Network Effects, Moats, & the Business of web3

A deep dive and tour through key business concepts -- from competitive advantage and Porter's Five Forces, to network effects and moats -- as builders of all kinds navigate business strategy in open source, and especially web3. How does one compete when you're building (and competing) in the open?

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:01Speaker 00

  How strong is the network effect? How much pull do users exert on each other? Does the platform achieve over time? There's a much greater threat in Web3 that your entire network could just get moved to a competitor, could even be a copy. There's an opportunity when you 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 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, in a real sense, part of the platform. In Web1, you were the consumer. In Web2, you were the product. And in Web3, you are the brand.

• 0:46Steph Smith?

  Hey, A16C podcast listeners. This is Steph. But today, we actually have a very special treat, which is longtime showrunner Sonal Choksi 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 Web3. 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 a new lens on loyalty, so make sure to listen

• 1:31Steph Smith?

  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 enjoyed this episode from our sister podcast, Web3 with A16Z. And if you want to hear more from Sonal and other A16Z crypto team members just like Scott, make sure to go subscribe to Web3 with A16Z 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.

• 2:13Steph Smith?

  You know, I've been at A6Z 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.

• 2:38Speaker 02

  Welcome to Web3 with A6Z, our show about building the next generation of the internet. I'm your host, Sonal Chakse, 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 Web3. As a reminder, none of the following is investment, business, legal, or tax advice. Please see a6z.com/disclosures for more important information, including a link to a list of our investments. Our expert guest today is A6Z Crypto Research Partner,

• 3:22Speaker 02

  Scott Prometors, 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 A6Z 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 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.

• 4:12Sonal?

  So Scott, the focus of this episode is all about business strategy for Web3. 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 Web3 and trying to figure things out. To start things off, like what would you give us as a framing mindset for how to think about business strategy for Web3?

• 4:37Speaker 00

  Absolutely. So almost every Web3 business is an example of a platform. And I use a very broad, general definition of platform. So a platform isn't just a two-sided marketplace where there are sellers on one side and 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 platform or users on the platform, the more powerful and higher quality the average interaction is. And I should emphasize that platforms are not a novel business model to the internet. Credit cards are platforms.

• 5:22Speaker 00

  The more people have a credit card, the more firms want to use 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 value from one person or entity to another. An NFT project, like the Board A B Yacht 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, or virtually all of them, are in fact platforms. And a lot of classical platforms have managed network effects by creating walled gardens.

• 6:07Speaker 00

  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 transferred or utilized or referenced by other platforms.

• 6:27Sonal?

  Yeah, it is the opposite of a walled garden. It is a public garden.

• 6:31Speaker 00

  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.

• 6:40Sonal?

  Well, it's dangerous, though, because it has allusions to like the whole history and origin of the tragedy of common 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 walled garden.

• 6:55Speaker 00

  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 web three 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 like what your, 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?

• 7:38Sonal?

  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 web three. So one great example is the classic, I mean, you know, you're a 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, actually. 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 two and web three, and then we can dive into others more deeply.

• 8:17Speaker 00

  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?

• 8:30Speaker 00

  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 really good at software engineering. That'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?

• 9:09Sonal?

  Right, the value creation.

• 9:11Speaker 00

  The value creation. Like, does the fact that you were 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 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?

• 9:36Sonal?

  Right.

• 9:36Speaker 00

  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 is in the market, who is competing with you, and what their relative expertise and abilities are.

• 9:49Sonal?

  Which means it could change depending on which categories you're stacking up, which competitors against, and 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 Porter's Five Forces? And you know, sources of competitive advantage? And where platforms come in to Web3?

• 10:12Speaker 00

  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.

• 10:57Speaker 00

  And then on one side of that is new entrants. 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 entrance is west and east is substitute products. So not someone who does what you do, but someone who does something that the customers want just, you know, 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 like 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.

• 11:42Speaker 00

  But new functions evolved, competing for the usage share of social media.

• 11:47Sonal?

  Yeah. To me, the best example of this is Facebook as a social network versus Instagram.

• 11:51Speaker 00

  Yeah.

• 11:52Sonal?

  It's a substitute and they could see people engaging actively there in a very different way.

• 11:56Speaker 00

  Exactly.

• 11:56Sonal?

  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.

