct impact on the growth and the utility of the service or product. When the network effect grows then also the financial and social value grows. A given user derives more value from service as other users join the same network. Especially in the case of a network aimed at communication between participants, every new user increases the value of the network for all others.
Cardano is a distributed network that provides decentralized services to users. Likewise to email service, the value of blockchain services will grow with the number of users. For example, you can wish to send ADA to your neighbor but it is possible only in the case that he or she has installed a Cardano wallet and is able to provide you with a Cardano address for the deposit.
The majority of people in the developed countries have a bank account. You can be nearly sure that your neighbor has one and you can send him fiat money. At the moment, the adoption of cryptocurrencies, in general, is very low. It can take a decade then at least half of the population will have installed a cryptocurrency wallet. It can be said that the network effect of Cardano and all other major networks is low. It is ok. Blockchain technology must mature similarly to many internet services that also needed to mature before mass adoption. The ultimate goal is to increase the network effect of Cardano.
Scalability is needed to increase the network effect
The majority of users perceive services as a set of qualities that might be useful for them. The very basic service of blockchain technology is a Peer-to-Peer transactional network. Users are able to exchange value in a decentralized way. As we said, the utility of the service will grow with the number of entities that are able to accept the value. The network effect is important but it is not the only metric that matters when it comes to adoption. The quality of service is also important.
When too many people start using a service, congestion of the network can occur. Having too many users on the same network service can slow the speed of the network and decrease the benefit for users. The adoption depends primarily on the network effect and the network effect depends on the scalability of the network. It must be ensured that capacity can be increased sufficiently to accommodate all users. In the case of a decentralized network, it is a challenge. The current major blockchain networks face scalability issues. Transaction settlements are not only slow but users have to pay a lot for them. This is not definitely a service that would be ready for mass adoption.
Cardano, like many other blockchain projects, is naturally a global network. A public blockchain is not like a local service for a limited number of users. It is a global network where literally everyone on the planet can become a user. The population of our planet is nearly 8 billion. If only 1% of the population wanted to use Cardano for making at least 1 transaction a day then the network would have to process 80 million transactions every day. To serve 1% of the population, Cardano would need to process approximately 1000 transactions per second. The problem is that 1% of the population is a very low number of users. The network effect would be also low and thus, also the value of the network. It is needed to realize that 80 million is a lot of people if they all were in one place. The adopters of cryptocurrencies are scattered everywhere on the planet. Hence, if the adoption of cryptocurrencies in your country is 1% then only 1 person from 100 will be probably willing to accept ADA. 20% adoption in one country or city would start to be interesting from the network effect point of view. However, it would mean that Cardano would have to process approximately 20,000 transactions per second. It is likely that once the adoption reaches 16%, it will continue to grow since the early majority is the next group on the adoption curve. This group makes 34% of the population. The higher adoption will be beneficial for the network effect but it will also make high demands on the qualities of the blockchain networks.
It is obvious that we will need to develop second-layer solutions to handle such a big amount of transactions. Hydra is the second layer solution for Cardano. Hydra will be able to take over not only transactions but also the execution of smart contracts. Teams of every major blockchain network build something similar. It must be noted that second layers will never be the ultimate scalability solution. The scalability of the first layers must be also high as it is the major settlement layer and the highest source of truth.
Currently, we hold cryptocurrencies mostly for trading and speculations and we use centralized services. The mission of Cardano is to start using blockchain for real economic activities. That is why scalability is such an important topic. Building a network that is global from the beginning is challenging since it is hard to estimate the network traffic and it is technologically difficult to design the network in a way that it can handle it. Network effect and scalability will go hand in hand. If we really want to send Peer-to-Peer transactions to our neighbors, scalability is the key. In other words, a given service that runs upon a global network must succeed in a local context.
It means that the adoption rate might not be the same globally in given countries or geographical regions. For example, Cardano can massively succeed in one country in Africa for a locally specific reason and the adoption can be let’s say 50%. In other countries, it can be 5%. A nice example of that is the adoption of Cardano in Ethiopia. The government decided to adopt Cardano to improve the education sector. It is probably just the beginning. If the project succeeds then it is highly probable that surrounding countries will naturally adopt the same network. The Cardano infrastructure is available everywhere so adoption can be relatively fast. Once services work in one country it will be easy to use the same in other countries. It is the advantage of a global network.
Local economic activities can benefit from a global network that is unstoppable and the ledger is immutable. The utility of that can differ in a given local context and developing countries will probably be the early adopters. Cardano can be a trusted entity for many local contexts basically everywhere. As a benefit, all local activities are naturally available around the planet. For example, if you have a decentralized ID (DID) created via Atala PRISM, you will have the ID everywhere in the world. The same money. You can have your country currency in a wallet and quickly swap it for other currency that you need when you travel.
