Network Effects, Moats, & the Business of web3

25:00And I've worked on all of that content in the past. And in particular, yep, we used to have like a deck that was just explaining network effects because there's actually so much confusion and misconceptions around it. But just super quickly, you define network effects earlier, but to super simply put, it's, you know, the value of the network becomes more valuable for the participants as more users join. And the key idea there is valuable for users, right? I think people often treat network effects as more users and forget at the other half of it, which is adding value for the rest of the users.

25:30Yeah, forget that it's actually about value creation. Important footnote on that is that the value doesn't have to go up for all users equally. And it doesn't even have to be the case that all the users get a positive value boost for more users joining the platform. It's the net total value going up. Interesting, such a good nuance. So if you think about it, we use credit cards as an example earlier. And with credit cards, in general, we think of the network effects as being positive all around. Right? So if there are more holders of a given credit card, it's more valuable for a merchant to take it.

26:04If more merchants accept that credit card, as the individual, it's more valuable to get that credit card instead of some other one. And having more merchants doesn't really crowd out other merchants if anything, maybe it helps. So mostly the network effect of a credit card is cross -platform. It goes from holders to merchants and vice versa, and it's strictly positive. By contrast with newspapers, the more readers the newspaper has, the more valuable it is to be an advertiser. The more advertisers the newspaper has, the more annoying it might be as the reader to read the newspaper because you eventually get to this position where every other page is some gigantic ad, you really want to finish the article that you're reading and instead you have to flip through pages of advertisements or something.

26:49And so there, there are actually some negative platform externalities as well. The advertisers exert a negative externality on users and a negative externality on each other, but it can still be the case that the overall network grows as we add more users. And so the net value creation goes up. As we add users on either side of the platform, readers and advertisers, even if there are actually some negative effects on the margin for some of them. So the point being that you have to look at the value of the total and not worry so much only about like creating the super pedantic definition of value for all users.

27:27It's creating value for all users and aggregate, not necessarily for each user individually. Although note that if your platform gets really unpleasant for any given user, they might leave. And by the way, users will leave if they can overcome the switching costs and there's a good enough outside option. And so, users ability to respond to negative network externalities, to things that make the network potentially less pleasant for you as the individual, even though its net value and aggregate might be higher, is much harder in Web 2. There's a really high -barrier to exit. It's just hard to exit.

28:02And that means you're kind of locked in, which means you have very little bargaining power. And so that's how we get to this extractive equilibrium. with three is as we've been saying in a lot of ways the opposite right yeah you have all of your your network sort of embedded with you I have lots of NFT communities I'm a part of and any platform I connect to you know they can see all the communities I'm part of and anyone who's part of those communities on the platform can find me immediately right like I was totally you know stunned When I joined my first Web 3 enabled social media, it was, it was a forecaster.

28:41And I could search by community. Right? I could go and find the people who held, there's a network of content I'm really into. Right? These are all people who are a lot like me. That's why we're all in the same NFT community in the first place. And that was sort of wild, right? I had brought this like external network affiliation directly into a platform and taking all of that connection with me. totally just a pause on what you're really saying there because I think this is so profound. In Web 3, you're saying that it's not just that you can take your data with you, but you can actually take your reputation history, interactions, like there's so many other things, that kind of embeddedness of that.

29:20But just the more profound idea here, I just wanted to sharpen that nuance. Is platforms previously were never portable? And you're almost saying that the user and themselves are the platform, and that is now portable. That's like so fascinating. Absolutely. And this goes directly to this like community cohesion structure, right? Like Christian Catalini in an article we published just about 12 months or so, we talk about the network effect now accruing to the asset rather than to the platform or the portal. And that's sort of what's going on here, right? It's like, you know, elite skulls and FTE or a subduck or a board ape or whatever.

29:57the network is embedded in the collective of people who own these assets. And so there's sort of a new game about trying to be the platforms whose assets are the ones that people want to attach to their identity. And like are the thing that they want to use across the internet. And so if you think about Web 3, social media, design paradigm at a very high level, farcaster directly encourages the development of many different clients, different ways of displaying and remixing and serving the information that lives in the protocol. In Web 2, that would be dangerous. Here, that's actually very powerful because it draws more and more activity and value back to the underlying forecast or protocol.

30:43It becomes more embedded. Right, and it goes back to your way earlier point. It's increasing the size of the pie for everyone. I just want to also quickly just mention that in that article, which I'm just going to link to in the show notes. This was the article that you guys published in competition policy international, right? That you're referring to can we be like tech read critical. Yeah, can web three bring back competition and digital platforms, but you do point out that web three could reduce the fundamental costs of verification, the costs of interoperability and portability and the cost of composability, which is exactly kind of what you're talking about there.

31:16Yeah. But it's funny because then it go going back to my original question. I still haven't really heard. like it's definitely good in terms of bringing back competition to digital platforms as your guys' article posits, and in terms of making them less concentrated and consolidated among a central few. But it doesn't answer the question of who and how those people get the advantage. So I finally understand what you what you were meant when you asked about, you know, is this reducing competition or really like, you know, creating competition at all? So I think it's changing the character of competition.