• 12:04Speaker 00

  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, you know, discover they really like absolutely need it, something that was previously social becomes a critical work function. The other forces that shape competition are these relative levels of bargaining power, right? It's like, how, how well can you bargain relative to your suppliers, to whom you're paying and your customers who are paying you?

• 12:48Sonal?

  Right, so those are-

• 12:49Speaker 00

  Those are the five forces.

• 12:50Sonal?

  And they're called forces because each of these forces exert pressure onto that industry.

• 12:53Speaker 00

  Yes, exactly.

• 12:54Sonal?

  And then how does that apply to Web 3?

• 12:56Speaker 00

  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, but a lot of their critical information, right? User, user identity, reputation, you know, the, the stuff that we think of as most valuable is often stored in, in the public, you know, on the blockchain. Because that's a lot of the advantage that the blockchain is giving Web 3, 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.

• 13:39Speaker 00

  And so, you know, that, 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.

• 14:00Sonal?

  Yeah, that's true in any open source, right?

• 14:01Speaker 00

  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 and under their control, they have more ability to move from place to place. They can, you know, 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, the bargaining power of your users is often getting stronger.

• 14:42Sonal?

  Right.

• 14:42Speaker 00

  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

• 15:23Speaker 00

  on too, which is that you have this opportunity to create what my co-author, actually several co-authors, Jan Esber and I have written about this, Christian Catalini and I have written about this, we call community cohesion. There's an opportunity when you convert your users into people who have a true preference for your platform. They 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, and often give them some degree of governance or, or advanced user privileges or whatever.

• 16:07Speaker 00

  That causes people to want to participate in a given platform. It's not that we've, you know, 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 a thing that we didn't have a way to do previously, you know, at least not at the scale that we're talking about in Web3. Yeah. But remember I said there were two saving graces. Like one of them is that there is this like completely new way to maintain your network affected, which is maintaining a network of, of personally invested users. And the second thing is, while competition is maybe getting more intense in a lot of

• 16:46Speaker 00

  dimensions, those personally invested users also have, you know, a strong incentive to create a lot of value. The ideal of Web three 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, like you've sort of 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

• 17:30Speaker 00

  base, everyone who wants to the platform to succeed because they succeed along with it.

• 17:35Sonal?

  I love that. I really do. But to take a step back and just kind of pulse check where we are in all this, in this broader context of business strategy for Web three, what I'm really hearing you say is it's hard, it's much more competitive, it's, it's open source. That's the whole point. It's a feature and a bug in some ways, but

• 17:54Speaker 00

  Absolutely.

• 17:54Sonal?

  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-optician or like some kind of, you know, cross pollination or whatever, you know, insert whatever other kind of buzzy

• 18:39Sonal?

  word there. I just wonder if there really is such thing as quote competition.

• 18:43Speaker 00

  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.

• 19:09Sonal?

  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?

• 19:26Speaker 00

  Yes, if it's free, you're the product.

• 19:27Sonal?

  Yeah.

• 19:28Speaker 00

  No, in fact, my co-author Steve Kazinsky says, "In Web 1, you were the consumer. In Web 2, you were the product, and in Web 3, you are the brand."

• 19:36Sonal?

  That's a nice framing. Onto 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.

• 19:58Speaker 00

  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.

• 20:35Sonal?

  So given that, how would you answer the question?

• 20:37Speaker 00

  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, right? 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, you know, an NFT trading platform like, you know, OpenSea 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 interact with all of these different systems.

• 21:22Speaker 00

  And so all of these things are like cross pollinating and cross operating platforms in a way that is much less centralized. There's always been some degree of cooperation of this form. Think about like payment processing companies, right? Like the invention of a more efficient web-based payment processor fostered 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.

• 21:53Sonal?

  It reminds me of the early days of the API economy as well.

• 21:56Speaker 00

  Yes.

• 21:56Sonal?

  And the thesis was that 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.

• 22:12Speaker 00

  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 much faster and easier. It has less friction. It's like there's sort of an infinitely public API 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 if you build something that works really well, there's a much greater threat

• 22:56Speaker 00

  in Web 3 that like your entire network could just get like moved to a competitor, could even be like a copy. Some new entrant can try to capture all of that activity by directly incentivizing users to switch. This is what's referred to colloquially as a vampire attack. And it's a funny name, of course, because vampire attacks are actually like-

• 23:19Sonal?

  Blood sucking.

