I wrote about the bitcoin infrastructure flywheel several years ago. The premise was simple: investing in bitcoin infrastructure improves the network and makes it more valuable, which in turn creates increased demand and more users, thereby driving further investment and infrastructure buildout as the cycle continues. That is, investing in bitcoin technology drives network effects to the industry. 

This has been a core part of Ten31’s thesis, and we have deployed over $125 million of equity into the bitcoin ecosystem over the last several years with this understanding. Our thesis still very much remains intact, and more investors over time will come to realize the merits of our strategy as bitcoin continues to eat the world. If understanding the flywheel from investing in bitcoin infrastructure is Bitcoin Technology Investing 101: Industry Network Effects, in this essay I would like to present the next level topic, Bitcoin Technology Investing 201: Portfolio Network Effects.

A Primer on Network Effects

Network effects is by now a common concept, popularized in the mid-90s by W. Brian Arthur with Increasing Returns and the New World of Business. Arthur pointed out that while traditionally there had been an assumption of diminishing returns in a market (that is, “products or companies that get ahead in a market eventually run into limitations, so that a predictable equilibrium of prices and market shares is reached”), he saw evidence that in the world of technology, information, and ideas, the mechanisms at play could drive increasing returns instead: that is, the tendency for that which is ahead to get further ahead; or, more practically, as a company or product with network effects becomes more successful and scales, it actually will command increasing returns and share over time. 

Early examples of businesses that capitalized on network effects were Microsoft and IBM, and more recent examples include Airbnb, Amazon, Google, Meta, and Uber. David Sacks at Craft Ventures illustrated Uber’s network effects beautifully in 2014 when he tweeted “geographic density is the new network effect”. The network effects of Uber are obvious: the more drivers who sign up with Uber, the faster a customer can secure a ride; the faster a customer can find a driver, the more customers will want to sign up; and the more customers sign up, the more attractive Uber becomes to drivers. 

While the graphic above is applied specifically with respect to geographic saturation, it is easy to apply the concept more generally to any business with a network effect, particularly so-called marketplace businesses like Uber which provide a technology platform to connect providers (sellers) on one end and users (buyers) on the other. As the marketplace grows, it becomes a better value proposition for both providers and users, and this results in a more valuable tech platform for its owners.   

From Metcalfe’s law many will be aware the value of a network generally increases exponentially with scale, not linearly. As such, successfully investing in tech-enabled marketplaces with network effects has been a very lucrative business. Many investment firms have cemented their legacies based on the success of an early investment in just one of these marketplace businesses which later became dominant in its sector. However, marketplaces and network effect businesses can also present a number of potential issues and challenges for not just the participants on each side, but also the companies building the platforms and their investors: 

• Participant lock-in: Successful marketplace businesses often lead to provider and user lock-in. The inherent network effects imply high switching costs for market participants, as the alternatives offer a suboptimal experience, service or value, and lock-in can eventually lead to exploitation of providers and users. An example is Uber “blitzscaling” in NYC by undercutting taxi fares to establish geographic density and network effect, only to later raise prices after they had successfully run the taxi companies out of business or driven them out of the market. While initially users were better off, in the long run the end result was less competition, higher pricing, and worse service. 
• Bootstrapping problem: From an operator perspective, achieving truly sustainable network effects of meaningful magnitude is incredibly challenging. It is most common to underestimate the bootstrapping challenges with building a network and overestimate the likelihood of success. The last several decades of easy money pumped into VC funds which subsequently flowed into startup marketing budgets and “customer acquisition costs” only served to obscure this dynamic. What many thought were durable network effects proved only to be artificial growth driven by VC-funded user subsidies. As we’ve seen over the last couple years, once the VC money spigot dries up and marketing is pulled back, the “growth” and network effect go poof.
• Crowded trade: As the merits of seeking investments with marketplace characteristics and inherent network effects became more obvious over the last couple decades, more investors sought opportunities with this theme, and an entire category of investing and specialist funds evolved with this focus. These days you can go to virtually any Silicon Valley VC website and find tomes (tombs?) of content dedicated to investing in, building, and scaling marketplace businesses. It has become a very “crowded trade”. Not to say you can’t be skilled or lucky enough to pick a winner, but the competition is fierce, the upside is increasingly priced in, and the likelihood of success incredibly low without a unique informational or sourcing edge.
• Disruptive risks remain: Even if you have managed to achieve much sought after network effects, it doesn’t mean you are immune to disruption. There are a myriad of examples of network effects businesses which became obsolete after new waves of technology were adopted or user behavior evolved. For example, consider the famous Craigslist infographic depicting all the disruptors which spawned to compete in each Craigslist category, many of which proved successful in taking the lion's share of their respective categories. 

