Santiago Roel Santos, founder and CEO of crypto investment firm Inversion Capital, said cryptocurrencies are usually not subject to positive network effects, but other experts disagree.
In a recent Substack post, Santos wrote: “The price of cryptocurrencies is predicated on network effects, which it doesn’t have.” He also referred to the network effects valuation system, Metcalfe's Law, saying that it “doesn’t justify the valuation of crypto” but as a substitute “reveals it.”
Santos claimed that many network effects of cryptocurrencies are detrimental on account of congestion, comparable to higher fees, poorer user experience, and slower transactions. “Facebook didn’t worsen when it added 10 million users,” he said.
Other experts object
Some analysts agree that cryptocurrencies could also be overvalued, but others say Santos is applying the mistaken framework.
Santos admitted that recent blockchains improved transaction throughput, but claimed that this resulted in reduced friction moderately than increased value. Still, he said liquidity, developers and users could move, while code might be forked and value creation was weak.
Jasper De Maere, desk strategist at leading crypto market maker Wintermute, told Cointelegraph that the idea that Layer 1 blockchains are overvalued on account of negative network effects is “applying consumer app logic to infrastructure,” expanding on the Facebook example.
“Facebook's backend also experienced overloads and outages early on; these negative effects were simply internalized and abstracted.”
De Maere said that “users mustn’t interact directly with L1s,” making monthly energetic users and user retention irrelevant. According to him, “the true network effects for an L1 are on the validation, security and liquidity levels, not on the end-user level, and that’s where interest actually occurs.”
Tomas Fanta, director of crypto investment firm Heartcore, said he disagrees with Santiago that fees go down as usage increases. He said that with high-performance blockchains, “fees go from meaningless to meaningless,” and that liquidity improves and yields increase as adoption increases.
Ben Harvey, digital asset researcher at crypto trading firm Keyrock, told Cointelegraph that he largely agrees with Santos' claim that L1 blockchains are overvalued. Still, he doesn't imagine this is applicable equally to all L1s, with protocol scalability and artificial intelligence integration being key aspects.
Analysts debate the logic of crypto valuation
Santos pointed to some rough mathematical estimates of the worth an on-chain user has to a blockchain. Considering the crypto market's current total capitalization excluding Bitcoin (BTC) of $1.26 trillion, that will put the worth tag for the 40 million to 70 million monthly energetic users estimated by enterprise capital firm Andreessen Horowitz last month at $18,000 to $31,500 each.
The same report estimates that 716 million people own crypto. This would lead to an estimated value per user of nearly $1,760, but it surely is an overcount as Bitcoin isn’t excluded. With Santos' estimated 400 million users, the worth could be $3,150 per user.
With Facebook's 3.1 billion monthly energetic users and Meta's market cap of $1.6 trillion, we get a valuation per user of $516. In addition to Facebook, Meta also operates other paid platforms and services.
Market capitalization per user comparison. Source: Santiago Roel Santos
Martin Kupka, a former investor at Web3 investment firm RockawayX, told Cointelegraph that crypto network effects “are here to remain in stablecoins today, centralized exchanges, and future decentralized exchanges.” He explained: “The more useful it’s as a medium of exchange and collateral, the more traders a CEX or perpetual venue has, the upper the liquidity and the higher the execution.”
Wintermute's De Maere said that “Web3 is modular and this makes the underlying network effects much easier to see” in comparison with Web2. He explained that these effects generally occur in L1 as security and validator concentration, in stablecoins as liquidity, and in decentralized and centralized exchanges, in addition to in the applying layer where users aggregate.
“Because these layers are separable and never bundled, you may clearly observe where the connection takes place,” said De Maere. “That's why we base it on traditional metrics like ARPU […] They can appear overvalued,” he added. The current state of crypto valuation is analogous to when “we had difficulty valuing Web2 platforms.” […] and developed special models for this,” he said.