Among other topics, scalability is topic number one regarding adoption. New users will be judging the speed and price of transactions. The second layer solutions will probably be the major players when it comes to increasing the network effect. Overall, users will judge the quality of services and not the level of security or decentralization. These qualities are too abstract and hard to understand for the majority of users. Moreover, they take them for granted. End-users will want to easily install wallets and reliably consume services.
More services mean more utility
The transaction service with native tokens is not the only service that blockchain can offer. At least, in the case of Cardano, you can expect much more. Besides ADA coins, users can issue and transact with other tokens. It opens the door for many other services and utilities.
Issuing tokens that are globally available and users can really own them similarly as money in their wallets is a powerful tool. We have never had something similar before since client-server architecture is not able to let you really own coins and tokens. We have experienced the Initial Coin Offering (ICO) craze around 2017. After that, Decentralized Finance (DeFi) applications appeared and now we are in the middle of Non-Fungible Token (NFT) mania. All these concepts are sound. Despite many scams that could be expected in a non-regulated environment, we can perceive it as a success.
Teams were able to collect funds for their ICO projects on a global level. We can name a few problems with the first wave of ICO. Teams bore no accountability for the delivery of promised projects and received the whole funds right away from the collection. Moreover, the team could collect money anonymously. In some cases, it was not necessary to reveal real identity. For the next wave, we will have a solution. Collected funds will stay locked in a smart contract and people will be able to vote about releasing a part of it for the next time period. When the majority of investors will not be satisfied with the results they can get the rest of the fund back. It will be easy to write a more complex smart contract and allow investors to vote on the Cardano platform. Moreover, Atala PRISM can be used to work with verified identities of the team members. It can be expected that the next wave of ICO, or other similar collective funding, will be more trusty, reliable, and protect investors. If the industry faces regulations, it is more probable that this form of ICO will satisfy the requirements.
The DeFi sector has similar problems as ICO. Anonymous individuals or teams can issue functionality via smart contracts with no accountability. The functionality of services is often buggy since it is relatively difficult to write secure and reliable smart contracts. Moreover, many teams test the application right in the production. Hence, many users lost a lot of money. In addition, the current DeFi platforms are clogged and are not able to handle a big amount of transactions. Fees are too high for ordinary users to play with applications. As a result, trust in DeFi application has not crossed the cryptocurrency industry. Cardano has a solution for DeFi as well. Plutus allows developers to write much more reliable smart contracts and test them before going live. Cardano already has Proof-of-Stake consensus and is more scalable than the current major platforms. Once Hydra is rolled out it will probably take over a significant part of transactions and execution of smart contracts.
The NFT industry is booming but it is questionable whether it is successful or not. Issuers mostly create digital images and link them with tokens. They then sell the tokens that represent the images. Buyers become owners of tokens but are they really owners of the images? Owners can use the images in their profiles or as wallpapers. If people download an image they can use it without a token. The NFT industry needs some improvements. For now, it is quite ok that people play with NFT and learn how to use the infrastructure and wallets.
In our view, the NFT industry needs to be bonded with the legal system to protect owners and ensure copyrights. Then, it will have the sense to have a token that will represent physical arts, or buy digital arts or items. In the digital world, NFT needs some additional infrastructure that will allow the consumption of digital art. For example, we can imagine a platform that allows users to play a song or video for a small payment. The platform will automatically send all payments to owners of tokens that represent digital art. An author of a song, Alice, can tokenize it. Alice will also be the first owner of the token and offer the song via a decentralized platform. Users will pay for listening to the song and Alice will receive payments. When Alice sells the tokens to Bob, Bob will receive the payments. Alice can sell only half of the token. Thus, Alice and Bob will receive half of the payments.
People can steal the song and replay it over and over for free. It usually happens nowadays and blockchain is not a solution for stealing digital arts. Some people are willing to pay authors and some not. The willingness can differ from country to country. Anyway, the legal system should prevent offering the song on other pirate platforms. What blockchain can do, is the decentralization of the service and avoid the middleman that would own the platform and take profit from authors and listeners. In theory, if the platform would be for free, then authors could receive 100% of payments. In reality, the authors of the platform will probably charge minor profits for usage. However, it can be cheaper than it usually is. Let’s add that it is generally hard to compete with existing services but it is another story. We just wanted to predict how the NFT industry could look like in the future.
