Santiago Roel Santos, founder and CEO of cryptocurrency investment firm Inversion Capital, stated that cryptocurrencies are not influenced by positive network effects, although other experts disagree.
In a recent Substack post, Santos wrote, "The pricing of cryptocurrencies is based on network effects that they do not possess." He also pointed out the network effect valuation system known as Metcalfe's Law, claiming it "fails to justify the valuation of cryptocurrencies" and instead "exposes it."
Santos claimed that many network effects of cryptocurrencies are negative due to congestion, such as higher fees, poorer user experience, and slower transactions. He said, "Facebook did not get worse when it added 10 million users."
Some analysts agree that cryptocurrencies may be overvalued, but others argue that Santos applied the wrong framework.
Santos acknowledged that new blockchains improve transaction throughput, but he claimed this leads to lower friction rather than compounded value. Nevertheless, he stated that liquidity, developers, and users can migrate, and code can be forked, resulting in weaker value capture.
Jasper De Maere, a strategist at leading cryptocurrency market maker Wintermute, told Cointelegraph that considering a layer one blockchain to be overvalued due to negative network effects is "applying consumer application logic to infrastructure," and expanded on the Facebook example.
De Maere stated, "Users should not interact directly with L1," which makes monthly active users and user stickiness irrelevant. According to him, "The true network effects of L1 exist at the validator, security, and liquidity levels, not at the end-user level, where the compounded effects actually occur."
Tomas Fanta, head of cryptocurrency investment firm Heartcore, expressed disagreement with Santos's view that fees worsen as usage increases. He said that on high-performance blockchains, "fees go from negligible to negligible," and as adoption increases, liquidity improves and yields increase.
Ben Harvey, a digital asset researcher at cryptocurrency trading firm Keyrock, told Cointelegraph that he largely agrees with Santos's assertion that L1 blockchains are overvalued. However, he believes this does not apply to all L1s, as protocol scalability and AI integration are key factors.
Santos pointed out some rough mathematical estimates of the value held by on-chain users for the blockchain. Considering the current total market capitalization of cryptocurrencies, excluding BTC, is $1.26 trillion, this would price the estimated 40 to 70 million monthly active users, as estimated by venture capital firm Andreessen Horowitz last month, at $18,000 to $31,500 per user.
The same report estimated that 716 million people own cryptocurrencies. This would lead to a per-user value estimate of nearly $1,760, but this is overestimated since BTC is not excluded. Based on Santos's estimate of 400 million users, the value would be $3,150 per user.
Facebook has 3.1 billion monthly active users, and Meta's market capitalization is $1.6 trillion, leading to a per-user valuation of $516. Additionally, Meta operates other platforms and services besides Facebook, which are also factored into the pricing.
Martin Kupka, a former investor at Web3 investment firm RockawayX, told Cointelegraph that the "network effects of cryptocurrencies today exist in stablecoins, centralized exchanges, and decentralized exchanges for perpetual futures." He explained, "The more useful a centralized exchange or perpetual trading venue is as a medium of exchange and collateral, the more traders it has, the deeper the liquidity, and the better the execution."
De Maere from Wintermute stated that compared to Web2, "Web3 is modular, making the underlying network effects easier to observe." He explained that these effects often manifest in L1 as security and validator concentration, in stablecoins as liquidity, and also in decentralized and centralized exchanges as well as user-aggregating application layers.
De Maere said, "Because these layers are separable rather than bundled, you can clearly observe where compounded effects occur." "That's why, based on traditional metrics like ARPU […], they may appear overvalued," he added. He noted that the current state of cryptocurrency valuations is similar to a time when "we struggled to assess Web2 platforms […] and created specific models to do so."
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Original article: “Debate Erupts Around Cryptocurrency Network Effects, Investors Question L1 Value”
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