a16z Podcast - Network Effects, Moats, & the Business of web3

Episode Date: June 23, 2023

with @skominers @smc90In this deep dive and tour through key business concepts, from theory to practice, we cover the topics of strategy, competitive advantage,  network effects, moats, and more -- covering both both basic foundations, as well as the tricky nuances in a new world of open source, including web3.  In the first half of this discussion, we cover foundational business concepts and questions -- such as the nature of competition, and how it *really* changes in web3; as well as how network effects really work -- and then, in the second half (in case you want to skip ahead), we cover mindsets and general guidance for builders…Our expert guest -- in conversation with editor in chief and host Sonal Chokshi -- is a16z crypto research partner Scott Duke Kominers, who is also a professor at Harvard Business School; a faculty affiliate in Harvard’s Department of Economics; and advises several companies on marketplace development, incentive design, and more; as well as advises, and is directly involved, in several NFT communities. Scott also teaches on these topics -- both at Harvard and also recently at our Crypto Startup School -- so be sure to subscribe to our playlist for those talks on the a16z crypto YouTube channel to get the latest updates as we release more videos from the 2023 cohort.  Listen to web3 with a16z: https://web3-with-a16z.simplecast.com/related links // see also:Can web3 bring back competition to digital platforms? by Christian Catalini and Scott Duke KominersWhy build in web3 by Jad Esber and Scott Duke KominersVampire attacks: A theory (and thread) on 'blood sucking' platform competition by John William Hatfield and Scott Duke KominersWhy NFT creators are going cc0 by Flashrekt and Scott Duke KominersDecentralized identity: Your reputation travels with you by Scott Duke Kominers and Jad EsberIncreasing returns and the new world of business (1996) by W. Brian ArthurNetwork effects, origin Stories, and the evolution of tech with W. Brian Arthur, Marc Andreeessen, and Sonal ChokshiThe five competitive forces that shape strategy (2008 reformulation of 1979 paper) by Michael PorterStrategies for two-sided markets (2006) by Tom Eisenmann, Geoffrey Parker, and Marshall Van Alstyne Stay Updated: Find a16z on Twitter: https://twitter.com/a16zFind a16z on LinkedIn: https://www.linkedin.com/company/a16zSubscribe on your favorite podcast app: https://a16z.simplecast.com/Follow our host: https://twitter.com/stephsmithioPlease note that the content here is for informational purposes only; should NOT be taken as legal, business, tax, or investment advice or be used to evaluate any investment or security; and is not directed at any investors or potential investors in any a16z fund. a16z and its affiliates may maintain investments in the companies discussed. For more details please see a16z.com/disclosures. 

How strong is the network effect? How much pull do users sort of exert on each other? Does the platform sort of achieve over time? There's a much greater threat in Web3 that like your entire network could just get like moved to a competitor. Could even be like a copy. There's an opportunity when convert your users into people who have a true preference for your platform. They actually want to use your platform over competitors. The ideal of Web3 is not that you sort of have these platforms that have

locked in a bunch of users and are just extracting value from them. To the contrary, you have engaged users who are sort of in a real sense, like part of the platform. In Web 1, you were the consumer. In Web 2, you were the product, and in Web 3, you are the brand. Hey, A16C podcast listeners. This is Steph, but today we actually have a very special treat, which is longtime showrunner, So Don't Choxi, returns for this episode, and she is joined by Scott Commoners. And together, they discuss a subject very near and dear to A16C, network effects. They discuss so much, including the misconceptions when it comes to network effects, how to effectively kickstart them and bring in the right types of users early,

and also how competitive forces change with Web 3. For example, protocols can be immediately forked and users can exit more easily. So how do you build something that's really sticky? Scott makes a wonderful point on developing and new lens on loyalty. So make sure to listen in for that. And even though this focuses on Web3, in the AI era, understanding competitive forces and how to build a real moat is as important as ever. All right, I hope you enjoy this episode from our sister podcast, Web3 with A16C. And if you want to hear more from Sonal and other A16C crypto team members just like Scott,

make sure to go subscribe to Web3 with A16C. wherever you get your podcasts. Oh, and I have to tell you this. We have an amazing episode dropping next week. Without giving too much away, I got to try a technology that I have been waiting for for no joke, no exaggeration over a decade. You know, I've been at 816Z for now over a year, and honestly, this was one of my favorite experiences yet. So I hope you'll tune in. And if you really cannot wait until then, you can head over to our YouTube channel to see a teaser that we just released. All right, Sonal, Scott, take it away.