What is important for our article, all mentioned sectors succeeded regarding network effect. It can be expected that these sectors will be transformed and they have the potential to be even more successful in the future. In every case, they are not going to disappear. It should be said that the adoption of cryptocurrencies is in general very low so many ideas and services failed not because they are conceptually bad but because they were not adopted or used by a sufficient number of users. Teams tried to offer brand new decentralized services but sectors lacked demand.
We can observe that for the very basic service of cryptocurrencies. As we said, it is the payment. Let’s quietly assume that the volatility of cryptocurrencies is not a problem. If a local merchant accepts payment by cryptocurrencies then probably not more than 1% of customers will use it. You can imagine how difficult it is for a team to push through other services. With a higher adoption and awareness about cryptocurrencies and other services, the number of users will also naturally rise. It will go hand in hand with maturing of technology.
They are services for which a global context is good. For example, offering a song globally via a decentralized platform is a good idea and it does not matter that service is used mostly by teenagers that are scattered around the world. There are other services, for which a local context with an overlap to a global context is important. Ethiopia decided to create identities of students via Cardano and Atala PRISM. One day, the majority of Ethiopians can have such an identity. They will use it in the local context, in Ethiopia, but they can travel and use their digital ID (DID) elsewhere in the world. They can use the identity for other services that Cardano can offer. Citizens can collectively fund a repair of a church and use real identities. Farmers can offer their products on a global market and buyers from westerns countries can verify that they are real farmers. The loan business can work without excessive collateral and it will be possible to fund the business of Ethiopians from western countries. Do not forget the payment industry. If a local currency was issued on Cardano as well then all payments in Ethiopia would go through blockchain and Hydra.
Building and replacement of the old infrastructure
We need more pieces of Lego to build other blockchain services. Every new piece will bring new utility and thus also higher security and reliability. Regulations and involvement of the legal systems within the local contexts will also help. The financial nature of cryptocurrencies and social context cannot be separated. Thus, it is not possible to separate for example payments and the legal system.
Imagine the following scenario. Alice promises to do some physical work once Bob pays in advance. What should Bob do when he has paid and Alice refuses to do the work? The blockchain transaction is settled and it is correct from the digital point of view. What about the social context? Only the legal system can probably remedy the situation in the case Alice does not care about her reputation and Bob does not want to fight with her.
Notice that the legal system would need to resolve the situation regardless of whether the traditional bank system or blockchain is used. Alice will have to do the promised work or send money back to Bob. In general, all services built on blockchain will work better when the digital and social contexts will be more interconnected. It is often argued that for many services a database would be a better option. That can be true. However, if we want to build decentralized services we need to replicate the current services. Let’s do not suppose that we can fully avoid the social context in the decentralized world. Smart contracts are able to prevent some frauds in the digital world but it is probably impossible when the physical world is involved.
Similar issues will occur regardless of whether a database or blockchain is used. We should as to whether blockchain can bring us some benefits over a database. If yes then it is a comparable or better solution. It is not a worse solution. Cardano uses PoS and will have Hydra in order to provide similar services like a database. It does not mean that user data will be in the blockchain. Blockchain will always be only a layer ensuring immutability and serving as a base layer for additional services. We will benefit from every piece of human work that can be reliably automated in order to avoid censorship, corruption, and fraud. Cardano allows us to build a decentralized infrastructure exactly for that. In places where corruption and frauds are common, the usage of Cardano is a good idea since there is no need to use any local infrastructure that can be easily compromised. As we said, even if it is not 100% reliable and individuals can misuse their position, it can be better than using a database. For example, all records will be immutably protected by the blockchain so when a crime has been committed the proof cannot be deleted. Even if the digital record is not correct the legal system can act. Even the representatives of the legal system cannot change or delete the record.
The first PoW networks are slow and as it is often said, expensive. That is true but let’s do not forget that technology can always be improved. People are actually good at pushing the limits and innovating technologies. More than 10 years passed since the launch of Bitcoin. In the next decade, the crypto industry will be completely different.
It is all about economic activities
It is a paradox that holding cryptocurrencies in a wallet and waiting for the possible future rise of the price is the most spread usage of them. The narrative “hodling is using” is used to excuse the fact that nobody is willing to use cryptocurrencies for real economic activities.
Cryptocurrencies are treated as digital gold. When we have a look at the real-world analogy, we will find that only around 12% of people in the USA hold gold. Gold is only a subset of the financial system. Is a part that is useful only for rich people. The majority of people are part of the financial systems without the need to own gold. Real economic activities are independent of the existence of gold. On the other hand, money, which is used on a daily basis, is a necessity.
