You're listening to episode 9 on network effects in web 3 from the network effects master class Pete on the NFX podcast. In web 2, network effects were nice to have as companies scaled and carved out their section in the business world, but now they're more important than ever. You'll hear NFX general partner, Morgan Beller, uncover why in web 3, network effects fundamental and critical to survival.
You also get a brief history of the evolution of the web and our 3 stage framework for building a startup in the world of web 3. Let's jump in. I'm Morgan Beller, and I'm a general partner at NFX. Prior to NFX, I was at Facebook where I was a cocreator of the DM project formerly known as Libra, which was Facebook's cryptocurrency effort. And a life before that, I was at Andreessen Horowitz where I looked at some crypto deals around 2013 2014.
So I've been in and around this world that we now call Web 3 for the better part of 8 years. Now that I'm at NFX, I meet with web 3 founders, and we talk about the power of network effects and how network effects were. Nice to have in web 2, but really, really need to have in web 3. In this section, we're going to go over several areas. 1 is we believe that web 3 founders and companies need to be built in almost this inverted way.
So as discussed, outside the map, there's the social aspect, and we believe that Web3 products start there. Like growing your Discord, growing your community, and then bringing the product towards the inside of the map. So we'll talk about that inverted path. Then we'll talk about our 3 stage framework for early web 3 founders.
Then we'll start with my experience at Facebook, the strongest case study for network effects in web 2, and how those learning lessons relate to my job and early stage founders today. And lastly, how Ethereum also has some parallels to everything that we've talked about in this section.
Not to be too corny about it, but we see ourselves as kind of being the river guides for web 2 founders trying to find their way into web 3, but also for web 3 founders trying to apply lessons from the web 2 network effects world to web 3. So with that, let's get started. If you're new to web 3, welcome.
I was first introduced to crypto, which is what it was called at the time, in 2013, when I was at Andreessen Horowitz and biology Srinivasan joined, and he was preaching crypto left, right, and center. I listened and I went on walks with him, and I'm really grateful for that learning experience, but admittedly, I was too dumb then to fully get it and dedicate my life to it. So if you're new, welcome, it's still really early. And one way to think about web 3 is relative to web 2 and web 1.
So most of the world was introduced to web 1 around Morgan, and it was read only. You could consume the internet. You could not, I mean, very, very few people actually contributed to what was read on the internet. Then around the 2000s, you had platforms start to emerge that were read and write. So you could consume content, but you could also create content. You could write a blog. You could post on Facebook. You could do a tweet.
And now, web 3 is this concept of decentralized ownership of all of these platforms. And that's kind of the big unlock. So whereas web 2, you maybe would read on Twitter, write on Reddit, but you didn't necessarily have ownership in those platforms. Maybe you own some Twitter shares, but that's different, and we can talk about it. But in Web 3, the creators are also the consumers, but are also the owners of these products and platforms, and that changes the whole dynamic.
Are my definitions of Web 3 and effects, of course, we created our own. So our definition of Web 3 is any product that equalizes ownership and participation across the consumers and creators of products and platforms. Alongside our definition, there's also this ethos of web 3.
And by the definition of distributing the sense of ownership and participation, the ethos is also this shared sense of ownership in that not only do you tactically own a piece of these protocols, but in virtue of doing so, you also feel like a real owner and contributor to the products and the protocols and the platforms that you interact with. So you engage differently. You tell your friends to join differently. You care differently.
So that distributed sense of ownership and participation really is pervasive across how you feel interact and share that product as well. If you are a founder, thank you for being here. We largely see 2 buckets of founders in web 3. Let's start with the first. First is web 2 founders We're really excited about building in web 3. So these are founders that come from more traditional web 2 companies with strong product and engineering backgrounds.
They have been following Web Pete for a while or are very new to it, and they have the mental virus, which we are all familiar with. And they just need to have their next act being web 3. We are very excited about this wave of founders coming into web 3 because that the product standard in Webb 3 is the equivalent of eating glass products are really hard to use. Us, crypto folk have use them because we have to and because for the love of the James.