31:48Oh, say more. So we've seen over the last year, extremely intense competition among NFT trading platforms on fees and on features. We've seen intense competition in various, you know, DeFi trading contexts, literally, like, you know, people writing algorithms that will like move someone's assets from one liquidity pools on one platform to another one, you know, sort of automatically. We've seen aggregators that basically make it easy to like price compare across all the different places you could place a given trade. That's what we often think of classically as competition, right? Like, fundamentally, if you think about classical competition policy, a lot of it was about pricing and or like, degradations in quality, or you're often asking, will this reduce the quality of the customer experience?

32:35Are they're either going to like pay more because, you know, now prices go up because there are fewer competing companies, right? You know, or the quality going to go down because there's less incentive for the firm to innovate because now they don't have to stay ahead of their competitor. That's right. That type of competition, like Web 3 is rife with. But the question is where do we go? What it really turns into is the platform is having to work to retain consumers, to create an environment in which the customer wants to stay on the platform rather than switch over to a competitor. And so what I think of as particularly virtuous competition, development of features, development of rewards and loyalty programs, right?

33:13Developments of various infrastructure that improves the customer experience, and often that's going to come through mixing and matching, it's like aggregating sort of all the best features from all the different platforms. I got my answer. Thank you, thank you. I didn't know what the answer was, by the way, I was just like trying to genuinely understand it. No, no, it was a great question. My listeners, we actually learned stuff. Exactly. Push out a thing and they're like, oh, I get it. There's your answer. One thing we haven't talked about is where does this idea of composability, which, you know, critics and as a great line, how composability is to crypto, what compounding is to finance, it's this idea that it's like an exponential force.

33:52And that's super interesting to me. And you have talked about in your work, Scott, this idea of compounding innovation as one of the benefits, you know, that can come out of Web 3. And I kind of wanted to dig in on what is it and why doesn't matter. Just also move us a little bit beyond what can come off as platitudes in the public discourse to kind of really understand the value behind that, those words, because they can be a little jargon -y. Totally. Okay. So first of all, just what is composability? It has a technical meaning in the context of software, right? And software, you're embedding existing software components into other ones, into new ones, and so you can use their operations as inputs to whatever your software is supposed to do.

34:34but at a business level, what it means is that you can build on top of other things that have been created. It's not just about software, it's not just about functions that are sitting in smart contracts in the blockchain or something. It's also every other digital asset. Composition is if you have an NFT and somebody else builds a new game that that NFT manifests an avatar in. There's this massive NFT ecosystem, I guess, is the right word around some very, very simple NFTs loot, which basically are just lists of various adventure game items, you know, bag of holding, you know, you know, rod of wrath or whatever, I don't remember any of the actual like loot items, but it's stuff like that.

35:25And people are building entire games that embed the loot assets. So if you show up with a given one of these quote -unquote loot bags, you'll have those assets in the game, and now they do things. And this is a form of composition as well. But okay, so from a business perspective, like why do we care that you could even do that? Well, it speeds up innovation. It allows people to innovate in ways that maybe they couldn't before. Maybe someone is really good at doing one type of business function and not others. And now there's a whole library they can pull from. Honestly, we saw this as well with all the web to infrastructure platforms.

36:03Once there was, you know, a bunch of out of the box, you know, web platform creators. Now, if you had a really good idea, if you maybe didn't need to also be a ridiculously good software engineer at the beginning, you could you could integrate a bunch of tools together and launch a pilot, you know, a minimum viable product with almost no complex software engineering. Web 3 is just that, but for everything. It's that for the underlying software that runs the platforms. It's that for all the brands and identity formation that people are doing. It's that for reputation markers. It's that for like our personal data.

36:36It's all of that rolled into one big snowball, right? You know, you can combine all of this stuff however you want. So we've got this like snowball. It's rolling down the hill getting super gigantic. And then at the bottom we have a gigantic snowball and we can like carve out any little bits of it we want to create our business. That's funny. the analogy I was trying to think of was a bit like a primordial suit. Yeah. And the reason that came to mind is, do you remember back in the day, it was a kind of the early days of Google when Hal Varian, who was a chief economist there, wrote about combinatorial innovation and it's so darkening of a phrase.

37:08Yeah. The idea is really fascinating. You're a mathematician. You know combinatorial math. Yeah. Permutations and combinations grow quickly. Exactly. Or derivatives that you can actually extend. And when you mentioned loot, actually, it's really funny that you brought that up. It's obviously one of my favorite examples too. But what I found so fascinating about the loot example there is it doesn't have to be full future, which is a big difference on the kind of early days versus now because you have literally primordial ingredients that aren't fully bit late and fleshed out because there is this sort of innate ability for these ingredients and these people and communities to sort of form quickly and bottom up and move around them and put them together in ways without having to have like this full future to it too.

37:48That's such a cool point. You're exactly right, right? Imagine if 10 years ago, anyone ever said, I'm going to launch a product which is basically just like the foundational items for an adventure game and then like some people are going to build the game around it. Makes no sense, right? Yeah. Whereas here you can do that. You can say, look, I've got this cool set of items I want to like enable a game or multiple game ecosystems around them. Let me put the items out into the world and invite people to build. Totally. And so it's possible to have these micro components. People can launch products where the product is basically just some tiny input that goes into everything else.