Welcome to Web 3 with A6 and Z, our show about building the next generation of your internet. I'm your host, Sonal Chuxi. And while this show is for anyone working on or interested in blockchains and crypto, whether entrepreneur or creator or policymaker, today's all-new episode is also relevant to all kinds of technology.

businesses, because it's a deep dive on the business strategy behind competitive advantage, network effects, moats, and more, covering both basic foundations, as well as the tricky nuances in a new world of open source, including Web 3. As a reminder, none of the following is investment, business, legal, or tax advice. Please see A6Cency.com slash disclosures for more important information, including a link to a list of our investments. Our expert guest today is A6Cryptor research partner Scott Komeners, who is also a professor at Harvard business school, a faculty affiliate in Harvard's Department of Economics, and advises several companies on marketplace development, incentive design, and more, as well as advises

and is directly involved in several NFT communities. Scott teaches on these topics, both at Harvard and also recently at our crypto startup school, so be sure to subscribe to our playlist for those talks on YouTube under A6 and Z Crypto to get updates as we release more videos. In the first half of this discussion, we cover foundational business concepts and questions, such as as a nature of competition and how it really changes in Web 3, as well as how network effects really work. And then, in the second half, in case you want to skip ahead, we cover mindsets and general guidance for builders. So, Scott, the focus of this episode is all about business strategy for Web 3. Now, that is a

meaty topic, and that's a lot to cover. But this episode is really meant to be both for existing business leaders seeking to understand new strategies and where the future is going, as well as people who are already in Web 3 and trying to figure things out. Start things off, like, what would you give us as a framing mindset for how to think about business strategy for Web 3? Absolutely. So almost every Web 3 business is an example of a platform. And I use a very broad general definition of platform.

So a platform isn't just, you know, a two-sided marketplace where there are sellers on one-sided buyers on the other and the platform is mediating between them. Rather, platforms are any context in which a business is engaged in enabling people to interact with each other, but it's characterized by network effects. The more people on the, or users on the platform, the more powerful and higher quality of the average interaction is. And I should emphasize that platforms are not a novel business model to the internet. Credit cards are platforms.

You know, the more people have a credit card, the more firms want to use it. it and vice versa, the more firms will accept a credit card, the more people want to use it. And very broadly, Bitcoin is a platform. It's a network for sending, you know, for sending value from one person or entity to another. You know, an NFT project, like the Borde ABIot Club is a platform, right? That's a community, right? It's a brand as a platform, a way to connect people with a similar aesthetic and shared interests and enthusiasm with each other. And it has network effects, the more awesome people are in an NFT community, the more valuable it is to be in

that community. So all of these businesses, virtually all of them are in fact platforms. And a lot of classical platforms have managed network effects by creating walled gardens. But Web3 is about doing the opposite. Web3 platforms operate on blockchains which are public and according to technology

standards which are interoperable. So if you create content on your platform, it can typically be seen on the blockchain by anyone, And then, you know, transferred or utilized or referenced by other platforms. Yeah, it is the opposite of a wild garden. It is a public garden. Exactly.

It's actually like trying to be as open as possible. Wow, I don't think that I've ever heard that term in reference there, but we should totally use it. The opposite of a walled garden is a public garden. Well, it's dangerous, though, because it has allusions to, like, the whole history and origin of the tragedy of commons work back in the day in Central Park. So we can get into some weedy areas if we go too far down the analogy. But it works for the purpose of just, like, you know, what we're trying to say here. which is great.

Cool. And then it's not a wild garden. Yep. I mean, this necessitates a very different thinking about what your platform is and how it's going to work, right? You typically can't maintain network effects by locking in users if most of your platform data is stored publicly and the users have control over their data assets

and can just take them from one platform to another. And so on one hand, almost every Web3 business is fundamentally building a platform. On the other hand, we're in an environment where, maintaining platform dominance has gotten much harder. And so you have to think very carefully about what your strategy for value creation is. And then also how you manage value capture. How do you actually get value out of your business in the end? Great. So before we dive into specific nuances of network effects in crypto, and I do want to go into that for sure. I also want to talk about some other classic models and contrast them to Web3. So one great example is a classic. I mean, you know,

professor at Harvard Business School, like of all people, you should know all about, you know, Michael Porter's Five Forces. But that is a common, another mental model that comes up often in thinking about strategy in any business action. Can you walk us through what that is? Because what I want to do is set up a lot of the frameworks that are kind of common foundational thinking and how they contrast in Web 2 and Web 3. And then we can dive into others more deeply. Yeah. So Michael Porter's Five Forces is one of the most influential business frameworks, a condensed way of thinking about how do you find and maintain a competitive advantage? And competitive advantage is a term that gets thrown around casually a lot. People say like, oh, this is my competitive advantage. My business does