• 23:20Speaker 00

  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 actually like want more competition among platforms. We'd like users to be less locked in so that competitors can show up. But of course, a competition policymaker would 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?"

• 23:46Sonal?

  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-

• 23:55Speaker 00

  I admit, I didn't know that specifically, but if you asked me how much money I was willing to bet on that fact, it would have been a very large amount.

• 24:03Sonal?

  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.

• 24:24Speaker 00

  That's awesome.

• 24:25Sonal?

  Yeah. And it's funny because it actually applies here in that if you 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-

• 24:37Speaker 00

  Exactly.

• 24:38Sonal?

  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.

• 24:47Speaker 00

  Absolutely.

• 24:48Sonal?

  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 at Asics and Z Crypto and Asics and Z. And I've worked on all of that content in the past. And in particular-

• 25:04Speaker 00

  Yep.

• 25:04Sonal?

  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 defined 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, which is adding value for the rest of the users.

• 25:30Speaker 00

  Yeah, they 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 from more users joining the platform. It's the net total value going up.

• 25:46Sonal?

  Interesting, such a good nuance.

• 25:48Speaker 00

  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

• 26:32Speaker 00

  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, 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

• 27:17Speaker 00

  for some of them.

• 27:18Sonal?

  So the point being that you have to look at the value of the total and not worry so much only about creating this super pedantic definition of value for all users.

• 27:27Speaker 00

  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 and there's a good enough outside option. And so users' ability to respond

• 27:47Speaker 00

  To negative network externalities, to things that make the network potentially less pleasant for you as the individual, even though its net value in aggregate might be higher, is much harder in Web 2. There's a really high barrier to exit. It's just 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?

• 28:14Sonal?

  Yeah.

• 28:15Speaker 00

  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 stunned when I joined my first, you know, Web 3 enabled social media. It was 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

• 28:56Speaker 00

  this like, external network affiliation directly into a platform, and taken all of that connection with me.

• 29:03Sonal?

  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.

• 29:24Speaker 00

  Yep.

• 29:24Sonal?

  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 like, so fascinating.

• 29:33Speaker 00

  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 NFT, or a Subduck, or a or a Bored Ape, or whatever, the network is embedded in the collective of people who own these assets.

• 30:02Sonal?

  Mm hmm.

• 30:03Speaker 00

  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 then like are the thing that they want to use across the internet. So you think about Web three, 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 two, 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.

• 30:44Sonal?

  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?

• 30:58Speaker 00

  Yeah, CBI Tech Reg Chronicle.

• 31:00Sonal?

  Yeah. Can Web three bring back competition in digital platforms? But you do point out that Web three could reduce the fundamental cost of verification, the cost of interoperability and portability, and the cost of composability, which is exactly kind of what you're talking about there.

• 31:16Speaker 00

  Yeah.

• 31:16Sonal?

  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.

• 31:37Speaker 00

  So I finally understand what you what you 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.

• 31:48Sonal?

  Oh, say more.

• 31:50Speaker 00

  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. Where you're often asking, will this reduce the quality of the customer experience?

• 32:35Speaker 00

  Or they're either going to like pay more because you know, now prices go up because there are fewer competing companies.

• 32:39Sonal?

  Right, right.

• 32:40Speaker 00

  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?

• 32:45Sonal?

  That's right.

• 32:46Speaker 00

  That type of competition, we see like web three is rife with. But the question is, where would that go? What it really turns into is the platforms having to work to retain consumers to like

• 32:59Sonal?

  Yes.

• 32:59Speaker 00

  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.

• 33:26Sonal?

  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.

• 33:32Speaker 00

  No, no, it was a great question. This is how you actually learn stuff.

• 33:35Sonal?

  Yeah, exactly.

• 33:36Speaker 00

  You push on a thing and I'm like, oh, I get it. There's your answer.

• 33:39Sonal?

  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

• 34:01Speaker 00

  Yeah.

• 34:02Sonal?

  come out of web three. And I kind of wanted to dig in on what is it and why does it 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.

• 34:17Speaker 00

  Totally. Okay. So first of all, just what is composability? You know, it has a technical meaning in the context of software, right? With software, you're embedding like existing software components into 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,

• 34:38Speaker 00

  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, you know,

• 35:19Speaker 00

  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, 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 two infrastructure platforms.

• 36:03Speaker 00

  Once there was, you know, a bunch of out of the box, you know, 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, 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 three 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.

