Web3 Network Effects: Five Mental Models

Network effects powered the rise and dominance of Web2 platforms and captured the imagination of builders and investors over the past decade. Some believe that network effects will be even more powerful in Web3 while others believe that Web3 will kill network effects.

In the midst of all the hype and buzzword soup that plagues Web3 discourse today, the answer to this lies in reshaping our mental models about network effects. What we’ve learnt in a Web2 world (covered in my book Platform Revolution) may not apply as directly in a Web3 world. To understand network effects in a Web3 world, it’s helpful to rethink network effects from first principles and understand what changes as we move from Web2 to Web3.

This article dives into five mental models, whose implications we subsequently unpack through forthcoming articles over the coming weeks.

 

Network effects in Web2 vs Web 3: Four key differences

To understand network effects in Web3 ecosystems, we need to first qualify the differences between Web2 and Web3 ecosystems and understand how these differences impact the creation of network effects.

First, in Web2 ecosystems, market infrastructure is created by the platform provider.  In Web3 ecosystems, on the other hand, market infrastructure isn’t provisioned by the platform provider, but needs to be built out by the ecosystem, both through resource commitment (e.g. commitment of storage capacity) and through infrastructure development. As a result, creating and scaling network effects poses a unique challenge in Web3 ecosystems, which need to orchestrate not just market activity (as web2 platforms do) but also market infrastructure development.

Second, token value provides an additional value lever to kickstart and scale network effects. Market activity is managed through tokens. Producers may be incentivized to bring supply to the platform early on in exchange for tokens whose value appreciates as market activity increases. Likewise, developers responsible for building out market infrastructure may be incentivized to create core infrastructural components in exchange for tokens. Tokens provide a new incentive mechanism, absent in Web2 ecosystems.

Third, data and reputation portability, combined with technology interoperability, makes network effects much less defensible in Web3. Even if Web3 ecosystems rapidly build out network effects, they cannot lock-in their users (or the supply from producers) or extract surplus value from user data the way their Web2 counterparts so effectively (and now infamously) did/do.

Finally, Web2 ecosystems primarily comprise market participants. Web3 ecosystems need to consider participants not just at the market layer but also at the infrastructure layer, the financing layer, and the governance layer. A Web 2 marketplace like Etsy is open to third party sellers but largely creates the core marketplace infrastructure internally, and manages funding and governance centrally. In contrast, a Web3 commerce protocol (e.g. Boson Protocol) needs to

1. organize market infrastructure creation around the protocol at the infrastructure layer,
2. manage token liquidity to drive funding as well as token value appreciation (which in turn incentivizes all participants) at the funding layer, and
3. scale out governance to ecosystem participants, beyond the initial team, at the governance layer.

Let’s unpack these as we run through various mental models around Web3 network effects.

This is the first of a series of articles leading up to the Web3 Bootstrapping Playbook.

Get your copy of the Web3 playbook here