Blockchains have created a small number of dominant players across various categories.

As the protocols grow, it becomes harder for new protocols to gain market share due to the Network Effect of existing protocols associated with Developers, TVL, users, community, and economies of scale. we can already see this effect in action in Areas such as liquid staking, lending/borrowing, stablecoins, derivatives, and prediction markets where few protocols dominate.

In liquid staking, LIDO dominates and has a 58% market share followed by Coinbase, Rocketpool, and Eigenlayer.

In decentralized exchanges, Uniswap has nearly 50% market share in TVL followed by Curve, PancakeSwap, and Balancer.

In lending/borrowing, Aave has nearly 55% of the market share followed by Compound, Spark, and Morpho.

In stablecoins, USDT has nearly 70% of the market share followed by USDC, and DAI.

In derivatives, GMX+DYDX controls 75% of the market share. Protocols for betting with leverage

In prediction markets, Azuro + Polymarket controls 60% of the market share.

A network effect refers to the quality of a company or system where the value for each user increases exponentially as more people join the network. It serves as a robust economic advantage, creating a significant barrier against competitors.

1. One-Sided Network:

   • With two telephones or "nodes," there's only one possible connection.

   • Three telephones (A, B, C) result in three connections (A to B, A to C, B to C).

   • For four telephones, there are six possible connections, and for ten telephones, it jumps to 45 connections.

   • The telephone is a one-sided network, allowing users to connect with each other, with each node being the same.

1. Two-Sided Network:

   • Two-sided networks involve distinct types of nodes. For instance, type "a" nodes seek connections with type "b" nodes but not with other type "a" nodes.

   • eBay (EBAY) is an example of a two-sided network that gained immense value by attracting both buyers and sellers.

Making native use of the internet was the 10x better usage that allowed newcomers to disrupt existing networks. Email disrupted physical mail, e-commerce disrupted physical commerce, Airbnb disrupted the Rental market, and Uber disrupted taxis.

Use of Blockchain will be 10x better for many applications to disrupt existing networks.

Let's take LIDO as an example to illustrate the network effect. LIDO exhibits a two-sided network effect, benefiting both Ethereum users with ETH who prefer not to run an Ethereum node and Ethereum users who want to run a node but lack the required 32 ETH. As more ETH is added to LIDO, more node operators join the network, enhancing its overall value. LIDO leverages these network effects and economies of scale to achieve various advantages.

When evaluating a Web3 protocol, consider key factors:

1. Community: In the blockchain realm, where most data is open, a competitive advantage is challenging to establish. A community-first approach is vital in Web3, going beyond marketing to embrace community-driven projects. Building and managing a community requires effort but can attract developers, users, evangelists, and enthusiasts, creating a positive feedback loop and driving exponential user growth.

2. First-Mover Advantage: Recognizing that network effects take time to establish, some projects aim to launch early to bootstrap these effects, even if competitors offer superior services. Established network effects can provide a first-mover with a lasting competitive advantage and economic moat.

3. Composability: Due to the benefits of permissionless composability, the Web3 ecosystem may generate stronger network effects than existing counterparts. Interconnecting decentralized applications allows for unprecedented product combinations, fostering innovation that centralized models struggle to match.

In conclusion, while blockchains have created a small number of dominant players across various categories, these players must give back ownership to users to maintain their competitive advantage. In Web3 most of the data and code is open source, making it easier to create substitutes (forks) and this increases the importance of community.

https://medium.com/dragonfly-asset-management/network-effects-the-most-important-economic-moat-in-crypto-a10135913745

https://www.grayscale.com/research/reports/bigger-is-better-blockchains-as-network-technologies2

https://chain.link/education-hub/web3-network-effects#:~:text=A%20network%20effect%20is%20a,creating%20a%20positive%20feedback%20loop.

https://www.lynalden.com/bitcoins-network-effect/