Metcalfe’s Law
- "All this means, in its basic form, is that the network is more valuable the more people that use it." For a longer explanation check out this link (5-5-2020)
- From Coin Metrics #37 (11-2-2020):
"Metcalfe’s law states that the value of a communications network is proportional to the square of the number of connected users of the system. The foundation of this law is in the mathematical relationship that each user of a communication network can make (n - 1) connections with other users. If each connection is considered equally valuable, the total value of the network is proportional to n (n - 1) / 2, which asymptotically approaches n2. Metcalfe’s law has been successfully applied to the valuation of social networks. As an example, Zhang, Liu, and Xu (2015) empirically test Metcalfe’s law and several other network effect laws by using data from Tencent and Facebook and find that Metcalfe’s law fits better than competing laws.
Application of Metcalfe’s law to valuing cryptoassets is straightforward and was first conducted in gbianchi (2014), where the key insight was made to define a user of the Bitcoin network as the number of addresses with zero balance, a proxy chosen after backtesting and considering other alternatives. A formula to predict the price of BTC based on the square of the number of addresses with zero balance is presented. The article also made a significant contribution to another thread in the literature by introducing the idea of tracking the number of addresses between certain balance thresholds.
Alabi (2017) tests Metcalfe’s law on BTC, Ethereum (ETH), and Dash (DASH), and illustrates how deviations from predicted values can be used to identify asset bubbles. Peterson (2018) applies Metcalfe’s law using an alternative representation for users: the number of wallets from blockchain.info. The model is used to identify a period of suspected market manipulation in 2013. Franek (2018) tests Metcalfe’s law and competing laws on BTC and ETH, and introduces a price-to-Metcalfe ratio to identify periods of over or undervaluation. Kalichkin (2018) combines predictions from Metcalfe’s law with predictions from Odlyzko’s law and similarly introduces a price-to-Metcalfe ratio.
The application of Metcalfe’s law to cryptoassets touches upon another emergent element in the literature: the study of the number of users of a particular cryptoasset. While the transparency afforded by blockchain ledgers allows for many candidate proxies to represent the number of users, we still lack the clarity of a concept similar to daily active users, a common metric used to track the usage of internet applications. The mapping of on-chain activity to real world entities and individuals is still unclear and an active area of research. As more work is done in this adjacent area, a more precise application of Metcalfe’s law to valuing cryptoassets is possible."
