One bitcoin is worth $700,000. Or $0. Or $1,300. Now that this specific cryptocurrency is mainstream, everyone has an opinion on its exact value. Some have brought up other Bitcoin competitors, like Litecoin and the tongue-in-cheek Dogecoin, as an example of just how unvaluable and easily created something like Bitcoin is. However, the fact that Bitcoin has held its value despite these competitors demonstrates its moat, one that it shares with many other companies: network effects.
Network effects, the same thing that gives Bitcoin value, give Facebook (NASDAQ:FB), Twitter (NYSE:TWTR), and eBay (NASDAQ:EBAY) value. The more people who use these networks, the more valuable they are for each user.
Bitcoin's first network
There are actually a few networks that generate value for Bitcoin. One is the network of buyers and sellers who use the digital currency. For each merchant that accepts Bitcoin, it strengthens the case for someone to take part in that economy. Like eBay, the more buyers and sellers, the more opportunity to find someone to buy what you have or to sell what you are looking for. Like eBay's PayPal, the more sites that integrate the payment option into their business, the easier it can gain customers.
And stunningly, even though they've been around longer than a decade, eBay and PayPal's user bases are growing at increasing rates. In the last two quarters of 2011, eBay's active marketplace customers grew 6% compared with the year prior. In the previous two quarters of 2013, active customers grew 14% over the previous year. For PayPal, active accounts grew 13% and 14% for the late 2011 quarters, and grew 17% over the prior year in the latest quarter.
While Litecoin offers many of the same benefits of Bitcoin, and even claims improvements over Bitcoin, if it can't offer this network of broader acceptance, it won't be a viable competitor.
Bitcoin's second network
The next network that Bitcoin capitalizes on is a bit technical. Simply put, the network of peers that confirms each Bitcoin transaction supports the value of Bitcoin. The more peers holding this ledger of transactions, the harder it is for one entity to take control of the Bitcoin network and write its own fraudulent transactions. Its substitutes, like Litecoin, have significantly smaller networks to protect against the potential fraud that can occur when one entity takes control of a majority of a network.
The same can be said for Twitter and Facebook, where the network of peers makes these services valuable. One could compare the network of Bitcoin peers that record each transaction to the lists of friends and followers that support the value for each individual Twitter and Facebook user. Without these peers actively using these services, they are useless.
Creating a service that provides what Twitter or Facebook provide is relatively simple, just as it's easy to create yet another cryptocurrency. But the differentiator is the user base. So, when reports of declining user activity of Facebook users pop up, investors should take notice. In the latest conference call, Facebook CFO David Ebersman said that the company saw a decline in daily users, "specifically among younger teens."
On the other hand, according to Pew Research, Facebook still reigns in terms of percent of adults following a specific social network, with 71% compared with Twitter's 18%. And Facebook still rules in terms of daily use, with 63% of its users arriving daily versus Twitter's 46%.
As long as Bitcoin keeps ups its own lead in peer network size, pointing to other cryptocurrencies and their ease of creation as a reason for Bitcoin's lack of value is not a sound argument. It's easy to copy many things, but the network supports the true value.