Gradually, then suddenly.
In the context of financial networks, it is worth considering the degree to which network effects attract users and value-extraction repels users.
As for-profit entities, legacy financial systems impose extractive repulsor forces in the form of fees, overdraft penalties, and onerous exchange rates. In addition to these forces, there are minimum balance requirements, limited business hours, withdrawal limits, and wait times that encumber the user who seeks to store and exchange value. These things are anti-valued by users, but tolerated to the limit where they remain with the network.
Until recently, the Metcalfe-Hall equilibrium within legacy financial systems has been at least partially supported by a lack of alternatives. Whereas a person can delete their Facebook account and take their social lives elsewhere, deleting their bank account or credit card to take their financial lives elsewhere was more difficult.
With the growth in the Bitcoin ecosystem for buying, selling, borrowing, lending, and securing value digitally, a new financial network is emerging. This new network offers a completely different approach to fees, wait times, business hours, exchange rates, minimum balances, and withdrawal limits. The marginal user seeking to manage their finances can now do so in an alternate network.
Within the payments space, people gravitate towards bigger credit card providers for their convenience, despite fees ranging from 1.3% – 3.5% per transaction (or more in some markets), and credit card companies having a history of abusing their payment network dominance . However, with the advent of Bitcoin, the Lightning Network, and Lightning-based services such as Strike or recently the Cash App , this equilibrium is poised at disruption.
The video of Strike’s CEO Jack Mallers streaming dollars over the Lightning Network is a demonstration of a fundamentally different payment network. If Lightning Network-based payments can offer final settlement at a lower cost, the marginal merchant may offer preferential pricing to pay via Lightning, or simply restrict or deny credit cards altogether. If more people switch to a Lightning-based payment network, credit card companies may have to compensate for their declining revenues by imposing higher fees on their users, which could accelerate a popular switch to Lightning. This is the downslope of a network effect.
Another notable example is the remittance industry, which enables workers to send money abroad via its networks of offices, agents, ATMs, and websites while extracting value via fees and exchange rates. As more people remit via the Bitcoin network, chasing more attractive fees, wait times, and exchange rates, the legacy remittance industry will face a crisis. Declining revenues may force raising fees, reducing customer service, or worsening exchange rates, which will serve to both depress the network attractor force and amplify the extractive repulsor force.
Mitigating customer loss by improving network robustness is no small feat in the face of a worsening financial position.
The fixed overhead costs of for-profit financial networks can be seen as structural extractive repulsor forces, integral to their business models. Whereas historically people may have gravitated to the largest networks with the biggest economies of scale, those same networks now carry the biggest financial burdens on the downslope of a network effect.
For financial networks, the deleterious impact of a declining network may be less sudden and noticeable at the outset. A large number of customers and merchants adopting Bitcoin-based networks will not immediately diminish the value that legacy financial networks provide to their existing user-base. Credit cards will still be swiped, money will still be transferred, and account balances will still be accessible. However, over time as network attractor forces increasingly pull marginal users away from legacy networks, the fees, wait times, accessibility, and exchange rates will worsen, not improve.
That worsening user experience can be self-reinforcing at an exponential pace and is the downslope of a network effect.
As Bitcoin and the Lightning Network offer alternatives for value storage and exchange with little to no barriers to entry, legacy financial networks will be challenged. Any business that relies on the power of network effects, should recognize the precariousness of a Metcalfe-Hall equilibrium and that declines can be steeper than inclines.
Gradually, then suddenly.
This is a guest post by Matthew Pettigrew. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