this. But first, let's just be like really clear about what it means. In Porter's view of the world, competitive advantage is a distinction of your firm relative to others, and it's measured in terms of value creation. Competitive advantage isn't like saying, I'm, you know, I'm really good at software engineering. That's my, it's my competitive advantage. Because the question isn't like, are you good at this thing, but rather, how does it map into the output? Right, the value creation. The value creation. Like, are, like, does the, fact that you are good at software engineering, enable your firm to deliver a superior product or a lower cost product or both. Have you expanded the value that is created by your business

operation? And, you know, it's about performance, right? It's not like just, are you good at this thing, but rather, how does that affect your performance and enable you to outperform your competitors in some way? Right. And secondarily, it's key that it's relative. It's all relative to competitors, right? Competitive advantage is not absolute. It depends on who else. else is in the market, who is competing with you and what their relative expertise and abilities are? Which means it could change depending on which categories you're stacking up, which competitors against, or if you're a business that has multiple categories, or it can change, obviously, as a market changes, et cetera. So that makes a lot of sense. And then what are the

nuances when it comes to thinking about a model like quarters, five forces and, you know, sources of competitive advantage and where platforms come in to Web3? Great question. Okay. So from competitive advantage, what are the five forces? So the five forces shape competition in that industry and affect how easy it is to attain competitive advantage. So first of all, there's just like general competition among your rivals, right? So there's sort of the static state of like what are all the businesses building similar products, competing for the same users, sort of how strong is that rivalry, how intense is it? And what are those firms? Oh, and I should say This is usually represented with a circle in the center, which is competition among current rivals.

And then, you know, the other four forces are usually oriented around it, like a compass rose, I guess, northeast, southwest. You get the idea. So the circle in the center is the current competitive landscape. And then on one side of that is new entrance. So if this is a particularly valuable market or if someone, you know, invents a new technology that enables them to enter, they might show up and become a new competitor. the new entrances west and east is substitute products. So not someone who does what you do, but someone who does something that the customers want just sort of as a replacement.

So think about this with the social media wars. One ongoing threat to the competitive advantage of any social media company is the possibility, not that somebody new will come and compete with them directly. It's proven in many contexts to be very hard to compete with the dominant social media platform with a given function because the network effects are so strong, but new functions evolved competing for the usage share of social media. To me, the best example of this is Facebook as a social network versus Instagram. Yeah. It's a substitute and they could see people engaging actively there in a very different way. Another example might be like cable and you

could have new entrants in the form of more cable providers, but then you have a threat of a substitute like on demand. On demand streaming. Perfect. Beautiful illustrations. So that's west and east. So then north and south, think about like a supply chain. So above, there's the bargaining power of your suppliers and below there's the bargaining power of your customers. And so if something happens that gives the customers more bargaining power, could be a change in law, could be like a change in the demand structure, like maybe the customer's bargaining power could go down, right? If they discover they really like absolutely need it, something that was previously social becomes a critical work function. The other forces that shaped competition,

are these relative levels of bargaining power, right? It's like how well can you bargain relative to your suppliers to whom you're paying and your customers who are paying you? Right. So those are the five forces. And they're called forces because each of these forces exert pressure onto that industry. Yes, exactly. And then how does that apply to Web 3? So blockchain based platforms store their, you know, store their data in public, which means that a new platform can leverage a lot of that data. By the way, this is an oversimplification, right? a lot of platforms store some of their data in public and some of it in private, but a lot of their critical information, right?

User identity, reputation, you know, the stuff that we think of as most valuable is often stored in the public, you know, on the blockchain, because that's a lot of the advantage that the blockchain is giving Web3, right? It creates this ledger upon which many different things can build and interact. But that, of course, means that it becomes easier for an entrant to show up because they can build on the code base that's available. they can build on all the content networks. And so, you know, that West, you know, point on the compass rose is getting more intense, right?

There's more competitive pressure there. Meanwhile, on East, that was our availability of substitutes. So suddenly now with decentralized protocols, there's often an immediate substitute available, which is just a fork of the original protocol. Yeah, that's true in any open source, right. Any open source context, exactly. And then meanwhile, on bargaining power on both the buy and sell side, One thing that we're seeing is that because users of the platform,

a lot of the critical data and information is stored in their crypto wallet under their control, they have more ability to move from place to place. They can freely pick up all of their data assets and just move them to another platform simply by connecting their crypto wallet. And so there's more of a threat that people will leave. And so in both sides, you know, north and south for bargaining power, you know, the bargaining power of your users is often getting stronger, right? because they have more direct control. And then finally, that circle in the center, right?

