Is All Of Finance Just A Big Network Effect?

Ecommerce, Selling Online, Online Sales, E-Commerce

In college I was a registered Republican. After I graduated I registered as a Democrat. And a few years ago I registered as an Independent. I guess I just couldn’t ever figure out which tribe I belonged to – which network I wanted to associate with. The last eight years have been interesting to me mainly because I feel like I’ve watched two competing network effects trying to convince one another that their network is better and the more they can demean, retain and recruit others the more powerful their network becomes.

Anyhow, I am really exhausted from all the politics of the last few years so I won’t torture you with more of it. But it all has me thinking about the power of network effects and how people can buy into things that are only loosely grounded in fact (or sometimes void of any fact) just because they want to believe in the network.

This economic idea of network effects is grounded largely in the work of Hal Varian, a Berkeley economist. I’ve always loved this 2004 article in the NYT in which he asked why Dollars have any value. His answer:

In the jargon of economists, the value of a dollar is a result of “network effects.” Just as a fax machine is valuable to you only if lots of other people you correspond with also have fax machines, a currency is valuable to you only if a lot of people you transact with are willing to accept it as payment.

This seems especially timely given low inflation (which is evidence of surging money demand), skyrocketing Bitcoin prices and surging stocks. After all, how could inflation defy all this stimulus? How could Bitcoin’s valuation defy its relatively low utility? Or how could stocks defy what seem to be perpetually high valuations?

In 2014 I said that Bitcoin was really interesting because it was largely grounded in a network effect. There aren’t men with guns backing it. Taxes don’t “drive” this money as MMT people might claim. Bitcoin works as money because people find it useful as money. Full stop. No matter how silly you might think the narratives around Bitcoin are, the simple fact of the matter is that Bitcoin has moneyness because people believe it has moneyness. And the more people adopt that view the stronger the network effect becomes and the more useful Bitcoin becomes.

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