The reason why adoption is so incredibly significant is because it represents the difference between investing and speculating in the crypto space. We have seen how crazy volatile crypto space can be many times, how hype and speculation alone can have an enormous impact on the price.
But if you zoom out and go very long term, ultimately the only thing that will sustain very large increases in price is genuine adoption. That means that not just people are using it to trade online or to speculate that a year from now it will be higher because everyone else is going to buy it.
You need some kind of genuine use case that would sustain long-term fundamental growth in value, which will translate to the price of cryptocurrencies.
When it comes to adoption and what actually gives value to the cryptocurrency is the concept of network effects. This is because once a cryptocurrency or any kind of network or protocol reaches a certain level of adoption after which there is no going back, and this is typically called the critical mass crossover. In adoption stages this is the chasm part. Before chasm first mover advantage is nothing, and after the chasm first mover advantage is everything.
What is happening at at that point when any cryptocurrency reach critical mass crossover first, it is beginning to outcompete all competition at a scale because then it becomes much easier, simpler, and quicker to onboard new users relative to all of the other competition. This leads to not just dominance in the market share, but actually it’s developing into what’s called super dominance, where you basically have a de facto monopoly occurring.
You can think of something like Google, which has reached this kind of point with search engines. There are some competitors out there, but Google dominates searching space with 93% of the market share.
I think that this is what will very likely happen with lots of cryptocurrencies as well. Do not be afraid though, world is big enough for few big players in each category. But sometimes there will be one superdominant player.
This happens because of Metcalfe’s Law.
To provide a quick definition of it, the value of any network (which applies to cryptocurrencies because they are just networks), is proportional to the square number of users on that network. For any network, every additional user is not just a little bit more valuable, but significantly more valuable, because it makes the entire network much more valuable in and of itself.
Normally, when you add one more user to a network, it’s almost like multiplication because there is an enormous increase in the possible connections between all users in the network.
To give a simple example, let’s say you’re into video games and want to play some games that are exclusive for PlayStation. Then you will decide to buy PlayStation over Xbox. But let’s imagine that all your friends have Xbox, then you would not be able to play with them games that they are playing. Now although you like most one game that is exclusively on PlayStation, but you will buy Xbox because that allows you to be part of the network that is meaningful to you. That is how network effects are strong.
As you get more methods of connecting and communicating with other peers, you naturally gravitate towards that network, and this phenomenon happens with any communication tool or network. That’s how a particular company or network becomes superdominant, and why there seem to be so many monopolies in the tech world today.
One thing worth studying is the dominance of the internet protocol TCP/IP. That is a story about how this inferior technology won and became super dominant. Lot of times, you see a protocol that looks better on paper, but it doesn’t necessarily win, and it’s because of adoption, or other words network effects.
Now there are all many different networks, developer networks, speculator networks, user network, the marketplace, and it’s really about getting mass adoption first. An inferior technology can get mass adoption first, so it’s really about looking at the adoption of these things, not necessarily what they look like on paper.
Studying adoption is incredibly important as a cryptocurrency investor because ultimately it makes the difference between just speculating and actually long-term investing, which is what I am doing.
Once a cryptocurrency, or if a cryptocurrency, reaches a certain level of mass adoption, if it gets past that critical mass crossover, it has the ability to cement and establish wide network effects that allow it to become super dominant relative to its competitors and basically steal and swallow up all value and just leave everything else far, far behind.
Ss an investor, you want to look for where these network effects are being established so that you can capitalize and make huge amounts of money.
But this works only over the very long term, decade at least. What price will market put on it during the road to superdominance, it not relevant, because they are focused at what price will it have a day, a week, a month, few months from now.
OK, but how do we measure this?
You can apply this concept to create a data model for the value of cryptocurrencies based on the number of transactions that occur on the network.
The best data source or chart for applying this idea of Metcalfe’s Law is the network value to transaction ratio (NVT). This ratio measures the number of transactions that occur on a daily basis and then compares that to price to gauge whether the cryptocurrency is currently overvalued or undervalued. This is another one of Willy Woo’s charts, which you can find here.
As it states, NVT Ratio (Network Value to Transactions Ratio) is similar to the PE Ratio used in equity markets.
When Bitcoin`s NVT is high, it indicates that its network valuation is outstripping the value being transmitted on its payment network, this can happen when the network is in high growth and investors are valuing it as a high return investment, or alternatively when the price is in an unsustainable bubble.
Regarding calculation, Bitcoin`s NVT is calculated by dividing the Network Value (market cap) by the USD volume transmitted through the blockchain daily. Note this equivalent of the bitcoin token supply divided by the daily BTC value transmitted through the blockchain, NVT is technically inverse monetary velocity.
In the chart above, the NVT line is smoothed with a 14 day moving average.
The lower the NVT, the better, as this means that the price is low while the number of transactions is high, indicating a potential undervaluation. On the other hand, a high NVT ratio means that the price is higher than the number of transactions would justify, indicating a potential overvaluation.
NVT is one of the single best metrics that can be used to gauge whether a network or cryptocurrency is relatively expensive or relatively cheap compared to the number of users or amount of adoption that is occurring.