Bitcoin Network Effects Powering an Investment Portfolio

One of the most underappreciated aspects of investing in the bitcoin ecosystem is the open and interoperable nature of the bitcoin protocol and the benefits that accrue to all participants from development in the space. Any developer, entrepreneur, or business can build on top of bitcoin’s standards and immediately plug into the scale of the network and both benefit from and contribute to its development over time. 

What this means is that unlike what we’ve seen in the traditional Silicon Valley VC world, building and investing in exciting bitcoin technology companies is not zero sum. The success of one company does not have to be detrimental to another. This is because the network effect being developed is not at the company level, but actually at the industry level (i.e. across the entire bitcoin ecosystem). 

At its core, money is the ultimate network effect. Money generally converges around one medium because its utility is liquidity, and liquidity consolidates around the most secure, long term store of value. Those who are contributing to bitcoin and building infrastructure interoperable with the bitcoin network are therefore enhancing bitcoin’s network effect as superior digital money and strengthening the ecosystem around it in which all participants operate. There are numerous benefits:  

• Plugging into the bitcoin network provides access to a global base of users already on the network, thus helping bootstrap a potential user base and addressable market
• A company developing innovative technology, products or services for holders of bitcoin can enhance bitcoin’s utility, benefiting all participants in the network and driving increased adoption 
• In a reciprocal way, participating in the bitcoin network allows one to benefit from the work of others who are adding value to the network
• Finally, the open and interoperable nature of bitcoin allows for more significant opportunities for collaboration with others than was possible before bitcoin

This last point is perhaps the least recognized aspect of the intra-bitcoin network effects and the point I want to emphasize the most. Because of the interoperability of bitcoin and its industry wide network effects, there are mutual benefits to collaboration and opportunities for partnership which are simply infeasible in traditional industry when competing standards, closed systems, and legacy competitive zero sum dynamics are often at play. Consider Venmo and Paypal: Venmo has been owned by Paypal for more than a decade, yet payments between the two are still not integrated. And that is within the same company; integration between separate companies will clearly present additional challenges. 

The bitcoin network benefits from the opposite dynamic. Not only is interoperability ensured by compatibility with the base protocol, but the next order effect is an environment where collaboration can occur in interesting and unconventional ways, such as between companies which might otherwise be viewed as competitors in a traditional, non-bitcoin sense, or between seemingly unrelated companies whose only common ground is operating in the bitcoin network. One such example from within our portfolio is between Strike and Primal. Strike provides the backend bitcoin infrastructure which allows Primal to offer a native bitcoin wallet and bitcoin payments in-app within Primal’s broader social networking features. While there are many traditional companies that offer backend payments infrastructure for social media or online communities, the open source nature of bitcoin and nostr means Primal and Strike can still benefit from users within the network who are not locked into either business, and this is unprecedented. When viewed through a bitcoin lens, the aperture for collaboration presents compelling opportunities for groups to pursue shared objectives in an advantaged way relative to doing it alone. 

At Ten31 we began seeing glimpses of this dynamic as our investment portfolio grew from 10 companies to 20 companies and beyond, and as the interconnectivity between these companies increased. Below is a depiction of the portfolio connectivity today as compared to two years ago. Each dot represents a specific company I have kept anonymous for purposes of this exercise, and each line indicates where there is a collaboration, official integration, or formal relationship in place between companies. No dots have moved positions from the left chart to the right; only new dots have been added (with new Ten31 investments over time), and new lines have been connected indicating increased collaboration across the group.