But for the next wave of consumers to enter the space, the product experience needs to be better than where it is today. So these web 2 founders who are coming in, they have years of experience building some of the products that millions of not billions of, you know, normal people use every day, and we're really excited to see how they can apply those skills to web 3. That said, web 2 founders that are new to web 3, the biggest risk is platform risk.
So if you're building a web 2, there's little or smaller platform risk than building a Web 3 in that. If you are choosing to build an iOS app where you're choosing to build even just a website. Like, there's little platform risk. Like, you're pretty confident that iPhones aren't going anywhere for the foreseeable future. In web 3, you need to choose which island to build on. So which protocol to build on? Which blockchain chain to build on, which layer 1 or L1 to build on.
And there is risk there in that there's risk to the underlying token price. And what does that mean for your product? There is risk to the underlying infrastructure. And what does that mean for your product? So there isn't one answer, and we are not here to pick favorites.
And we do believe that there are different answers for different use cases and different founders, but I would say the most important decision to make as far as, like, the start of your journey and on the decision tree is which protocol you're going to build on. Can actually, let's say, pause and rewind in the most important decision to make of which problem are you gonna solve for people or consumers or end users.
And then what is the best architecture and infrastructure to help you achieve that goal? Because as mentioned before, there isn't one answer. There are some islands, blockchains that are better Morgan certain use case, and there's some that are better for other use cases. So figure out the problem. That you can uniquely solve. And then the biggest choice from there is what island are you going to build on.
And the reason why it's so important is for the reasons I mentioned before, infrastructure of what that will impact your product and business token price will impact your product and business. And then also it is the community and the infrastructure that is built around that island. So Morgan instance, like some Blockchains are supported on a lot of exchanges. Some blockchains are supported on fewer exchanges.
Some have more on and off ramps, meaning it's easier for consumers to get fiat money US Beller, euros into and out of those. So there are all of these ancillary ecosystem benefits or disadvantages to various blockchains. And the most important decision you can make once you figure out what you wanna do is which blockchain are you going to build on? One of the most important heuristics to evaluate those blockchain through is the network effects lens.
So we will be putting something out that will evaluate various blockchains through various network effects, lenses, and Stay tuned for that. The second bucket are the web 3 founders that are native to web 3. So you have Pete, slept, and breathed this world for the past. You don't even remember life Morgan, and we love you too. And we are so excited to work with you as well. So you are kind of rolling your eyes at what I said in the last section. You know the ecosystem.
You are very familiar with the pros and cons of the various blockchains, but We believe that there are some learning lessons from the before time that are still relevant to you. We recognize that Web 3 is this whole new world, and that a lot of the mental models from web 2 and earlier do need to be thrown in the garbage because they do not apply. But we also believe that there are common denominators from the before times that are still relevant.
And, of course, that includes, like, the network effects framework. So we will be talking about that today as well. I'll also add that my partner, Gigi, has a mental model for types of businesses in Web3. And he says that there's 3 types of businesses in web 3. 1 are kind of the completely net new products. So I think L1s, which the old world doesn't apply. They are valued and who knows how.
And they have James, and they have cult followings, and they are religions, and they are wonderful, and it's hard to or harder to apply mental models from the before times to those. Then the second bucket is products that are net new to web 3 and that they could not have existed Morgan. And everything about them is Web 3 native, but they are still grounded in some reality and that maybe they still have an equity evaluation versus a token valuation, something else we can talk about.
And maybe they also have to acquire users in similar ways. And then the 3rd bucket are web 2 businesses with web 3 sex appeal. I'm allowed to say that, which are businesses that are still really traditional businesses in that they are still based on transaction volume, or they still have to by Facebook ads, or they still have to do enterprise James.
Like, a lot of the inner workings of how these companies will be built and how they will succeed are really the same as they were, but what they're selling is a product that touches the web 3 world in some way. And those products and founders really need to study lessons from the before times. So we work with teams in all three buckets, and we are excited about all three buckets.
For the 3rd bucket, I would say that the caution is thinking that those businesses are maybe more net new than they are. Now that I've been at FX for a long and a short 18 months, I've met with 100, if not thousands of web 3 founders, and I've realized that there are these common denominators if you wanna build network effects into your business. So With that, we've developed a 3 part framework for how to Beller network effects into your business. Stage 1 of the framework is network binding.
