Challenging the Narrative of Positive Network Effects
Santiago Roel Santos, founder and CEO of crypto investment company Inversion Capital, has asserted that cryptocurrencies do not benefit from positive network effects, a claim that has drawn disagreement from other industry experts. In a recent Substack post, Santos argued that "crypto is priced for network effects it doesn’t have." He specifically referenced Metcalfe's Law, a system used for valuing networks, stating that it "doesn’t justify crypto’s valuation" and instead "exposes it."
Santos contends that many of the network effects within the crypto space are actually adverse. He pointed to issues like network congestion, which leads to higher fees, a degraded user experience, and slower transaction times. He drew a parallel, stating, "Facebook didn’t get worse when it added 10 million users."
Counterarguments and Alternative Perspectives
While some analysts acknowledge the possibility of crypto being overvalued, a significant portion argue that Santos is employing an inappropriate framework for evaluation. Santos conceded that advancements in blockchain technology have improved transaction throughput. However, he maintained that these improvements lead to lower friction rather than compounding value. He further elaborated that liquidity, developers, and users can readily migrate, and code can be forked, indicating weak value capture.
Jasper De Maere, a desk strategist at the prominent crypto market maker Wintermute, countered Santos's assertion. He told Cointelegraph that applying consumer-app logic to infrastructure, as seen in the Facebook example, is misguided when deeming layer 1 blockchains overvalued due to negative network effects.
"Facebook’s back-end also had congestion and outages early on; those negative effects were simply internalized and abstracted."
De Maere emphasized that users are not intended to interact directly with layer 1 blockchains, rendering metrics like monthly active users and user stickiness irrelevant. He believes the genuine network effects for a layer 1 blockchain reside at the validator, security, and liquidity layers, not the end-user layer, and this is where true compounding occurs.
Tomas Fanta, a principal at the crypto investment firm Heartcore, expressed his disagreement with Santiago's view that fees escalate with increased usage. He stated that on high-performance blockchains, fees remain negligible, and liquidity and yields actually improve as adoption grows.
Ben Harvey, a digital asset researcher at crypto trading company Keyrock, largely concurred with Santos's assessment of layer 1 blockchains being overvalued. However, he cautioned that this valuation disparity does not apply uniformly across all layer 1s, highlighting protocol scalability and artificial intelligence integration as critical differentiating factors.
Analyzing Crypto Valuation Logic
Santos presented calculations to estimate the value an on-chain user contributes to a blockchain. Considering the current total crypto market cap, excluding Bitcoin (BTC), at $1.26 trillion, and an estimated 40–70 million monthly active users identified by Andreessen Horowitz last month, this would imply a per-user value ranging from $18,000 to $31,500.
A separate report from Andreessen Horowitz estimates that 716 million individuals own crypto. If Bitcoin were excluded from this figure, the per-user value estimate would be nearly $1,760, though this represents an overcount due to Bitcoin's inclusion. With Santos's estimate of 400 million users, the per-user value would be $3,150.
In comparison, Facebook boasts 3.1 billion monthly active users, and Meta's market capitalization stands at $1.6 trillion, resulting in a per-user valuation of $516. This figure also encompasses Meta's other platforms and services beyond Facebook.
Martin Kupka, a former investor at Web3 investment firm RockawayX, told Cointelegraph that current crypto network effects are most pronounced in stablecoins, centralized exchanges, and perpetual decentralized exchanges. He explained that the greater utility of these platforms as a medium of exchange and collateral, coupled with higher trader volumes on CEXs or perpetual venues, leads to deeper liquidity and improved execution.
Wintermute's De Maere commented that Web3's modular nature makes its underlying network effects more discernible than those in Web2. He elaborated that these effects typically manifest at the layer 1 level through security and validator concentration, within stablecoins via liquidity, and across decentralized and centralized exchanges, as well as at the application layer where users congregate.
"Because these layers are separable rather than bundled, you can clearly observe where compounding happens," De Maere stated. He added, "That’s why, based on traditional metrics like ARPU [...] they can look overvalued." De Maere concluded that the current state of crypto valuation is reminiscent of the period when "we were struggling to value Web2 platforms [...] and created specific models to do so."