38:27And by the way, obviously AI will play a big role in super -tragion when you think of creative AI that is exactly. Totally. And even in the early days, right? It was only meant to be what you're doing. And then the users came up with games. Like, Chris Messina came up with the hashtag. Other people came up with, let's do so and so on Thursdays. And the community did all that and they got nothing for it in creating that value. So kind of coming full circle, another difference here. It's not like these platforms didn't allow it, although to your point, to be more precise, here we're talking about everything being composable, not just one element.

39:00But two, there was no way for the community to capture and participate in that value. Yeah, you're totally right. Yeah, just kind of coming full circle. And to the extent that value capture for the user for the community existed, it often came through these very arcane things that were then delinquent from the platform, right? Like how did people capture value from hashtags? They came up with other platforms that would have hashtags in them. There were all these disconnects because you had to go off platform, you had to drive people to go to your website and do something. Whereas Web 3 sort of invites everyone to do this stuff actively and makes it all sort of cleanly interlinked.

39:36Yeah, totally agree. And now let's switch into... Let's get tactical. Yeah, let's get tactical. Let's get tactical. Tactical. Sorry. Do you guys remember that song? I'm gonna be a newton John. Let's get physical. Let's get tactical. Let's get tactical. Tactical. Oh my god, that's so good. My voice doesn't go that high. That was really funny to hear you try to do that. My voice doesn't go that high. Sorry. Great. So now I want to spend the rest of the time just going now into what does anybody do with all this information. And if we don't have answers, let's share of mindsets what to do, you know, just all of it.

40:16So in terms of breaking this down, the good place to start for the builders and the audiences, like, how would you help them understand the key aspects of network effects, and then how do they sort of think about it, depending on what type of thing they're building in Web 3? Cool. So first of all, it's really important, just the high level. I like to think about network effects in terms of their strength, their valence, and their source. Ooh, cool. So strength is exactly as it sounds. Like how strong is the network effect? How much pull do users sort of exert on each other just the platform sort of achieve over time?

40:49And note, there's absolute strength, and then there's marginal. It's like how much do you know, when we add a new user, like how much does that affect the network effects in general? And it might vary by user as well. So some users might really benefit from there being a lot of people in the network. If you're an online job search platform, people who are looking for jobs benefit a lot from the fact that there are a lot of jobs available in the platform. And people who are not actively looking for jobs might also benefit some because think about all those in -downs, one gets on LinkedIn or whatever.

41:21But they might not benefit as much from having all those jobs in the platform because they're mostly happily situated. And so it might be disversion among users. And another key factor in terms of strength is like are the network effects local or global? There's a different bike share company in like almost every city that has bike share. It's an exceedingly local network effect. You want there to be enough users biking around that the bikes are sort of available at all of those pickup and drop off spots. But the fact that you're a bike share customer in Boston has very little implication for whether you have any interest bike shares in New York or San Francisco or whatever.

42:01And it doesn't really matter whether it's the same company that you use in your home city. Like you can buy like a one week contract or all a card or something of the sort. It has very, very strong local network effects, but very weak global network effects. Right. And just before we go into the next item, can we address the nuances of strength for Web 3 and how you would advise people to think about it? So we've already sort of like implicitly been talking a lot about the strength of network effects in Web 3. There's good news, right, which is that a lot of network effects have suddenly become global.

42:35Even like a brand or a fandom can have network effects, right? So if you're a huge fan of Taylor Swift and you're wearing a Taylor Swift t -shirt and you walk by some other swifty wearing their Taylor Swift shirt, you can like connect, But you don't have a lot of interaction by default with Taylor Swift fans in other countries. Despite the fact that there are in fact a lot of Taylor Swift fans all around the world. With Web 3, a lot of those like sort of localized network effects suddenly become global. You can be in part of a brand community interacting with and making friends with people from everywhere.

43:09Like all of these different NFT communities I'm in are fundamentally global as brands. If they become really popular in South Korea or something, I gained some value from that because then there's like people creating cool content that supports the product and like more people at the virtual meetup. And so in a lot of ways by creating this global network infrastructure layer, like the blockchain is like a big network of networks, a lot of network effects have gotten stronger at the sort of core level. There's fundamental assets that to which the network effect accrues. But in the other hand, there's been a lot of network effect dilution, as we talked about, with platform context that used to be walled gardens.

43:47So there might be a stronger core network effect to the underlying protocol for a Web 3 social media platform. But there might be a much weaker network effect than before for any individual app that serves that protocol. Any of the like a bottom line. So the bottom line is that Web 3 has strengthened a lot of classical network effects. But it's also moved where they reside. The strong network effects are often tied to the digital assets, to the networks that's for all across the blockchain, rather than to any individual platform that operates on top of those assets. Yes. This goes back to that point we were talking about about this profound insight that Web 3 often allows these network effects to be portable in that sense, or tied to a different entity.

44:35Okay, so the first dimension of network effects that was strength and that was a super helpful breakdown. And then you also mentioned valence, which I don't even know what that word means by the way. I vaguely remember it from chemistry, I think. Yeah, valence is a positive, negative. I don't really remember my chemistry classes either. But it's about direction and positive versus negative orientation relative to strength. Anyhow, so how it applies here is valence is about direction. In Web 3, we're seeing a lot of new network effects, the new opportunities for positive network effects. This goes back to the composability point we were talking about earlier.