Do you know why the U.S. left the gold standard? The government was not able to resolve the economic crisis in 1933. Faced with mounting unemployment and spiraling deflation, the U.S. government found it could do little to stimulate the economy. To deter people from cashing in deposits and depleting the gold supply, the U.S. and other governments had to keep interest rates high, but that made it too expensive for people and businesses to borrow. So in 1933, President Franklin D. Roosevelt cut the dollar’s ties with gold, allowing the government to pump money into the economy and lower interest rates. Notice that the U.S. is arguably one of the most developed and democratic countries in the world and the government does not directly need a scarce resource.
Our society and the financial markets are based on transactions and contractual agreements among people, companies, banks, states, etc. The exchange of value is a very important part of society. One is able to produce something that the other needs and is willing to pay for it. That is a very basic pillar of the economy. Money became the means of payment. Money is exchanged for things that have similar value. There might be more complex exchanges of value between two parties that require making a contract. A contract is a record with the agreement details and conditions. Transactions and contracts are drivers of the economy and society.
Now, let’s ask a question. Have we already replicated the financial system? Definitely not. We suppose we have replicated gold and we have a digital form of it. Really? At least a few percent of people on the planet think so. The usual narrative is that once a higher number of people adopt volatile cryptocurrencies the price will stabilize and we will use them more often for payments. That is why we just hold them and wait for what is going to happen next.
As we have explained above, it is difficult to achieve a higher network effect in the global context. A globally famous company can accept cryptocurrencies as a payment method but the majority of people will still use fiat money. Probably even the cryptocurrency holders.
Stable coins and all tokens that are issued are very important since people learn how to use the wallets and transact. People might be willing to experiment but not everyone is willing to face volatility. Issuing fun tokens that are for free and you can send them to your friends nearly for free is actually a big thing for further adoption. Cardano will allow users to pay fees directly in the tokens that are being sent. Users will not need to own ADA coins to use tokens.
Once we remove the speculative nature of cryptocurrencies people can use coins and tokens for real economic activities. Only a part of the population is interested in speculation. The majority of us do not care much about it or do not understand the topic well. This group of people cannot be omitted from the decentralized economy. Stable coins solve the issue nicely. In our view, further adoption of cryptocurrencies and decentralized services will depend on stable coins. It does not depend on issuers of stable coins. They will be many of them and the key is to ensure seamless interoperability among platforms. More complex decentralized services will be adopted once the speculative aspect will be completely removed.
Let’s ask a tricky question. Can decentralized services be used with centrally issued or controlled digital currencies? Why not. Some people might think that we need 100% decentralized money to build a decentralized economy. Well, but what if we are not able to ensure the stability of fully decentralized cryptocurrencies? Decentralization is about the ability to avoid middlemen. The issue is that when regular people should decide between decentralization and stability they will choose stability. Hence, we need to strive for both, for services that will satisfy requirements for stability and decentralization. Using Central Bank Digital Currencies (CBDC) in decentralized financial services is also a significant step towards decentralization. In the ideal case, it would be great if we could create algorithmic stable coins that would be independent of a central issuer. We believe that we will be able to do so one day.
Real economic activities require stability and as time has shown the volatility prevents real usage of decentralized services including payment. We have already found the solution and once the blockchain technology matures a new wave of adopters will join the sector. Cardano will probably be one of the platforms that will be ready for mass adoption. There are two important reasons to think so. The technological advancement and strong community.
Moreover, Cardano is the first project that has been adopted on a national level. Ethiopia is the first adopter and we will probably see others. As we have explained in the article, adoption in the local context is also very important. It is naive to think that the whole planet will switch from traditional services to decentralized ones in one moment. It will happen somehow gradually. To see one country that reliably uses blockchain in real sectors of the economy is a necessary prerequisite for further adoption. Let’s hope that Cardano succeeds in Ethiopia and will provide the first proof that it is possible. Without that, do not expect that the whole planet will use cryptocurrencies.
Currently, we use cryptocurrencies mostly for trading and speculations. Some people use centralized services for holding cryptocurrencies. The mission of Cardano is to let people use blockchain technologies for real economic activities. It is a challenge from the technological and adoption points of view. Like it or not, the further adoption of blockchain technologies needs innovations. It is not only the second layer solution but many other parts of the infrastructure. In the article, we have talked about ICO, DeFi, and NFT sectors. We expect that we will see other new sectors. Cardano has added another piece of Lego. It is Atala PRISM which is the identity management solution. It is another important piece of infrastructure that will interconnect the digital and physical worlds. The blockchain has big potential and we believe that Cardano will push the adoption one level up.