Network of bonding is really important. You need to start with your community. You need to start with the people that you're solving a problem for, and you need to talk to them. So instead of building in a vacuum and then going out into the world and hoping that the users exist and that they want what you're selling them, we believe you need to invert it a bit, which is start with the people that you're solving a problem for, but not only that, because that's always been Morgan.
Start engaging with them sooner and having them engage with you sooner. So I recognize that animal farm didn't work and that there's a spectrum Pete.
And we still believe that there does still need to be some team that is building and making decisions and using their judgment at the same time, we believe that instead of that team kind of being off on their own and then coming up for air when the time was right to launch the products that That team needs to be engaging with the people that they're solving a problem for Currier, meaning specifically that ask them what they want, ask them what features they
want, ask them, what they're looking to see in the product on day 1.
And to the point that there's a spectrum between complete dictatorship and animal farm, I would say maybe make a finite list of what are the parameters in your product that you're comfortable letting the community have control over or letting the community have some say over and let them play kind of in that sandbox because it would, of course, be chaos if you opened up the whole scope for the whole world, and that's why there are people who are product
managers and there are people who are engineers and there are experts at certain things. But you do want your community to feel ownership. And specifically, like, the litmus test that I use as a proxy is, does your community, does your user base feel and know that the product looks and feels and is different because of input that they had. And, again, whether or not that's true, it should be true.
It's very important that they feel that way because coming back to the ethos part of web 3, you want the people you're having a problem for to feel like they are really owners. But one of the more common ways of network bonding and crypto that we see is tokens. So Tokens are interesting because they are a utility that is unique in how democratic they are. And by that, I mean that in the past, there were different tools used to incentivize different parties related to a business.
So you are Facebook to use them Morgan. And you pay your employees with cash, and you also pay them with equity grants, and you pay your contractors with cash, but those are in of contracts, but you also have stock that public shareholders can buy. And there's various forms of compensation that can be used to coordinate the parties in your ecosystem. In crypto, that is democratized and that there's one unit, and that is your token.
The value of that token is tied to the health of the product or the protocol. So when the product and protocol is doing, right, or is doing well, the value of the token goes up. And, again, if used as a tool, an incentivization tool, then you have all of the various constituents in your world, customers, employees, contractors, partners incentivized to make the token go up, which, again, is incentivize to make your business and protocol healthier.
So as we keep saying, we believe that the social network effects, the ones on the outside of the map, are the extra important ones for web tree founders as far as where to start. And I'm realizing that it's worthwhile to pause and go over what those social network effects are. So the social network effects are tribal Beller, bandwagon, and language, and let's go through each one.
So tribal is finding your tribe, finding groups of people who share a common interest, whether that's baseball cards or Morgan credits, or Arizona ID. Once you find those people, the beauty is that it's no longer one to no longer you trying to find those people, it becomes money, and the growth then becomes exponential. And your tribe helps instill the second network effect, which is the belief network effect.
So the belief network effect is much like gold and religion, and Bitcoin, which we will get to. And the belief network effect is creating shared beliefs among a group of Pete, so that they are motivated to achieve a common goal. And once more people start to believe in the same thing, the value of that belief rises. The bandwagon network belief is more or less creating FOMO, creating something that feels exclusive that the people on the outside want to be a part of.
And that the people on the inside feel really special to be a part of. And then last but not least is language. And language isn't the most important. It's not like you can't start without it. But it's a very, very nice to have. And language is this subculture that people wanna be a part of. And you see it between projects, but you also see it at crypto at large. Like, if you saw people saying g n for good Morgan, or if you see people spelling when WEN instead of WEN.
Those are all of the little things that create the shared language and the shared subculture. Between a group of people, which makes it feel more like a tribe. So even though those are 4 distinct network effects, you can also kind of see how the 4 social network effects play together. And build on each other and can kind of snowball. It's definitely something you should be shooting for. So the 2nd phase is once you have your social network effects in place or a good enough place.
The real challenge is that how do you navigate your team, your product, and your tribe closer towards the center of the circle? So social network effects are great and strong. And again, where we believe web 3 founders should start, but the trick is that the strongest network effects are actually in the middle. So as you figure out where you're going to land in that center, think of some examples.