45:16Like there's just so many more ways to leverage all the information and architecture to drive new value to whatever you're building and back to the underlying assets or protocols that you're building on top of. So to the extent that we've created new forms of network effects, most of those are new positive network effects. But when you're thinking about this as an entrepreneur as a builder, you have to think about your entire ecosystem and where the positive and negative network effects are. It's not just about how strong your network effects, but it's also like, are they going to drive more value for everyone?

45:51Are they going to make some people want to quit your platforms that you actually have to reward them more in order to get them to stick around? That's the important thing to puzzle over there. The message on valence is mostly the same as it was in Web 2 and before. You need to understand which network effects are positive and or negative for which users. Then the Web 3 opportunity that's special here is through composability. There are many new opportunities for aggregating positive network effects, either yourself or through partners and future developers who build on top of what you've created.

46:21Okay. Then the last one you mentioned source. Talk to me about what that is in this context of dimensions of network effects for builders to think about and then application of web 3. Okay, source, you know, in some sense is the most self -explanatory of the three. Source is just where the network effects come from and why do we care about that? So the first we talked about strength and valence are really about value creation. They tell you how much value your network will create and how that value will grow as you bring in new users and add new functionality. source is about understanding how specifically you foster that network effect and relatedly how defensible it is.

46:57So does your network effect come from liquidity? Which could be the presence of lots of drivers and writers in a ride -hailing platform. So they can, you know, you can ensure that if you're out driving, you can, you will have people to pick up and if you're looking for a ride, you'll be able to find a driver or, you know, an NFT, or sorry, I keep using NFT examples to them at total degen, but NFT trading platform, are you going to be able to find the specific asset that you want when you show up. So could be about liquidity, could be about data or user know how, lots of different sources for network effects.

47:29And those sources define the pathway that often answers the strength and valence question. How does where the network effect comes from determine how strong it is and who benefits the most. And then segueing back into the competition discussion, it also tells you how defensible it is. Like in a lot of Web 2, as we've talked about, the network effect defense came from having aggregated massive amounts of proprietary data and user reputation and user content that it was very difficult, if not impossible, for users to take with them to get a similar quality experience elsewhere. And in Web 3, we're seeing a lot of those old sources of network effects that become much less defensively.

48:11Awesome. And the bottom line? The bottom line on source is you have to understand the source, you have to actually understand the mechanism of network effect. It's not enough to just say like, oh, we have a network that's growing in value. So like, you know, you should, you should join and invest in our network. Like, that's not how it works. You actually have to be able to understand the pathway through which the network generates that increased value. And you have to understand how to protect it and whether it's protectable. Again, if your network is totally indefensible, then you might have the opportunity to create a lot of value, but not be able to capture any of it.

48:46And so you're not just looking for network effects necessarily, but defensible and sort of buildable network effects. And question on this one actually, people often saying Web 3 when you mentioned modes that the modes that they have are things like design. And earlier you mentioned community cohesion, but what's your take on modes? Scott, I feel like people bandied that about a little too casually and easily for my satisfaction. You know, it's funny. One of my longest term collaborators on Web 3, Chad Esperine. He was one of my former students in my MBA class, one of the strongest students I've ever taught.

49:17He and I have been trying to really, clearly express how we think about modes and Web 3. And still work in progress, but the core insight, like with our conversation about the five forces earlier, is that most things have gotten much harder. Previous sources of platform competitive advantage, platform modes where the core network effect might be you have all the liquidity on your platform, and the competitors don't have nearly as much, or you have all this proprietary information. It might be economies of scale. You're a used car platform, and you can offer really cheap insurance because you have a lot of know how about the cars, or network insight, like Amazon, with its logistics operation.

49:59It can move the products to places before the people place orders because it sort of knows what's going to be ordered when. or our platforms can create defensibility through standalone value, technical advantages, things that they do that are just superior. This is you asked about design, you know, possibly even through partnerships, and sometimes also through multi -homing costs. Right, you might have a defensible competitive advantage simply because it's hard for users to deal with using multiple platforms at once. Like maybe it's easier to only have to search on one online restaurant platform or something.

50:33So those were all core sources of competitive advantage in platforms, all of which, by and large, is often going to be sort of an open book on the blockchain. You know, similarly, technical advantages, so much of the operations of a platform are public. We're going to road faster than they used to. Although I would argue on that one encounter to that is actually the talent and that the technical advantage is actually not just the features baked into said protocol, but the ability of that team behind it to really innovate. And that is going to be, I think, a bit of a mode on that one. Absolutely.

51:07No, no, I totally agree. It's totally right. That's not platform specific, but it is a very important source of competitive advantage. Remember, we talked about higher quality or lower cost. Both of those things are influenced by the quality of your talent. And talent has always been a competitive advantage, especially in complex and high -tech firms. As Web 3 is more complex and often more high -tech than anything that's come before it in category. The talent mode has widened and deepened. Yeah. But like the core platform competitive advantages have mostly weakened. There's one though that really stands out as having strengthened tremendously.