Because the users can get up and leave, we're seeing lots of strategies whereby platforms try and incentivize users to switch. And so there's been more intense competition for users because of this relative low switching cost, like flexibility of moving across platforms. And so on every one of these dimensions, there's at least one pressure

that makes the competitive forces stronger. In Web3, it sounds kind of bleak, But, but, exactly, yeah, right? It's like, you know, hang on a second. Two really important things to keep in mind. First of all, on the customer and supplier side, there is something really good going on, too, which is that you have this opportunity to create what my co-author,

actually several co-authors, Jan Isbrough and I have written about this, Christian Catalini and I have written about this. We call community cohesion. There's an opportunity when convert your users into people who have a true preference for your platform. actually want to use your platform over competitors. And ironically, that comes through the same thing that creates this lack of switching costs, right? The giving users a slice of digital

ownership, you know, sort of, you know, controlling assets that come from their interaction with the platform and often give them some degree of governance or advanced user privileges or whatever, that causes people to want to participate in a given platform. It's not that we've somehow locked the users in, but we've actually given them a preference for staying with the platform. Through shared ownership, that's really powerful. That's the thing that we didn't have a way to do previously, at least not at the scale that we're talking about in Web 3. But remember, I said there were two saving graces. One of them is that there is this like completely new way to maintain your network effect, which is maintaining a network of personally invested users.

And the second thing is, while competition is maybe getting more intense in a lot of dimensions, those personally invested users also have, you know, a strong incentive to create a lot of value. The ideal of Web3 is not that you sort of have these platforms that have locked in a bunch of users and are just extracting value from them. To the contrary, you have have engaged users who are sort of in a real sense, like part of the platform, like often, often literally, right? Like they're making governance decisions for the platform. And that doesn't just make them want to stay with your platform, but actually make

them want to help it succeed. And so there's this possibility of like growing the pie far, far larger than classical platform design because now you have this like highly engaged user base, everyone who wants to the platform to succeed because they succeed along with it. I love that. I really do. But to take a step back and just kind of pulse check where we are in all this and this broader context of business strategy for Web3, what I'm really hearing you say is it's hard. It's much more competitive. It's open source. That's the whole point. It's a feature and a bug in some ways. But you have a greater potential for a lot of these other things and we'll

dive deeper into what, you know, builders can do. So now let me dive deep on some of these questions and I kind of want to push a little harder on this idea of competition what you painted feels so bleak to me and to be clear I'm hopeful just as you are that this is just a beginning and we're going to see a lot of experiments play out and then see what happens but in terms of the value capture piece of it the value creation I have no doubt about that is actually the easy half of the equation but the value capture part however I have to ask is there really such thing as competition in this world like I know that sounds like a really basic question but is it going to be some kind of co-optitian or like some kind of, you know, cross-pollination or

whatever, you know, insert, whatever other kind of buzzy word there. I just wonder if there really is such thing as, quote, competition. It's a great question. Okay, first of all, it's important to note as we talk about value capture, that value capture is also to some degree about value creation, right? If there's no way to capture value, then people are actually not going to invest in doing the value-creating activities. So it's not like we're focusing here just on the part, how do you extract?

value from the ecosystem. It's actually more, it's like no one's going to build the ecosystem if they can't extract at least enough value to keep running. That's actually a really important point because that is actually a fundamental mindset shift from Web 2 and Web 3 for sure. Like, that doesn't happen in Web 2 as easily because you have no rights to the value you create for the platforms at all. You're just, you're kind of like captured. What do they say? There's that line that if it's free, you're the product. Yes, if it's free, you're the product. Yeah. No, in fact, my co-author, Steve Kaczynski, says in Web 1, you were the consumer. in Web 2, you were the product

and in Web 3, you are the brand. That's so nice framing. On to your point, though, it's funny because I fell into the Web 2 trap right there. I almost was like, yeah, we don't have to think about this half of the equation as if it's separate, but A, your point reminding that just in general business strategy,

there's obviously a loop between the two, but the nuance in Web 3, that in fact, the users can also be the owners and are incentivized to do so, et cetera, et cetera, et cetera. So our colleague Tim Sullivan frames it as, you know, Web 2 was very much about, you know, the relationship between platforms and users was predominantly extractive, whereas in Web 3, value is much more shared, right? Platforms and users, you know, grow and co-create together and share value together. And then, again, feeding that

into this value creation and capture loop, it's especially important if you're relying on your users to, like, help build your platform with you, that both the platform and the users in the end be able to capture value or else no one actually has the incentive to build. So given that, how would you answer the question? Yeah. So I think there really is competition. I think there's a lot more cooperation than there might have been in previous iterations of technology platforms. There's very much a sense in which it's platforms all the way down. It's a little bit like turtles all the way down. Every piece of core infrastructure is a platform. And so, you know, if you think about it like,

you know, a wallet like Metamask is, of course, a platform. and an NFT trading platform, like OpenC is a platform. And, you know, Metamask benefits from the existence of these NFT trading platforms and from all the people who are creating NFTs, the platforms, the NFT creators benefit from the availability of Metamask and users, you know, sort of interact with all of these different systems. And so all of these things are like cross-pollinating and cross-operating platforms in a way that, like, is much less centralized.

