Back

studBit

13 min read

0

NETWORK EFFECT

The network effect is a phenomenon where the value of a product or service increases as more people use it. This means that the more users a product or service has, the more valuable it becomes, creating a positive feedback loop. This effect is commonly observed in technology-based industries such as social media, messaging apps, and online marketplaces.

In the context of cryptocurrencies, the network effect is a crucial factor that influences their value and adoption. Cryptocurrencies that have a large user base and are widely accepted by merchants and service providers tend to have a stronger network effect, making them more valuable and attractive to new users.

Bitcoin has a strong network effect due to its widespread adoption and long history as the first cryptocurrency. As more people use Bitcoin to buy and sell goods and services, the value of the currency increases, which attracts even more users, creating a self-reinforcing cycle.

In the early days of the market, Bitcoin was the most popular cryptocurrency and enjoyed a dominant position. However, the emergence of other cryptocurrencies like Ethereum with better functionalities and features indicate that Bitcoin’s first-mover advantage may not be enough to sustain its dominance in the market. Realized capitalization and other on-chain metrics can provide insights into the market dynamics and competition among cryptocurrencies.

Network effect is an important concept in understanding the growth and adoption of cryptocurrencies, as it highlights the importance of a large and active user base in driving the value and utility of these digital assets.

MARKET POWER

Market power refers to the ability of a firm or group of firms to affect the price or quantity of a good or service in a given market.

Market power is another factor that affects the market structure of the cryptocurrency industry. Some large players in the market, such as exchanges, concentration of ownership and mining pools, have significant market power due to their ability to influence prices and control the supply of certain cryptocurrencies. In the case of the market for coin mining, market power is unlikely to arise due to the decentralized nature of the bitcoin system and other cryptocurrencies. This means that no individual miner or group of miners can control the total supply of virtual monetary units.

However, mining pools, which are groups of miners that come together to perform collective mining, could potentially engage in strategic and opportunistic behavior that could harm the credibility of the cryptocurrency. For example, a mining pool could force losses upon miners outside of the pool, thus reducing competition and consolidating their market position. The potential for such cartels is enhanced by the fact that major mining operations are concentrated in China, where a few companies dominate the industry.

The computational power of bitcoin network has pushed out all but the strongest and richest miners, creating quasimonopolistic positions in the mining industry, small miners have been pushed out by large operations located where electricity is cheap.

The concentration of ownership of crypto tokens is also high, with an estimated 95% of all bitcoin in circulation held by just 20% of bitcoin addresses. This means that a few players, often referred to as (whales), have a massive market influence and can potentially manipulate the price of cryptocurrencies.

CRYPTO NARRATIVE

The crypto narrative is also an important factor in shaping the market structure of the cryptocurrency industry. This refers to the collective beliefs, values, and stories that shape how people perceive and use cryptocurrencies. The narrative around Bitcoin as a store of value has helped to drive its adoption and increase its value. Similarly, the narrative around decentralized finance (DeFi) has led to the rise of decentralized exchanges and other decentralized financial services.

The statement ‘When prices go up fundamental analysis becomes better, when price goes down fundamental analysis becomes worse’ is a humorous take on the role of narratives in shaping market perceptions and realities. While it may seem like a joke, there is a kernel of truth to this statement, particularly in the context of speculative markets like cryptocurrencies.

In traditional financial markets, fundamental analysis is a method of evaluating the intrinsic value of an asset based on its underlying economic and financial factors, such as earnings, revenue, and cash flow. However, in speculative markets like cryptocurrencies, where prices are often driven more by narratives and beliefs than by fundamentals, the effectiveness of fundamental analysis can be limited.

When prices go up, it may be easier to justify higher valuations based on optimistic narratives and expectations, which can make fundamental analysis seem more accurate and effective. On the other hand, when prices go down, negative narratives and fears may dominate, making it harder to justify valuations based on fundamentals alone.

This is especially true in the world of cryptocurrencies, where narratives and memes play a significant role in shaping market perceptions and behaviors. Social media platforms like Twitter and Reddit have become key drivers of crypto narratives, with users sharing and amplifying beliefs and opinions about specific coins and tokens.

These narratives can have a significant impact on the price and adoption of cryptocurrencies, as they can create a sense of momentum and FOMO (fear of missing out) among investors. For example, the rise of Dogecoin in early 2021 was largely driven by a viral meme on social media, which created a sense of community and excitement around the coin.

FUNDA(MEME) ANALYSIS

Let’s say the price of Apple stock goes up 20%, Analysts can compare the new price to their valuation estimation tied to the performance of Apple the company as to what they think a fair price should be. Then they determine that the apple stock is now overvalued or undervalued

What if BTC price goes up 20%? Well, the market now thinks that bitcoin should be worth that much. we can look at various metrics, on-chain activity, google searches, compare it to the stock-to-flow model, app usage and hundreds of other indicators which can be useful but ultimately won’t tell us what the price should be. No one knows and that’s exactly the point - it’s the result of collective imagination. The comparison between BTC & AAPL isn’t completely apt since we know that stocks also don’t just exactly follow whatever they should be worth - it’s still be market pricing them.

The price is ultimately determined by the most basic market forces - supply and demand. Even so, the price of apple stock can be tied to apple (the company), while most cryptocurrencies don’t have anything concrete to tie their value to and that is why we have to pay close attention to narratives. Bitcoin was memed into existence. memes can have tremendous power and can spread very rapidly over the internet

Let’s examine how the historical bitcoin narrative changed. Bitcoin started as a peer-to-peer electronic cash system, then it was used to buy cocaine and acid on silk road, then it became censorship resistant digital gold, then the base assets for the cryptocurrency asset class, an inflation hedge, an institutional grade macro asset and whatever people think of it and its used for these days.

The point is that, in addition to being a technology that incorporates computer science, cryptography, economics, there is an inherent social layer to bitcoin, money and value are social concepts and just like any other technology, they change over time. Pay attention to what’s happening. as bullish narratives get strong, they can drive up the price a lot and as bearish narratives take precedence, they can crash the price a lot, add to that an abundance of forced selling or buying in the forms of liquidations in a predominantly overleveraged market and we have got ourselves a solid foundations of outlier events.

This is the kind of environment in which you can get extreme moves like the one that happened in May 2021, where some one thousand billion dollars were wiped out from the market in a matter of days. And billions in a matter of seconds.

Context is extremely important to consider. For example, if some very bearish news doesn’t have much of a reaction, we are probably in a strong bull phase. Conversely, if some bullish news has a disproportionately bearish reaction, the bears may be in control for now. It can also be useful to pay attention to how the market reacts to certain types of news events or apparent changes in the narrative.

I think I’ve established that narratives play a major part in pricing markets. Not only that, they practically define their realities. The ability to propagate these narratives to millions of people in a matter of seconds magnifies this effect even further. As a result, the crypto markets exhibit very strong reflexivity, both to the upside and the downside. If you pay attention to the underlying narratives and how the market reacts to these narratives unfolding, you can take advantage of certain situations or save yourself from making stupid mistakes.

This isn’t anything new, but what is new is that almost anything can become a market thanks to the permission less internet of value. While many things have been markets for thousands of years, there was no way to price them, but now that’s changing.