51:40And that is. Which is embeddedness. And say more about that, you've mentioned that a few times. Yeah. So another way that platforms achieve dominance is by being embedded into everything. If you think about Gmail as the login to so many different web platforms, many people, they don't know their account credentials for those websites. all they do is connect Gmail and it propagates credentials for them. That's embeddedness, right? That makes Gmail a necessary service. Even if you didn't have all of your email stored in Gmail, the network effect comes from proprietary data and having all of your content stored there in a way that's really difficult to port.

52:14But even if you took all of that away, I give tomorrow all of the email became suddenly flexibly transportable between Gmail and Outlook, people would still have so many accounts that were managed through Gmail, they'd have to keep logging into it. This is where like wallets have a lot more potential for embeddedness. Absolutely. Even in FinTech, we'd talk a lot about not only wallet is interface, but Connie Chan and I did a piece around WeChat and the idea of the payments and Alibaba and everything Alipay and this idea. It was book payments and messaging combined that became the interface to everything in the whole world.

52:46And granted, that was a very locked walled garden because obviously it's not open to anybody, but the people on those platforms. And it was in China, so it's even more walled. But the example that does come to mind in Web 3 is how identity becomes the interface for decentralized identity. So there's like a lot going across the board on that embedded at this point there. And indeed, and exactly as you say, the AliPay example is perfect. That's a classic Web 2 style platform that maintains a lot of its advantages through embeddedness. It's just used in so many different services. Web 3 opens that up and again, it opens it up to everything.

53:22Yeah. Your crypto wallet can be embedded in many different services, but also so can your NFTs, so can your digital diploma, so can a simple function protocol you wrote. Something like Dispersed .cash can become part of many different finance products. That software embeddedness, which you mentioned open source earlier, this was also true in open source. It's like, how did individual open source software products become most successful? It was people built lots of stuff on top of them. So much so that those products became essential. Totally. Although one quick precision note on that one, as you know, obviously open source history person.

54:03You're like a literal expert on this. A couple of quick notes on that. It's really interesting when you compare Linux foundation and the kind of model they set up and then say something like NPN, the node packet managers and the node. JS community, etc. It's also very interesting when you also think about other little components like, what is it like SSH or whatever, like three people maintained it and it led to some serious vulnerabilities in like hospital systems software because a lot of people began using open source. So just a quick contrast nuance that it is very similar except very different because that lacked the economics of participation.

54:39Yes. And therefore no incentive to know you're totally right. Somehow now you have that same embeddedness opportunity, but with an incentive to build and maintain, et cetera. Yes, sorry. Yeah, yeah, yeah, yeah, yeah. You're right. Build and maintain spot on. And then just one quick other one, you've mentioned community cohesion a bunch of times and that's one of the other things that you put forth as one of the stronger benefits of competitive advantage in Web 3. Now I want to also have you answer the second part of that question and you already enter the first part, same for community. So like what, like what are the nuances there?

55:13The comment of a moat is it really? Pulse check it for me. Great question. So first of all, I should emphasize that, like, to me, you know, embeddedness was a classic model of platform competitive advantage, and it's gotten much stronger in Web 3. This community cohesion thing, I tend to think is pretty new. They're not that never existed before. But at least in the classic platforms that I've looked at, I have never seen it to my recollection as a central part of the business model. In some sense, that's I think because they lacked the ability to do so. Or they like good tools to do so. Web 3 makes it possible to turn your consumers or your users into people who are personally invested in the platform success and who often interact and interface with each other towards the goal of the platform success and in the process of using the platform.

56:13NFT communities are a great example of this, but maybe we also see it for far less branded platform context. Think about everyone who participates in governance, DeFi platform or something, to calibrate the protocol and decide how it will run. And that comes out of this shared ownership, and it comes also out of the opportunity for your digital assets to drive new forms of quality and experience. And so a platform can build a mode around a user base that like really wants to attach to it that wants to use its product rather than a competitors or rather than building their own and even better wants to contribute to making what they do higher value.

56:53We haven't really seen these things play out at scale yet because it's just too early, but we see really powerful examples of it at least in play already. And it reflects a desire to publicly and personally identify with the brand attached to the NFT. It's like a sports or a music or whatever fandom. It's like you see the other people in this group as akin to you when you want to engage with them and not just like hang out, but hang out in reference to and more deeply engage with the assets. Yeah. I mean, I've been thinking a lot about the nuance is what you're sharing all this. like, how is this different than a fandom?

57:31How is this different than any other community? Is it just a more of a matter of degree than kind? And I think I've kind of landed on what you, from based on what you just said, Scott, it almost feels, this is really an exaggeration, but like a tribe and even a religion where you have artifacts that you engage in. And again, I don't want to say that with all the negative connotations. No, it's funny. You say this. There's this concept of a shared text. Yes, yes, exactly. Shared artifacts, shared symbols. Exactly. Yeah, and it's like modern meaning making actually if you were to really take it to the next level because when you say cohesion That's like a fabric the way people describe social cohesion and things that type people together And that's often how people also think about religion So it's not some abstract like concept like strong ties versus weak ties versus like interest graphs and like affiliate interest Like it's actually really kind of core meaning at this.