There's always been some degree of cooperation of this form. Think about, like, you know, payment processing companies, right? Like the invention of a more efficient web-based payment processor fostered, you know, growth of lots of different types of consumer web platforms that couldn't have happened without payment processing infrastructure and vice versa. That's kind of like the relationship I've been describing with Metamask and the NFT platforms and so forth. It reminds me of the early days of the API economy as well.

Yes. In the thesis was that, like, there would be like all these different. companies that have like a specific core competence and they would focus on that core competence and then pull in APIs for everything else, which kind of supersized your powers and to be able to do that. It was like this interlocking set of like APIs. Yeah. But here, the scope of every one of these innovations is much broader. The process of integrating one of these platforms into yours or embedding features or something of the sort is as much faster and easier, it has less friction. It's like there's sort of an infinitely public API for for most of

the core content. And so in that sense, there's a lot more composition and collaboration among different players in an ecosystem. So going back to that diagram, as I mentioned on the West and East, it's much easier for new entrants to appear, and it's much easier for substitute products to be created in many contexts. And so, you know, if you build something that works really well, there's a much greater threat in Web3 that like your entire network could just get, like, moved to a competitor, could even be, like, a copy. You know, some new entrant can try to capture all of that activity by, you know, directly incentivizing users to switch. This is what's, you know, referred to colloquially as a vampire attack. And I know it's a funny

name, of course, because, you know, vampire attacks are actually like, blood-sucking. Exactly. It's like trying to suck the lifeblood out of your competitor. And of course, that's good from a competition policy perspective a lot of the time, right? Like, we have actually, like, want more competition among platforms. We'd like users to be less locked in so competitors can, you know, can show up. But of course, you know, a competition policymaker and say, we really want to incentivize more vampires in this market, right? That they'd be like, really? Like, you're sure you don't mean you want to buy more garlic? Yeah, totally. Now, fun little fact that you don't know, Scott, is I'm actually super into vampire lore and fantasy

literature, which we both have shared an interest in and talked about, but like, I admit, I didn't know that specifically, but if you asked me, how much of money, I was willing to bet on that fact. It would have been a very large amount. You know me well. But basically, it's funny because one of the things that does come up pretty often in vampire lore is like that nature balances the powers of the vampires. And that's why, for instance, they come out at night.

And, you know, that's why, like, there's certain things they can't do. They can't procreate. Like, there's all these, like, funny rules of vampire lore that cuts across many, many pieces of vampire literature. That's awesome. Yeah. And it's funny because it actually applies here in that if you think, think about it, like a company can do a vampire attack, but that very thing you described earlier

that there can be community cohesion as a defense, then that is where the nature of Web3 is providing a check and balance in a way. But I think it's yet to be seen how that plays out just to be very precise here, because I don't want to overstate it. And I do want to ask you a little bit more about community cohesion. But before we do, you have mentioned now network effects a number of times. Just to give the listeners context, we have covered network effects a lot A6 and Z crypto and A6 and Z. And I've worked on all of that content in the past. And in particular, 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 the other half of it, is adding value for the rest of the users. Yeah, they forget that it's actually about value creation.

Important footnote on that is that, you know, 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. If 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, right? 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

three pages of advertisements or something. And so there, you know, 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, you know, as we add, you know, 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 had to look at the value of the total and not worry so much

only about, like, creating this super pedantic definition of value for all users. It's creating value for all users in 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, then there's a good enough outset 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 it's net value and aggregate might be higher,

is much harder in Web 2. There's a really high barrier to exit. It's hard to exit. And 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. Web 3 is, as we've been saying, in a lot of ways, the opposite, right?

Yeah. You have all of 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, you know, Web 3 enabled social media. It was Farcaster. And 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 taken all of that connection with me. Totally. Just to 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. But 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 themselves are the platform, and that is now portable. That's so fascinating. Absolutely. And this goes directly to this 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 NFT or a subduck or a board ape or whatever, the 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 are the thing that they want to use across the internet. And so you think about Web3 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, like, would be dangerous. Here, like, that's actually very powerful because it draws more and more activity and value back to the underlying Farcaster protocol. It becomes more embedded. Right. And it goes back to your way earlier point. It's increasing in 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 Web3 bring back competition and digital chronicle? Yeah, can Web3 bring back competition in digital platforms? But you do point out that Web3 could reduce the fundamental costs of verification,

