Web3 has strengthened network effects globally, but also diluted some as platform context shifted.
Web3 offers new avenues for positive network effects through composability and leveraging different platforms.
Embeddedness has become a stronger source of competitive advantage in Web3, enhancing modes like talent and technical advantages.
Deep dives
Understanding the Strength of Network Effects
Strength refers to how strong the network effects are and how much value they create as more users join. Web3 has strengthened many network effects and made them more global, creating opportunities for positive network effects to drive value. However, it has also diluted some network effects as platform context has shifted. Builders need to understand the strength of network effects and their implications for value creation and capture.
Considering the Valence of Network Effects
Valence refers to the direction of network effects, whether they are positive or negative. Web3 offers new avenues for positive network effects through composability, allowing users to leverage the infrastructure and assets of different platforms to drive value creation. Builders should understand the valence of network effects in their ecosystem and how they impact the overall network value.
Examining the Source of Network Effects
The source of network effects determines how they are fostered and their defensibility. Sources can include liquidity, data or user know-how, economies of scale, network insight, stand-alone value, technical advantages, partnerships, or multi-homing costs. While some traditional sources of network effects have weakened in Web3, embeddedness has become a stronger source of competitive advantage. Builders need to identify the source of network effects and develop strategies to protect and leverage them.
Understanding Modes in Web3
Traditional modes of competitive advantage in platforms have generally weakened in Web3 due to the open nature of the blockchain. However, embeddedness has become a significant mode of competitive advantage, allowing platforms to be embedded in various aspects of users' digital lives. Talent and technical advantages also play a crucial role in maintaining a competitive edge. Builders should consider how to enhance and leverage modes to establish long-term success in Web3.
The importance of embeddedness and shared ownership in Web3 platforms
Embeddedness and shared ownership are key factors in Web3 platforms. In Web2 platforms like Alipay, the advantage comes from embeddedness - being used in multiple services. Web3 platforms take this a step further by allowing for the embedding of digital assets like NFTs and crypto wallets in various services, creating software embeddedness. This opens up new opportunities for developers and users. Shared ownership also plays a crucial role, as it fosters loyalty and community cohesion. NFT communities and DeFi platforms show how shared ownership drives engagement with the platform and contributes to higher value creation.
Strategic decisions and challenges for Web3 builders
Web3 presents unique challenges and strategic decisions for builders. One challenge is aligning short-term incentives with long-term platform success. In Web2, short-term gains often lead to extractive practices and user attrition. However, in Web3, shared ownership incentivizes users to contribute to the platform's success. Another challenge is launching a platform and deciding whether to focus on supply or demand first. The key is to subsidize and attract users who will create the most value for others, kickstarting the network effect. Web3 introduces new ways to subsidize users, such as token rewards, that align their incentives with the platform's growth. Additionally, addressing the vampire attack problem, loyalty in Web3 platforms comes from integrating users into the brand and fostering shared identity, rather than traditional loyalty programs.
In this deep dive and tour through key business concepts, from theory to practice, we cover the topics of strategy, competitive advantage, network effects, moats, and more -- covering both both basic foundations, as well as the tricky nuances in a new world of open source, including web3. In the first half of this discussion, we cover foundational business concepts and questions -- such as the nature of competition, and how it *really* changes in web3; as well as how network effects really work -- and then, in the second half (in case you want to skip ahead), we cover mindsets and general guidance for builders…
Our expert guest -- in conversation with editor in chief and host Sonal Chokshi -- is a16z crypto research partner Scott Duke Kominers, who is also a professor at Harvard Business School; a faculty affiliate in Harvard’s Department of Economics; and advises several companies on marketplace development, incentive design, and more; as well as advises, and is directly involved, in several NFT communities.
Scott also teaches on these topics -- both at Harvard and also recently at our Crypto Startup School -- so be sure to subscribe to our playlist for those talks on the a16z crypto YouTube channel to get the latest updates as we release more videos from the 2023 cohort.
As a reminder: none of the following is investment, business, legal, or tax advice; please see a16z.com/disclosures for more important information -- including a link to a list of our investments.
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