58:23Yeah, exactly And it's going to sound absurd, but like imagine a universe in which people went around the internet self identifying as platform users. It's like I get up in the morning and I am proud to be on Facebook saying that sounds a little bit hilarious. But you know, I was a really early Facebook user. You know, it had launched just before I got to Harvard as an undergraduate. And so we were proud to be on Facebook. We almost felt like we were building the product. We were finding weird errors and glitches and things and he would submit bug reports and they would go and fix the very unusual bug that you would notice.

59:03It was a totally different experience of the platform. Web3 is trying to take that type of experience and make it not just a small platform thing, but giving people that sense of pride and ownership and contribution in the platforms at every scale. Okay, so let's shift more now into a little bit even more advice for builders and how to really think about your strategy design and market design for web 3. And at a high level, we're not going to cover everything in this podcast, obviously. But I'm going to take some questions from Tim Sullivan, who's great former editorial director, HBR, and he was executive director of UC Press, and is now on my editorial team here, and works with you as well closely.

59:43So I actually think this is a very interesting question, particularly the second half, which is the adoption cycle, like consumer demand drives tech advances in investment, where are we in the web three space with regard to this dynamic? And how does this inform the space in which projects are making strategic decisions? It's going to address the second part of Tim's question, which I have found actually even more interesting, which is how this informs projects making strategic decisions. And the variation that I'm more fascinated with here is this question, which is start in me first and then grow.

1:00:15Do they try to go mainstream faster or do they do a bunch of niches and aggregate those, like how to think about that strategically. Do they go in thinking like here's what we should do? I just wonder if you have a quick answer. Yeah, it's a great extension of Macro question and you're actually asking a micro question. So first of all, there's a general piece of advice I often give in platform design, which is a lot of successful marketplaces and platforms more broadly start with a very broad approach. discover a specific vertical or version of the product that works very well, narrow to that, and optimize it like crazy, and then expand out again.

1:00:57Wow. Okay. So, one part of the answer on platforms is you often are in fact neither sort of going niche or broad. You're actually sort of doing both, but in sequence. And the idea is, like, you know, think about like, you know, early testing and minimum a viable product, you might not know precisely who your customer is or what the most viable use case for your product is at the outset. You've launched a crowdfunding platform and you don't really know whether it's going to be most effective for crowdfunding for art projects or for finance education or you have no idea what it's going to be useful for.

1:01:37You might start by trying all those different types of campaigns, a small number of them and see which stick. And then you discover that it's working really, really well for crowdfunding, like large scale, like, you know, theater performances or something like that. And they're like, okay, well, let's scope to that now and like really work on this theater vertical and figure out how we can like optimize the product for that. And then once you have like a really strong theater vertical, that's your beach head. Now you have like a regular user base, regular customers, and you can go to the people who are funding the theater performances and say, well, you don't just do theater, right?

1:02:12Like, what else would you want to see on the platform? And maybe they say, oh, yes, no, I don't just like theater. I also like various, like, you know, design and tech. And they're like, okay, great. Let's do design and tech. And so you start crying to find some campaigns and design and tech. And you do user crossover from your theater vertical. And so you start broad, discover like what fits. Nero, focus on that and then build out. Let me add one other footnote that's Web3 specific. The other thing that's very special about Web 3 in this context is that that build out component becomes much easier, right?

1:02:49Like again, because your core users are invested in the platform success, there's a sense in which like, you know, initial value can be fostered among a very small like initial community and then they help it broaden literally. They'll find other people who like, you know, want the theater vertical. And they'll be suggesting stuff like, gosh, my friends who were into theater are also into design and tech. And they might even help you build that or like recruit that sort of additional community. And so the value of a core community of users has grown dramatically relative to before because they're not just you're like evangelists, but they're also the people who help build and sort of broaden your use cases as you go.

1:03:32It's also kind of goes ties back to your community cohesion point because not building for themselves they're building for all or their their their interaction effects which also strengthens and turn their ties to that community then kind of further feeding it. Exactly spot on. Yeah that's super fascinating. Okay he has another question from which is how do you optimize a platform for growth or some other goal when it doesn't align with your power users desires and your power users actually have voting rights like indirect governance. And this is a really interesting question because we're not going to have decentralization because that's too big of a topic and it's a throughline through all of this.

1:04:08But obviously like no individual can make a decision on behalf of a community or network that's part of the whole advantage of Web 3. But the idea being that at least in the early days or you know before a platform has progressively decentralized there are some early decisions that maybe some of the you know community early decision makers may make to help set up that platform as it evolves. And I guess the real question here is like, how do you think about strategy and growth when you have this like a very unique case of Web 3 basically? You don't have like a classic manager that Porter was talking to you back in the day.

1:04:44Oh, absolutely. It's a very real issue, right? Like when you have partially or fully decentralized governance, or even when you have centralized governance, a platform's short term incentives are often not aligned with the long -term incentives. And that's honestly why a lot of web too has become so extractive. You know, in the short run, it's always better to like extract more today. But in the long run, that means that the users leave your platform at the earliest opportunity they actually manage. And similarly, you think about like a big community with a treasury or something. One thing you could do is you could invest the treasury and like building it in the bringing in the next like a 100 ,000 users.