the cost of interoperability and portability, and the cost of composability, which is exactly kind of what you're talking about there. Yeah. But it's funny because And 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's article posits 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 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. Oh, same 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, defy 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 and quality. Or they're often asking, will this reduce the quality of the customer experience? Or they're going to like pay more because, you know, now prices go up because there are fewer competing companies, you know, or is 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 we see like Web3 is rife with. But the question is where do that go? What it really

turns into is the platforms having to work to retain consumers to like 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, right? Development of features, development of rewards and loyalty programs, right? Developments 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. This is how you actually learn stuff. Yeah, exactly. You push on a thing and I'm 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, Chris Dixon has a great line, how composability is to crypto, what compounding is to finance. It's this idea that it's like an exponential force and 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. and 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 it can be a little jargony. Totally. Okay, so first of all, just what is composability? You know, it has a technical meaning in the context of software, right? Software, you're embedding, like, existing software components into other ones, you know, into new ones, and so you can, you know,

sort of use their operations as inputs to whatever your software is supposed to do. But at a business level, what it means is that you can build on top of other, you know, sort of other things that have been created. It's not just about software. It's not just like about functions that are sitting like 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 rod of wrath or whatever I don't remember any of the actual like loot items

but it's stuff like that and 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 2 infrastructure platforms. Once there was a bunch of out-of-the-box web platform creators, now if you had a really good idea, you maybe didn't need to also be a ridiculously good software engineer at the beginning,

you could integrate a bunch of tools together and launch a pilot, you know, a minimum viable product with almost no complex software engineering. Web3 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. It's all of that rolled into one big snowball, right? Like, you know, you can, 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 It's kind of in the early days of Google when Halavarian, who was the chief economist there, wrote about combinatorial innovation, and it's so dagony of a phrase. 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 feature, which is a big difference in the kind of early days versus now.

because you have literally primordial ingredients that aren't fully baked 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-futoredness to it too. That's such a cool point. You're exactly right, right? You know, imagine if 10 years ago anyone ever said, you know, 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 like invite people to build.

Totally. And so it's possible to have these like micro components. Like people can launch products where the product is basically just like some tiny input that goes into everything else. And by the way, obviously AI will play a big role in SuperTargent when you think of the creative AI that is exactly. Totally. And even in the early days, right?

It was only meant to be like 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 like, let's do like so and so on Thursday. And the community did all that and they got nothing for it in creating that value. So kind of coming full circle, now there's 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.

Yep. But 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 delinked 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. Yeah, totally agree. And now let's switch into... Let's get tactical. Yeah, let's get tactical. Let's get tactical. Let's get tactical. Sorry. Do you guys remember that song from Olivia Newton John? Let's get physical. Let's get physical. Oh my God, that's so good. My voice doesn't go that high.

That was really funny to hear you trying 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. So in terms of breaking this down, I think a good place to start for the builders in the audience is like, how would you help them understand the key aspects of

network effects? And then how did they sort of think about it, depending on what type of thing they're building in Web3? 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. It's like how strong is the network effect? How much pull do users sort of exert on each other does the platform sort of achieve over time? And note, you know, there's absolute strength and then there's marginal. It's like how much, 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, you know, really benefit from there being a lot of people in the network. You know, 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 on the platform. And people who are not actively looking for jobs might also benefit some because think about all those inbounds. You know, one gets on LinkedIn or whatever. But they might not benefit as much from having all those jobs in the platform because they're mostly happily situated.

And so there might be dispersion 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 spot. but the fact that you're a bike share customer in Boston has very little implication for whether you have any interest in bike shares in New York or San Francisco or whatever

and 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 a la carte 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 on to 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. Even 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, you walk by some other Swifty wearing their Taylor Swift shirt, you could 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. Like, 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 gain 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, those fundamental assets 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 contexts that used to be walled gardens. So there might be a stronger core network effect to the underlying protocol for a Web3 social media platform, but there might be a much weaker network effect than before for any individual app that serves that protocol. I need like a bottom line. So the bottom line is that Web3 has strengthened a lot of classical network effects,

but it's also moved where they reside, right? The strong network effects are often tied to the digital assets, to the sort of, you know, the networks that sprawl across the blockchain, rather than to sort of 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 Web3 often allows

these kind of network effects to be portable in that sense or like tied to a different entity. Okay, 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, yeah. Valance is like positive, negative.

I don't really remember my chemistry classes either, but it's about, you know, it's about direction and sort of 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 like new network effects, the new opportunities for positive network effects, right? This is, this goes back to the composability, point we were talking about earlier, like, 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, like, 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? Are 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 unveilance 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. And then the Web 3 opportunity. The 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. Okay. And 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 to 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 defensively it is. So does your network effect come from liquidity, which could be the presence of lots of drivers and riders in a ride-hailing platform? So they can, you know, you can ensure that if you're out driving, you can, you'll have people to pick up. And if you're looking for a ride, you'll be able to find a driver. Or, you know, in an NFT, I'm sorry, I keep using NFT examples because I'm a total DGEN.