It will be easy for any reader to gloss over the above graphic and not appreciate how remarkable the level of connectivity is and the potentially significant implications that follow, so I urge you to pause and think about this. I draw a number of initial conclusions from this graphic: 

• First, there are significant opportunities for cross-portfolio synergies in bitcoin, much more so than has ever been possible in traditional VC investing. You will not find any investment portfolio in any traditional VC fund which can demonstrate a similar level of collaboration with partnerships of significant substance. 
• Next, I believe some of the partnerships indicated in the lines above will enable groundbreaking offerings in the bitcoin market with the potential to produce astronomical value for the companies involved. While some of the most exciting companies are the most connected on the chart, there is also tremendous potential value in areas of the chart you may least expect. For example, the short, diagonally-down line to a single dot at “7 o’clock” on the chart could prove one of the most powerful partnerships of them all.
• Lastly, I believe the value of the portfolio will demonstrate increasing returns as it grows and becomes more interconnected.

The secret sauce to all of this of course is the bitcoin network effects. Everyone is rowing in the same direction. In addition, part of the portfolio effect is the ability of Ten31 to help facilitate connections between companies where a mutual relationship might not initially seem obvious to the parties involved, or where the Ten31 relationship can be additional common glue between companies to help reduce friction and encourage closer collaboration. As I have described previously, we created the Ten31 Tribe for exactly that reason–as a network of founders, investors, supporters, and interested parties whose main interest was actively supporting each other and the ecosystem as a whole. As one of the founders we are backing recently put it to me, “one of the best values we get from Ten31 is through involvement with the Ten31 Tribe”. 

It is a profound idea that one company in a portfolio can drive value in an investment portfolio not just based on its own success, but can also contribute positively to the investment prospects of other investments in a portfolio. In this way the value of the portfolio can truly be greater than the sum of its parts by leveraging the interoperability and network effects of bitcoin. In other words, bitcoin technology is the new network effect. Increased bitcoin technology investment provides greater infrastructure density and strengthens the overall network, adding value to the network and portfolio; increased investment density increases the opportunities for collaboration, allowing for better company performance and increased portfolio value. 

I also believe more favorable conditions persist with bitcoin’s industry and portfolio network effects as compared to the challenges I outlined initially with respect to business network effects:

• Lock-in: while it may be possible for companies to establish early leadership positions in certain segments of the bitcoin industry, any position is susceptible to competitive dynamics and less prone to lock-in given a participant can always seek a competing option and  remain compatible with the rest of the network, still benefiting from bitcoin’s network effects and interoperability. A company must continuously provide a superior experience to retain its users' loyalty. In the words of Jack Mallers, “open networks win”.
• Bootstrapping: as I highlighted above, using the bitcoin network can help jumpstart the bootstrapping process. Companies building in bitcoin towards the same network effects is inherently more additive than winner-take-all competition where everyone is fighting to establish their own siloed network dominance. The same points can be made about those building in the open nostr ecosystem, and the integration of bitcoin in the nostr ecosystem only compounds the scaling effects of building in the space.
• Crowded trade: a bitcoin-focused investment thesis remains a non-consensus strategy, and I have not seen any other group even identify the idea of unparalleled levels of cross-portfolio network effects within bitcoin, much less capitalize on them to the degree we are at Ten31. The upside for the companies, investors, and industry as a whole is that much more significant as a result. 
• Disruptive risks: I believe the industry and portfolio network effects will prove more sustainable with less binary risk of disruption, as any broken link in the network (e.g. from failed execution) or any new entrant in the market marginally reshapes the network effect topography while much can remain intact. This becomes increasingly true as the bitcoin network grows and the network or a portfolio’s interconnectivity increases. I believe this dynamic will encourage increased collaboration and result in more entrenched relationships across the network which may lead to a better value proposition for customers and users while fortifying the network as a whole. Much like a neural network, you can imagine the pathways in the network becoming more ingrained over time. This also reminds me of the network activity Slack observed after it  released shared channels. David Sacks was once again quick to point out that “inter-company network effects are the holy grail”, recognizing that greater levels of connectivity creates more resilience. 

Not many are paying attention yet, but I believe the next level of network effect economics is already at work in the bitcoin ecosystem. It is transforming the way companies work together and has significant implications. Bitcoin network effects are industry-wide and can deliver outsized value in a focused, interconnected investment portfolio. I am excited to see these concepts play out not just for the benefit of those companies in our portfolio and the investors supporting us, but also for the betterment of bitcoin as a whole as the network becomes more robust as a result.

This was originally published on Ten31's Insights blog. Find out more about Ten31 and our funds here.