1:05:20Another thing you could do is throw a big party for everyone in the community this week. Yeah. It's not actually like incorrect for people to have a preference for being in a party rather than doing some like very complicated abstract thing for a potential future return. So this alignment problem is hard It's been hard in companies historically and it's hard with with governance in web3 platforms as well Yeah One advantage of course in web3 towards this is that token holders You know, in effect share some alignment with the overarching platforms goals, right? Like, even if all the token is arcade token that can be used in all the different like mini games, the platform is building out, those tokens are more useful to you if the platform could build a lot of really cool mini games.

1:06:06And so there is a sense in which you at least have some incentive to vote in alignment with the platform's long -term interest, but it's still very hard. And even just the communication piece is hard, right? It's not always clear that everyone agrees on what the platforms best, long run interest is. So even if you didn't have the incentive challenge of like people wanting to extract value today, you might have the issue that people still don't know what the right direction is. Startups are in a haze of massive uncertainty. Right. And then you add Web 3 exactly exactly. But but then on top of that, as you say, there's this like incentive to vote your own your own private optimum rather than what is what is best for everyone.

1:06:43Yeah. We're going to have to see how this plays out. But But the strongest technique we have for this is shared ownership. That strengthens their incentive to want the platform to succeed, not just in terms of their creating and contributing to it, but also trying to guide the platform and what they at least believe is the best direction. Yeah, totally. So a couple more quick things. So when you're launching a marketplace, a particular platform, do you go after supply first or go after demand first? That's a common question. There's also this common question about like the bootstrapping problem, the chicken egg bomb.

1:07:14What advice would you give to Web 3 builders for how they should think about launching their platform? So, you know, you hear all this all the time, like, you know, the chicken and egg problem of platform launches. And this, again, not specific to Web 3 at all. It's just, it's a general principle of platform business that you have to figure out how to get your initial users and start creating that network effect. People frequently talk about platform launching, and, you know, in these sort of, like vague, like, you know, and very doctrinaire, like go after supply first, go after demand first, right?

1:07:44And I want to emphasize for an individual platform, right? If someone is advising you on an individual platform that you are launching, going after supply first or going after demand first, like this actually might be like the correct instruction. But there are people who just tell you, like it's always harder to get supply. You should always get supply first, like just, you know, make that work and if no one's going to supply in your platform, you're like, you know, forget it. But, but like fundamentally, like, it's not what economics has taught us, rather. And this This harkens back to a lot of like Tom Eisenman's work, a lot of like classical economics and strategy research on how to grow two -sided and multi -sided platforms.

1:08:17The real question to ask is who do you have to subsidize and who is going to like, you know, pay you to use the platform? And it's really about recruiting users who create the most value for everybody else, right? To launch your platform, you want to bring in some users who will kickstart a really strong network effect. maybe go to your initial developers or your initial liquidity providers and say, look, we need you for this platform to succeed. We're going to like give you like tons of discounts or early access or even to develop for us initially. And then meanwhile, that activity draws in users.

1:08:54That kick starts the network effect. Now there's a way for users to actually use the platform. And so you might then charge users. But the key is that these roles don't necessarily stay static over time. Like once you're like a thriving ecosystem, maybe you only subsidize certain market developers, whereas everybody else actually pays to use the platform or pays to have access. So chicken and egg is not a rigid like, oh, it's always the suppliers, it's always the developers, it's always the demand sites. It's who creates value for others? Who like grows that network effect as quickly as possible?

1:09:29And how much value do they put on using the platform? right? If you have to like convince them to use it, you're subsidizing them. If they have intrinsic demand for it, then maybe you don't need to. And quick bottom line on this, like where this is really kind of different or more nuanced in Web 3. Well, the way I think about the big change here in Web 3 is you have many new ways to subsidize. It used to be that the like form of subsidization was usually giving discounts, right? Or literally paying somebody to show up. Right, I was thinking of like paying celebrities to show up and that feels very not really sustainable because they pretty much leave after that.

1:10:04Exactly. It's super unsustainable. Here there's this opportunity, at least in principle, where you could subsidize people by giving them tokens that sort of like give them more value, you know, that's aligned with the activity they're conducting. If you give your initial, like, you know, developers or liquidity providers, or whomever say, you know, a bunch of tokens, then not only does this, you know, sort of, you know, drive them to participate right now, but it actually gives them much more reason to stay on the platform and keep participating in the future. And the value of those tokens goes up if they provide liquidity or develop software or features that attract a lot of users.

1:10:39And if it's successful, because obviously it could also go down, it could go both directions to be really clear. But the key point is that there is a mechanism for that alignment now. Exactly. There's alignment with the activity that they're undertaking and hopeful success of the platform and value creation. And then another quick tactical question, this is based on your paper with John William Hatfield. It's a simple theory of vampire attacks on the point that you made that not only do vampire attacks facilitate price competition, we obviously know that. But the most interesting part is that the Web3 platforms face even more competitive pressures when they have loyalty programs where like a classic traditional platform there would not face that same type.

1:11:19Great. So what would like be your one kind of key advice for how builders and web3 should think about this particular nuance. Great question. So we talked about vampire attacks earlier, and I mentioned that vampire attacks leverage on chain data and often involve a new entrant or an existing platform directly incentivizing an incumbent's top users to switch. If you think about it like with airline points or something, an airline keeps you locked in by giving you status on that airline. You get perks, you get the cheaper seats, you get fancier seats, and that's a form of lock -in. But it's actually not quite as locked in as we might expect, because airlines also have a thing called status match.