But an 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. And 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 civil. similar quality experience elsewhere. And in Web 3, we're seeing a lot of those old sources of network effects that become much less defensible. Awesome. 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. at 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. And 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 Web3 when you mention moats that the moats 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, band you that about a little too casually and easily for my satisfaction. You know, it's funny, one of my longest term collaborators on Web3, Chad Esper, he was one of my former students in my MBA class, one of the strongest students I've ever taught. He and I have been trying to really clearly express like how we think about MOTS and Web3 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 moats, 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 know, you're a used car platform and you can offer a really cheap insurance because you have a lot of know-how about the cars. Or network insight, like Amazon with its logistics operation, it can move the products to places before the people place orders because it sort of knows

what's going to be ordered when. Or platforms can create defensibility through standalone value, technical advantages, things that they do that are just superior. This is you asked about design. Possibly even through partnerships and sometimes also through multi-homing costs, you might have a defensible,

competitive advantage of simply because it's hard for users to deal with using multiple platforms at once. Maybe it's easier to only have to search on one online restaurant platform or something. So 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 going to a road faster than they used to.

Although I would argue on that one, a counter 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. No, no, I totally agree. 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 at high-tech firms. As Web3 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, totally. But like, the core platform competitive advantages have mostly weakened. There's one, though, that really stands out as having strengthened tremendously. And 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 like propagates credentials for them. That's embeddedness, right? That makes Gmail a necessary service. Even if you didn't have all of your emails 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. But even if you took all of that away, like if tomorrow, like all of the email became suddenly like 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 its 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 both payments and messaging combined

that became the interface to everything in the old world. And 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 a decentralized identity. So there's like a lot going across the board on that embeddedness 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 advantage through embeddedness. Like it's just used in so many different services.

Web 3 opens that up and again, it opens it up to everything. Yeah. Your crypto wallet can be embedded in many different services, but also so can your NFTs, so can your digital diploma, like so can a simple function protocol you wrote, like something like disperse. Cash can become part of many different finance products. That software embeddedness, which you mentioned open source earlier, like this was also true in open source, right? It's like, how do, how did like 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, the open source history person. Yeah, you're like a literal expert on this. A couple of quick notes on that. It's really interesting when you compare like 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 system 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. Yes. And therefore no incentive. Yeah, no, 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, you're right. And 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 Web3. Now I want to also have you answer the second part of that question, and you already answer the first part. Same for community. So like what are the nuances there? Like how much of a moat is it really? Pulse check it for me. Great question.

So first of all, I should emphasize that, like, to me, 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. 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 like They like good tools to do so.

Web3 makes it possible to turn your consumers or your users into people who are personally invested in the platform's 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. NFT communities are a great example of this, but we also see it for far less branded platform context. Think about like everyone who participates in governance on a defy platform or something to calibrate the protocol and sort of 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 moat around a user base that like really

wants to attach to it, that wants to use its product rather than a competitor's or or rather than building their own and even better wants to contribute to making what they do higher value. We haven't really seen these things play out at scale yet because it's just too early, but we've seen really powerful examples of it, at least in play already. And it reflects a like 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 and you want to like engage with them and not just like hang out but hang out in reference to and like sort of like more

deeply engage with the assets. Yeah. I mean, I've been thinking a lot about the nuances while you're sharing all this like how is this different than a fandom? How is this different than any other community? It's 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, God, 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 tie 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 intrascribes, graphs and like affiliate interests, like, it's actually really kind of core meaning at the part of it. Yeah, 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. it. And so we were proud to be on Facebook. We almost felt like we were building the product. We were finding like weird errors and glitches and things. And like you would submit like bug reports and like, you know, they would go and fix the very unusual like bug that you had noticed. It 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 Web3. 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 former editorial director at HBR and he was executive director of UC Press and is now on my editorial team here and works with you as well closely. So I actually think this is a very, interesting question particularly the second half, which is the adoption cycle, like consumer

demand drives tech advances and investment. Where are we in the Web 3 space with regard to this dynamic? And how does this inform the space in which projects are making strategic decisions? I want to address the second part of Tim's question, which I figured out on actually even more interesting, which is how this informs projects making strategic decisions. And the variation that I'm most fascinated with here is this question, which is start niche first and then grow? Do 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 a 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. Wow. 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 viable

products. You might not know precisely who your customer is or what the most viable use case for your product is at the outset. Like, 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, I don't know, like, sort of finance education or, like, you have no idea what it's going to be useful for. And so you might start by trying all those different types of campaigns, a small number of and see which stick. And then you discover 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 beachhead.