• 36:48Speaker 00

  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.

• 36:53Sonal?

  That's funny. The analogy I was trying to think of was a bit like a primordial soup.

• 36:56Speaker 00

  Yeah.

• 36:57Sonal?

  And the reason that came to mind is, do you remember back in the day, it was like kind of in the early days of Google when Hal Varian, who was the chief economist there? Wrote about combinatorial innovation and it's so dargony of a phrase.

• 37:07Speaker 00

  Yeah.

• 37:08Sonal?

  The idea is really fascinating. You're a mathematician. You know combinatorial math.

• 37:11Speaker 00

  Yeah. Permutations and combinations grow quickly.

• 37:14Sonal?

  Exactly. Or derivatives that you can actually extend. And, 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 featured, 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 featuredness to it too.

• 37:48Speaker 00

  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?

• 38:06Sonal?

  Yeah.

• 38:06Speaker 00

  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.

• 38:18Sonal?

  Totally.

• 38:18Speaker 00

  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.

• 38:27Sonal?

  And by the way, obviously AI will play a big role in supercharge it. When you think of the creative AI that is exactly.

• 38:32Speaker 00

  Totally.

• 38:33Sonal?

  And even in the early days, right? It was only meant to be like, what are you 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 Thursdays.

• 38:44Speaker 00

  Yep.

• 38:44Sonal?

  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.

• 39:00Speaker 00

  Yep.

• 39:00Sonal?

  But two, there was no way for the community to capture and participate in that value.

• 39:05Speaker 00

  Yeah, you're totally right.

• 39:06Sonal?

  Yeah. Just kind of coming full circle.

• 39:07Speaker 00

  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. De-linked 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, you had to go off platform. You had to drive people to go to your website and do something. Whereas Web three sort of invites everyone to do this stuff actively and makes it all sort of cleanly interlinked.

• 39:36Sonal?

  Yeah, totally agree. And now let's switch into

• 39:39Speaker 00

  Let's get tactical.

• 39:40Sonal?

  Yeah, let's get tactical. Let's get tactical, tactical. Sorry. Do you guys remember that song from Olivia Newton-John? Let's get physical. Let's get

• 39:49Speaker 00

  Let's tactical.

• 39:50Sonal?

  Tactical, sorry.

• 39:52Speaker 00

  Oh, my God, that's so good.

• 39:54Sonal?

  I might keep it.

• 39:55Speaker 00

  My voice doesn't go that high.

• 39:57Sonal?

  That was really funny to hear you trying to do that.

• 39:59Speaker 00

  My voice doesn't go that high, sorry.

• 40:02Sonal?

  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 mindsets, what to do.

• 40:15Speaker 00

  Right.

• 40:15Sonal?

  You know, just all of it. So in terms of breaking this down, a good place to start for the builders and 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 Web three?

• 40:29Speaker 00

  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.

• 40:38Sonal?

  Oh, cool.

• 40:39Speaker 00

  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 then 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.

• 41:19Speaker 00

  You know, one gets on LinkedIn or whatever, but they might not benefit as much from having all those jobs on the platform because they're mostly happily situated. And so it might, 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 spots. 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.

• 42:01Speaker 00

  And it doesn't really matter whether it's the same company that, that you use in your home city. Like you can buy like a one week contract or à la carte or something of the sort. It has very, very strong local network effects, but very weak global network effects.

• 42:15Sonal?

  Right. And just before we go into the next item, can we address the nuances of strength for Web three and how you would advise people to think about it?

• 42:24Speaker 00

  So we've already sort of like implicitly been talking a lot about the strength of network effects in, in Web three. There, 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 and 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 three, 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.

• 43:08Speaker 00

  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. Cause 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 on 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.

• 43:53Speaker 00

  But there might be a much weaker network effect than before for any individual app that serves that protocol.

• 43:59Sonal?

  I need like a bottom line.

• 44:00Speaker 00

  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.

• 44:24Sonal?

  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.

• 44:46Speaker 00

  Yeah, yeah, valence 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 Web3, we're seeing a lot of like new network effects, the new opportunities for positive network effects. Right? 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 infrastructure 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,

• 45:32Speaker 00

  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 like 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. Like, you need to understand which network effects are positive and/or negative for which users. And then the Web 3 opportunity that's special here is through Composability, there are many new opportunities for aggregating positive network effects, either yourself

• 46:17Speaker 00

  or through partners and future developers who build on top of what you've created.