1:11:58If you have high status on United, say, and you call up Delta, and say, hi, I'm a platinum user on United, and I'd like to switch to Delta. Delta might say, great. And send you a contract, like ask you to provide proof that you are a United Platinum member. It's very hard to verify. If I, most people, it's a lot of work to do this. Most people don't. Web three makes that type of status immediately verifiable. If I'm a new competitor and I'm watching a new NFT marketplace, I can just see who all the big NFT traders were because it's all on the blockchain. And I can tell all of them, like, look, come to my platform.

1:12:32Instead, I'm going to give you platinum tier status where you get to use all the fancy features. Full stop. You don't have to like, fax me a copy of your United ID card or whatever, like, I can see it. I know your high status. I want you to be high status on my platform. And so it's strengthened the vampire attack strategy, because now there are much lower costs to doing it. But I rightly, loyalty is still to some degree the defense. It just takes this different form. Loyalty is not just about giving people stuff. It's easy to replicate. Loyalty now becomes integrating people into the brand. It takes on purpose and identity for you.

1:13:10So an NFT trading platform wants their users to like want to use them and to feel attached to the platform. And it can do that in part through giving them premium features. Sure. But it mostly has to do that by leveraging them as a group together and forming identity around the platform. That's fantastic, Scott. That is so interesting. Thank you. But I do want to take a step back and say, it sounds to me like you're what you're also saying is it's kind of still early days for business strategy for Web 3. Absolutely. There's this unbounded Web 3 value in theory, but to make it practicable, we actually like have to solve these strategy questions to figure out how value capture is going to work.

1:13:50Yeah, even though if we have ideas of how it may play out, it feels like at some point we may have even abandoned a lot of these old frameworks and models and come up with entirely new first principles based ones because I think it's unprecedented in human history that that we have ever built businesses in this manner at this scale ever. I don't know. You can check me if I'm wrong. I mean, even past open source projects, like they've never monetized in the way that, you know, the type of composability and interoperability and all these things we're talking about. I don't think we've seen that before.

1:14:24No, I don't think we have. I think you're right. I mean, you say early days. I mean, it's really early days. Yeah. Right? Michael Porter's thinking was a reflection on the history of modern business to date. And even most of the things we know about various eras of the web and web platforms are still relatively recent and still transforming and morphing all the time. A lot of our early understanding of platforms and platform dynamics did not foresee the modern tech and media giants. And so absolutely, I think we're going to need completely new business frameworks. It's like how do you even start to define general principles for value, creation, and capture, and web3, and how do they relate to what we understood about previous incarnations of the web, and another related product movements, like open source software.

1:15:19But this is a super interesting space. And general call to people who hear this podcast, please think about it. And if you have cool ideas, please let me know. I did have one last kind of crazy question. You know, one of the people I've worked with at Xerox Park was Brian Arthur. And he wrote that seminal paper back in like 1996 on increasing returns on the new world of business. He began his paper saying how our understanding of markets and business was like based on stuff from like over centuries ago. And then the shift occurred where the underlying mechanisms that determine economic behavior shifted from diminishing to increasing returns.

1:15:53And that was a very seminal moment. Yeah. I feel like in economics, especially for actually more precisely, economics applied to technology behaviors and software in particular because that's where things really get kind of jiggered up. And I feel like we're in a similar moment in Web 3. And particularly when it comes to this question, because by the way, the other thing Brian, we've had him on the podcast because I had him talk with me in Mark a few years ago. And he actually talked about how like increasing returns can also stop after time. And you have to think about the long term sustainability.

1:16:23And I was wondering, like, what would the analog be for you if you were to kind of come up with a frame or just even a phrase that you would think about for capturing whatever the effect is in Web 3. I mean, this is all very rough and I don't have a, I don't have what I would call like a coherent or complete economic theory around this. Like, of course, as an echoer, theorist, I've always wary of like declaring a theory that I can't at least like visualize the theorem. But my rough instinct is that what we see in Web 3 is what you might call like expanding returns. That like every new thing that's created sort of creates a new like ecosystem of possibilities, which is a little bit like loosely like what's called an expanded graph and graph.

1:17:05Yes, but stay tuned. Maybe we'll do that in a in a future episode. Oh my God. I love that. That's a perfect note to end on. Awesome. Well Scott, thank you so much for joining this episode. That was so much fun. Thank you. for me too.

1:17:21Thank you for listening to Web 3 with A6 and Z. You can find show notes with links to resources, books, or papers discussed, transcripts, and more. At A6 and Zcrypto .com, this episode was produced and edited by Sonal Chauxy. That's me. This episode was technically edited by our audio editor, Seven Morris. Credit also to Moonshot Design for the Art, and all thanks to support from A6 and Zcrypto. So to follow more of our work and get updates, resources from us, and from others, be sure to subscribe to our Web 3 Weekly Newsletter. You can find it on our website at a6nzcrypto .com. Thank you for listening and for subscribing.

1:18:00Let's go!