Now you have, like, regular user base and regular customers, and you can go to the people who are funding the theater performances and say, well, you don't just do it. theater, right? Like, 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, narrow, focus on that and then build out. Let me add one other footnote

that's Web3 specific. The other thing that's like very special, about Web 3 in this context is that that build-out component becomes much easier, right? Like, 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 are into theater are also into design and tech. And they might even help you build that

or 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 your evangelists, but they're also the people who help build and sort of broaden your use cases as you go. It also kind of ties back to your community cohesion point because they're not building for themselves,

they're building for all or their interaction effects, which also strengthens, in 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, which is, how do you optimize a platform for growth

or some other goal when it doesn't align with your power user's desires and your power users actually have voting rights, like in direct governance? And this is a really interesting question because we're not going to talk about decentralization because that's too big of a topic, and it's a through line through all of this. obviously, like, no individual can make a decision on behalf of a community or a network.

That's part of the whole advantage of Web3. 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 Web3 based? You don't have like a classic manager that Porter was talking to back in the back in the day. Oh, absolutely. It's a very real issue, right? 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 2 has become so extractive. In the short run, it's always better to like extract more today. But in the long run, that means 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 can invest the treasury and like building in the, bringing in the next like 100,000 users. Another thing you could do is throw a big party for everyone in the community this week. 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 web three 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 platform's goals, right? Like, even if all the token is, an arcade token that could 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.

And so there is a sense in which you at least have some incentive to vote in alignment with the platform. 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 platform's best long-right 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 then on top of that, as you say, there's this incentive to vote your own private optimum rather than what is what is best for everyone. We're going to have to see how this plays out. 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 they're 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 or a particular platform, do you go after supply first or go after demand first? That's like a common question. There's also this common question about like the bootstrapping problem, the chicken egg problem. What advice would you give to Web3 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? And 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, like, you know, forget it. But, but like, fundamentally, like, it's not what economics has taught us. Rather, and this harkens back to a lot of Tom Eisenman's work, a lot of classical economics and strategy research on how to grow two-sided and multi-sided platforms. The real question to ask is, who do you have to subsidize and who is going to pay you to use the platform?

And it's really about recruiting users who create the most value for everybody else. 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, you know, give you like tons of, you know, discounts or early access or even pay you to develop for us initially. Yeah. And then meanwhile, that activity draws in users, right? That kickstarts 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 marquee 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? And 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 form of subsidization was usually giving discounts.

Right. Or literally paying somebody to show up. I was thinking of paying celebrities to show up and that feels very not really sustainable because they pretty much leave after that. Exactly. 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 of a 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 devisive.

develop software or features that attract a lot of users. And 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 working paper. It's a simple theory of vampire attacks and 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. Great. 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 in involve a new entrant or an existing platform directly incentivizing an incumbent's top users to switch. If you think about it with airline points or something, an airline keeps you locked in by giving you status on that airline. You get perks, you get 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. If you have high status on United, say, and you call up Delta and say, hi, I'm a, you know, 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, you know, provide proof that you're a United Platinum member. It's very hard to verify. Most people, it's a lot of work to do this. Most people don't. Web 3 makes that type of status immediately verifiable. If I'm a new competitor, 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 instead. I'm going to give you platinum to your 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, like, because now there are much lower cost to doing it. But ironically, like, loyalty is still to some degree the defense. It just takes this different form, right? Loyalty is not just about, like, giving people stuff, right?

It's easy to replicate. loyalty now becomes integrating people into the brand. It takes on purpose and identity for you. 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 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. Yeah, even though if we have like ideas of how it may be, they may play

out, it feels like at some point we may have to even abandon 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 we have ever built businesses in this manner at this scale ever. I don't know. I mean, you can check me, check me if I'm wrong. I mean, even past open source projects, like they've never monetized in like 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. No, 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? You know, Michael Porter's thinking was a reflection on, you know, sort of the history of modern business, you know, 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, right? Like a lot of our early understanding of platforms and platform dynamics did not foresee the modern, you know, 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 in 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? But 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. 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. And 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. Absolutely.

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 and 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. And 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 what I would call like a coherent or complete economic theory around this. Of course, as an economic theorist, I'm 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 expander graph and graph thing. But stay tuned. Maybe we'll do that 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 during this episode. That was so much fun. Thank you. No, it was so much fun for me too. Thank you for listening to Web 3 with A6 and Z. You can find show notes with Lerner.

links to resources, books, or papers discussed, transcripts, and more at A6NCrypto.com. This episode was produced and edited by Sonal Toxie. 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 Z Crypto. 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 A6NC Crypto.com. Thank you for listening and for subscribing.

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