• 46:21Sonal?

  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.

• 46:30Speaker 00

  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. 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 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, in an NFT, I'm sorry, I keep using

• 47:13Speaker 00

  NFT examples because I'm a total degenerate, 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. 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

• 47:57Speaker 00

  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 have become much less defensible.

• 48:11Sonal?

  Awesome. And the bottom line?

• 48:13Speaker 00

  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.

• 48:32Sonal?

  Ah.

• 48:33Speaker 00

  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. And so you're not just looking for network effects necessarily, but defensible and sort of buildable network effects.

• 48:54Sonal?

  And question on this one, actually, people are often saying Web 3, 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 moats, Scott? I feel like people bandy that about a little too casually and easily for my satisfaction.

• 49:08Speaker 00

  You know, it's funny, one of my longest term collaborators on Web 3, Chad Esprit, he was one of my former students in my MBA class, one of the, you know, one of the strongest students I've ever taught. He and I have been trying to really clearly express like how we think about moats and Web 3. And still, 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, you know, and the competitors don't have nearly as much, or you have all this proprietary information. It might be economies of scale, you know, like you're, you know, you're a,

• 49:49Speaker 00

  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, it can like 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, right? You might have a defensible competitive advantages, 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

• 50:31Speaker 00

  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. Similarly, technical advantages, so much of the operations of a platform are public, going to erode faster than they used to.

• 50:50Sonal?

  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 moat on that one.

• 51:06Speaker 00

  Absolutely. No, 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.

• 51:22Sonal?

  Right.

• 51:23Speaker 00

  As Web 3 is more complex and often more high-tech than anything that's come before it in category, the talent moat has widened and deepened.

• 51:30Sonal?

  Yeah, totally.

• 51:31Speaker 00

  But like, the core platform competitive advantages have mostly weakened. There's one, though, that really stands out as having strengthened tremendously.

• 51:40Sonal?

  And that is?

• 51:40Speaker 00

  Which is embeddedness.

• 51:42Sonal?

  And say more about that. You've mentioned that a few times.

• 51:44Speaker 00

  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.

• 52:27Sonal?

  This is where like wallets have a lot more potential for embeddedness.

• 52:30Speaker 00

  Absolutely.

• 52:31Sonal?

  Even in fintech, we'd talk a lot about not only wallets 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 that 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 three is how identity becomes the the interface for decentralized.

• 53:00Speaker 00

  Absolutely.

• 53:01Sonal?

  Identity. So there's like a lot going across the board on that embeddedness point there.

• 53:04Speaker 00

  And indeed, and exactly as you say, the Alipay example is is perfect. That's a classic Web two style platform that maintains a lot of its advantages through embeddedness. Like it's just used in so many different services. Web three opens that up and again, it opens it up to everything.

• 53:22Sonal?

  Yeah.

• 53:23Speaker 00

  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, you know, 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, you know, 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.

• 53:58Sonal?

  Totally. Although one quick precision note on that one.

• 54:01Speaker 00

  Yeah.

• 54:01Sonal?

  As you know, obviously the open source history person.

• 54:03Speaker 00

  Yeah, you're like a, you're a literal expert on this.

• 54:06Sonal?

  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 NPM, the node packet managers and the node JS community, et cetera. It's also very interesting when you also think about other little components like, um, 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.

• 54:39Speaker 00

  Yes.

• 54:39Sonal?

  And therefore, no incentive to.

• 54:41Speaker 00

  Yeah, no, you're totally right. Somehow now you have that same embeddedness opportunity, but with an incentive to build.

• 54:48Sonal?

  And maintain, et cetera.

• 54:50Speaker 00

  Yes, sorry. Yeah, you're right. Build and maintain. Spot on.

• 54:53Sonal?

  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 you put forth as one of the stronger benefits of competitive advantage in Web three. Now I want to also have you answer the second part of that question, and you already answered the first part. Same for community. So like, what like, what are the nuances there? Like, how much of a moat is it really? Paul's check it for me.

• 55:16Speaker 00

  Great question. So first of all, I should emphasize that, like, to me, you know, embeddedness was a was a classic model of platform competitive advantage, and it's gotten much stronger in Web three. This community cohesion thing, I tend to think is pretty new. You know, not that it never existed before, but at least in the 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 lacked good tools to do so. Web three makes it possible to

• 55:55Speaker 00

  turn your consumers and your 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's 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 contexts. Think about like, everyone who participates in governance, a DeFi platform or something, to 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 for your digital assets to to drive new forms of quality and experience.