Are you a platform like Ethereum where you are bringing developers to bring DApps and products experiences on top of your platform. Are you a marketplace? Like OpenSea where you have buyers and sellers and you're at the center of that, or are you a market network where you have end size of your marketplace, which make it even stronger because there's more constituents that are tied to your success.
The goal of stage 2 is navigating towards the center of the circle to find a more defensible position and landing place for your company. Stage 3 is reinforcement. So once you have your social network effects and once you've chosen your network effect, that's more towards the center. How do you reinforce that? How do you build defensibilities of defensibilities? How do you build Beller the walls of your castle even higher? How do you further ensure then it's harder to compete with you.
It's harder to replace you. It's harder to make you irrelevant. Reinforcement is an area where web 3 is particularly awesome. So in web 2, reinforcement, the onus was on the company, the onus was on the founder, to continue to build those defensibilities on defensibilities. In Webb 3, if done right, and that's why the social network effects are so Morgan, but you have a tribe working for you.
And it's kind of the self fulfilling prophecy where not only are you and your direct team working on the reinforcement and the defense abilities on defense abilities, but you have a tribe that has a belief system and a shared language that's out there kind of processes into the world, the power of your product and your platform, and incentives aligned are aligned across all constituents of your community to continue to reinforce these network effects.
And instead of it being, you know, one to many Morgan centralized team to many in this effort. It's many to many, and that's where even the reinforcement growth can be exponential.
If you set the social network of X building blocks in place correctly from the beginning and nurture them over time, And that's why to bring this full circle, we really, really believe that starting there is important because if you sew those seeds early, it kind of just continues to pay off for years years to come, and we'll continue to build that Pete for you which will make your life easier later.
So invest the time early to build the social network effects that later when you're at the reinforcement stage, you have a whole army of people working for you with you. So if you're starting a web 3 company, we recommend following this 3 stage framework. To build defensible network effects strategy into your business from the earliest days. As we try to tie in these DM learning lessons over the course of this course, One that I'm reminded of is how we really took that web 3 ethos to heart.
So we knew that we were maybe the ones coming up with the initial idea behind at the time it was called Libra, but we also knew and felt deeply and strongly that Libra had no chance of success if we didn't make others not only feel like they were owners, but actually also be owners.
So almost on day 0, we went to recruit other organizations, individuals, and entities to be part of the labor process from the earliest days so that everyone felt a sense of ownership and so that it didn't feel and so that it not only that it didn't feel, but so that in reality was not owned or controlled or birthed or conceived by 1 centralized entity. And that was really important to Morgan. Kind of every step along the way.
We kept pausing and checking ourselves and saying, is this truly a process that is not owned and controlled by us? Is this truly a community that we're building where everyone feels like Libra is as much theirs as it is ours? And is this truly a product that can stand on its own without us? And that's one of the really important litmus tests to ask for any Founder and Web 3.
Like, of course, there's gonna be a phase where you're needed and you're wanted, but an ultimate goal is to envision a future where one day if you were to disappear, can that product or protocol live on its own? And that was always something we asked ourselves every second and every day over the labor journey. If you've made it this far, thank you.
And you also have heard and hopefully understand why we believe network effects are so important for web 3 starting from social network effects to more of a center of the circle of what is the main network effect of your business. But at the same time, I'm gonna admit we don't really know anything in that. It's so early. And if you're new to web 3, I don't want this to be intimidating, but I also really want you to feel that it's so early.
And you hear people say that, and you might think it's a joke, but it's true. And as my partner, James has been following and studying and building and learning in the web 2 world, He has discovered new network effects from the web 2 world as web 2 has evolved, such as the hub and spoke network effect. So although we're here today, preaching what we know.
We also are very cognizant of the fact that we don't know a lot, and we expect to discover new network effects that are specific and relevant to web 3 as the space emerges and as web 3 eats web 2. So if you enjoyed this course, please stay tuned and subscribe and join the NFX family so that you can learn and discover with us as this world evolves. Stay tuned to the NFX podcast as we'll post 1 episode per week until we complete the course.
Can also watch this entire master class online atnfx.com/masterclass, where you can log in, track your progress, and watch full videos, retranscripts, and find other related material. Thanks for listening to the NFX podcast.