The Downfall of the Network Effect in Crypto
Web2’s favorite growth hack reconsidered: why the network effect is no longer a durable moat in web3.
Let’s first get the definition of the Network Effect and why it matters in Web2. Per ChatGPT:
Definition: A network effect occurs when a product or service gains additional value as more people use it. This means that each new user increases the overall value of the product or service for existing users.
Benefits from Network Effects (NE):
NE Increases Competitive Moat – More users make the product more valuable, blocking competitors.
NE Lowers Customer Acquisition Costs – Existing users attract new users through word-of-mouth, integrations, or ecosystem effects.
NE Creates Higher Switching Costs & Retention – As the network grows, users become more embedded in the ecosystem (e.g., social connections, data, integrations). This makes it costly or inconvenient for them to leave, leading to stronger retention and pricing power.
Expect pushback here, but I’m making a claim that Network Effects are not a lasting moat in crypto. They do not entitle crypto companies to the same staying power and sustainable competitive advantage as they do Web2 companies because of the below idiosyncratic traits in crypto.
Idiosyncrasy 1: Crypto Users Tend to Be More Mercenary
Developers as users: Developers are the users/buyers of blockchains (L1, L2, other “layers”). Blockchains offer developers a similar product: blockspace within an on-chain immutable database that records transaction history. Developers typically have common criteria when selecting where to build:
Lowest transaction fees
Fastest transaction processing
Highest liquidity available
Most ecosystem/community support, including grants
As evidenced in the chart above from Electric Capital’s Developer Report, Ethereum initially benefited from NE that attracted most developers to build exclusively on Ethereum (“Single Chain Developers”). However, the network effect was futile in saving it from its subpar performance and liquidity fragmentation in the face of performant competitors like Solana and Base, leading to a significant drop in the percentage of “Single Chain Developers” / “Total Monthly Active Developers” starting in 2022. This shift demonstrates the mercenary nature of developers, who flow to where their needs are met rather than staying for loyalty to the network.
Retail as users: As long as DeFi remains the primary use case in crypto, liquidity providers and retail DeFi users will continue to seek:
The highest yield on their liquidity
The lowest slippage in trades
The greatest variety of tokens
The most attractive farming rewards
This behavior often comes regardless of user experience or platform preference.
Moreover, wallets function as discrete agents in the crypto ecosystem. This makes switching between platforms—like Uniswap and Hyperliquid—frictionless and easy.
Validators as users: Validators naturally seek the highest notional value of block rewards—whether from their stake (in PoS networks) or from services rendered (as DePIN providers).
The decision to stay with or support an alternative L1, L2, app chain, or DePIN project comes down to a simple cost-benefit calculation. Validators evaluate perceived economic value and the sustainability of block rewards when making this choice.
Idiosyncrasy 2: Crypto is open-source by default, which drastically lowers the barrier to entry for copycats.
Enter the great invention of the “Vampire Attack” – SushiSwap copied the code and exact same UX from Uniswap, then designed a more lucrative token incentive to siphon Uniswap’s liquidity providers and users.
The equivalent attack in Web2 would be much harder to pull off. Someone would have to steal Facebook’s entire codebase, whip out an identical or superior product, then offer all of Facebook’s users money to lure them over to the new platform.
Idiosyncrasy 3: Crypto is interoperable by default, which minimizes switching costs for both developers and retail users.
Take the example of USDC, which arguably enjoys the highest degree of network effects in crypto, and compare it to one of its Web2 counterparts—the Visa network. If USDC is not accepted, it takes no time to swap it for USDT, USDe, or PYUSD on a DEX or CEX.
On the other hand, switching a card from the Visa network to Mastercard is much more onerous.
Now going back to my argument on why the Network Effect does NOT entitle crypto companies to the same benefits as their Web2 counterparts:
❌ NE Doesn’t Increase Competitive Moat in Crypto: Because of crypto’s forkable and open-source nature, on top of Bertrand-style competition among undifferentiated products (yield, blockspace, liquidity), network effects don’t necessarily make a first mover with more users more “competitive.”
❌ NE Doesn’t Lower Customer Acquisition Costs in Crypto: Crypto users — whether retail or developers — are much more mercenary in nature than the users of the Magnificent Seven in Web2. Retail optimizes for trading gains and yield. Developers optimize for the highest performance and deepest liquidity. Liquidity stays in an ecosystem for as long as the yield is lucrative for the LP, regardless of whether there’s a network effect.
An argument can even be made that❗️crypto has the opposite of the Network Effect: the more LPs in a pool, the lower the yield; the more users on a chain, the higher the fee and congestion.
❌ NE Doesn’t Create Higher Switching Costs & Retention in Crypto: Switching costs are minimal in crypto due to blockchain’s default composability and interoperability.
There’s no data moat in crypto either. Nothing on-chain can be considered “proprietary data,” which is a key retention lever used by big tech to keep customers in their walled gardens.
To cap this off, let’s examine a case study on Ethereum, widely regarded as the epitome of NE in crypto. Since its launch as the "World Computer," combining blockchain innovation with programmable money, Ethereum has benefited greatly from its early NE:
Developer Adoption: It attracted the largest blockchain developer community early on, mainly because its EVM became the industry standard for initial blockchain development.
Liquidity & DeFi Dominance: Ethereum hosts most of crypto’s liquidity through decentralized finance (DeFi) platforms – until being flipped by Solana lately. More liquidity attracts more users → easier and cheaper to trade/lend/borrow → more liquidity.
Security: Increased usage on Ethereum enhanced its security, attracting more projects and users.
Yet, we all saw the trend break this year—Ethereum misplayed a winning hand by procrastinating on product improvements and over-fragmenting its ecosystem by supporting L2s that cannibalized its own liquidity. Its developer outflow (ETH’s monthly dev count falling 17% in 2024 while Solana’s grew ~83% in new contributors) is as abysmal as its liquidity outflow (dropping from 100% DeFi dominance to 50%, according to DeFiLlama). And Ethereum’s supposed NE is futile in stopping the bleed.
In contrast, Web2 behemoths—namely Meta and Twitter—have also slacked off in their innovation and shipping, yet continue to comfortably dominate their respective markets. Why? Because the Web2 version of NE actually works and has staying power:
Competitors just can’t fork their code and offer similar products like they can with Ethereum.
Twitter and Facebook data are truly proprietary and irreplaceable
They are not interoperable with anyone except within their own ecosystems.
For these reasons, the traditional NE that secures long-term moats for Web2 companies just doesn't work in crypto.
Loved this take. The openness and flexibility that make crypto exciting also make it hard to defend. In crypto, the real moat isn’t attracting a crowd, it’s solving a real problem.