• 56:37Speaker 00

  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 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, right? It's like you see the other people in this group as akin to you and you want to like engage with them.

• 57:19Speaker 00

  And not just like hang out, but hang out in reference to and like sort of like more deeply engage with the assets.

• 57:25Sonal?

  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? 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, 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.

• 57:50Speaker 00

  No, it's funny you say this. There's this concept of a shared text.

• 57:54Sonal?

  Yes, yes, exactly. Shared artifacts, shared symbols.

• 57:58Speaker 00

  Exactly.

• 57:59Sonal?

  Yeah. And it's like modern meaning making, actually, if you were to really take it to the next level. Cause 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 interest graphs and like affiliate interests. Like it's actually really kind of core meaning at this.

• 58:23Speaker 00

  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 just 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 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.

• 59:07Speaker 00

  Web three 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.

• 59:19Sonal?

  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 three 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 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.

• 59:42Speaker 00

  Woo.

• 59:43Sonal?

  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 three 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 found 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.

• 1:00:15Speaker 00

  Oh.

• 1:00:15Sonal?

  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.

• 1:00:28Speaker 00

  Yeah, it's a great extension of the 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.

• 1:00:44Speaker 00

  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.

• 1:00:57Sonal?

  Wow, okay.

• 1:00:59Speaker 00

  So, so the one part of the answer on platforms is you often are in fact neither, you know, sort of going niche or broad, you're actually sort of doing both, but, 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 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 them and see which stick.

• 1:01:43Speaker 00

  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 beachhead. 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? Like, 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 trying to find some, some campaigns and design and tech.

• 1:02:27Speaker 00

  And you, 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, let me add one other footnote that's web three specific. The other thing that's like very special about web three in this context is that that build out component becomes much easier, right? Like, again, because your core users are invested in the platform's success, there's a sense in which like,

• 1:02:57Speaker 00

  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 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 your like evangelists, but they're also the people who help build and sort of broaden your, your use cases as you go.

• 1:03:32Sonal?

  It's also kind of goes ties back to your community cohesion point because

• 1:03:35Speaker 00

  Absolutely.

• 1:03:36Sonal?

  not building for themselves, they're building for all or their, their, their interaction effects, which also strengthens in turn their ties to that community than kind of further feeding it.

• 1:03:46Speaker 00

  Exactly. Spot on.

• 1:03:47Sonal?

  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 users desires and your power users actually have voting rights like in direct governance? And this is a really interesting question because we, 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. But obviously like no individual can make a decision on behalf of a community or a network. That's part of the whole advantage of web three. 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

• 1:04:31Sonal?

  is like, how do you think about strategy and, and growth when you have this like a very unique case of web three, basically, you don't have like a classic manager that Porter was talking to back in the, back in the day.

• 1:04:44Speaker 00

  Oh, 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.

• 1:04:59Speaker 00

  And that's honestly why a lot of Web 2 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 in 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.

• 1:05:23Sonal?

  Yeah.

• 1:05:24Speaker 00

  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 in Web 3 platforms as well.

• 1:05:41Sonal?

  Yeah.

• 1:05:42Speaker 00

  One advantage, of course, in Web 3 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 the arcade token that can be used in all the different like mini games the platform is building out, that 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'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 platform's best long-term interest is, right? So even if you didn't have the incentive challenge of like people wanting to extract value today,

• 1:06:28Speaker 00

  you might have the issue that people still don't know what the right direction is. Startups are in a haze of massive uncertainty.

• 1:06:33Sonal?

  Right. And then you add Web 3, exactly.

• 1:06:35Speaker 00

  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.

• 1:06:43Sonal?

  Yep.

• 1:06:43Speaker 00

  We're going to have to see how this plays out. But the strongest technique we have for this is 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 in what they at least believe is the best direction.

• 1:06:59Sonal?

  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 web three builders for how they should think about launching their platform?

• 1:07:19Speaker 00

  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 three 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, like, 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 would 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 on your platform, like, you know, forget it.

• 1:08:03Speaker 00

  But, but like fundamentally, like it's not what economics has taught us. Rather, and 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. The 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, 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, of, you know,

• 1:08:47Speaker 00

  discounts or early access, or even pay you to develop for us initially.

• 1:08:51Sonal?

  Yep.

• 1:08:52Speaker 00

  And then meanwhile, that activity draws in users, right? That kickstarts the network effect. Now there's a way for, 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 sides. 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 convince them to use it, you're subsidizing them.

• 1:09:37Speaker 00

  If they have intrinsic demand for it, then maybe you don't need to.

• 1:09:39Sonal?

  And quick bottom line on this, like where this is really kind of different or more nuanced in Web 3?

• 1:09:46Speaker 00

  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.

• 1:09:55Sonal?

  Right.

• 1:09:56Speaker 00

  Or literally paying somebody to show up.

• 1:09:58Sonal?

  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.

• 1:10:04Speaker 00

  Exactly. It's super unsustainable. Here, there's this opportunity, at least in principle, where you can 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 develop software or features that attract a lot of users.

• 1:10:39Sonal?

  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.

• 1:10:48Speaker 00

  Exactly. There's alignment with the activity that they're undertaking and hopeful success of the platform and value creation.

• 1:10:54Sonal?

  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 Web 3 platforms face even more competitive pressures. When they have loyalty programs where like a classic traditional platform there would not face that same type of...

• 1:11:19Speaker 00

  Great.

• 1:11:20Sonal?

  So what would like be your one kind of key advice for how builders in Web3 should think about this particular nuance?

• 1:11:26Speaker 00

  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." 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,"

• 1:12:07Speaker 00

  Delta might say, "Great," and send you a contract, like ask you to, you know, provide proof that you are 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. Web3 makes that type of status immediately verifiable. If I'm a new competitor, I'm launching 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 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, like I can see it. I know you're 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

• 1:12:51Speaker 00

  much lower costs 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.

• 1:13:07Sonal?

  Yes.

• 1:13:07Speaker 00

  It takes on purpose and like 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.

• 1:13:29Sonal?

  That's fantastic, Scott. That is so interesting.

• 1:13:31Speaker 00

  Thank you.

• 1:13:32Sonal?

  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 three.

• 1:13:38Speaker 00

  Absolutely. There's this unbounded Web three 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.

• 1:13:50Sonal?

  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.

• 1:14:24Speaker 00

  No, I don't think we have. I think you're right. I mean, you say early days. I mean, it's, it's really early days.

• 1:14:31Sonal?

  Yeah.

• 1:14:31Speaker 00

  Right? You know, the 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,

• 1:14:50Sonal?

  Yeah.

• 1:14:51Speaker 00

  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 Web three? And, and how do they relate to what we understood about previous incarnations of the web and, and other related product movements like open source software? But this is a super interesting space. And the general call to people who hear this podcast, please think about it. And if you have cool ideas, please let me know.

• 1:15:28Sonal?

  I did have one last kind of crazy question. You know, one of the people I've worked with at Xerox PARC was Brian Arthur, and he wrote that seminal paper back in like 1996 on increasing returns and the new world of business. He began his paper saying how his, you know, 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.

• 1:15:55Speaker 00

  Yeah.

• 1:15:56Sonal?

  I feel like in economics, especially for, actually more precisely, economics applied to technology behaviors and software in particular.

• 1:16:04Speaker 00

  Absolutely.

• 1:16:05Sonal?

  That's where things really get kind of jiggered up. And I feel like we're in a similar moment in Web three. 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 three?

• 1:16:34Speaker 00

  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, you know, as an economist, I'm always wary of like declaring a theory that I can't at least like visualize the theorem. But my, my rough instinct is that what we see in Web three 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 theory.

• 1:17:05Sonal?

  Yes.

• 1:17:06Speaker 00

  But stay tuned, maybe we'll do that in a, in a future episode.

• 1:17:08Sonal?

  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.

• 1:17:16Speaker 00

  Thank you. No, it was so much fun for me, too.

• 1:17:21Speaker 02

  Thank you for listening to Web3 with A6nZ. You can find show notes with links to resources, books, or papers discussed, transcripts, and more at a6nzcrypto.com. This episode was produced and edited by Sonal Choksi, 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 A6nZ Crypto. To follow more of our work and get updates, resources from us, and from others, be sure to subscribe to our Web3 weekly newsletter. You can find it on our website at a6nzcrypto.com. Thank you for listening and for subscribing. Let's go.