Debate Ignites Over Crypto Network Effects as Investors Question Layer 1 Value

A recent debate has emerged in the cryptocurrency community regarding the network effects of Layer 1 (L1) blockchains. Santiago Roel Santos, CEO of Inversion Capital, argues that cryptocurrencies are overvalued due to a lack of positive network effects. In contrast, several industry experts suggest that Santos's framework is flawed and emphasize that different factors contribute to the valuation of Layer 1 networks.

Key Takeaways

Santiago Roel Santos contends that cryptos lack beneficial network effects, calling their valuations into question.
Some experts argue that Santos misapplies consumer-based logic to infrastructure-level assets like Layer 1 blockchains.
The impact of network effects is more complex, involving factors such as validators, security, and liquidity rather than just end-user interactions.
Estimates of on-chain user value highlight discrepancies between crypto and social media platforms.

Debate ignites over crypto’s network effects as investors question L1 value

Unpacking the Debate on Layer 1 Cryptos

Santiago Roel Santos, the founder and CEO of crypto investment firm Inversion Capital, is raising eyebrows with his assertion that cryptocurrencies are not experiencing positive network effects. In a recent post on Substack, he stated, “crypto is priced for network effects it doesn’t have.” Santos criticized the valuation framework known as Metcalfe’s Law, arguing that it fails to support the current crypto valuations and instead reveals their vulnerabilities.

He identified adverse network effects within the crypto landscape, citing issues like congestion that lead to higher fees, poorer user experience, and slower transactions. “Facebook didn’t get worse when it added 10 million users," he pointed out.

Counterarguments from Industry Experts

While some analysts concur that crypto may be overvalued, others challenge Santos's viewpoint, suggesting that he is using an inappropriate lens for assessing Layer 1 blockchains. Santos acknowledged improvements in transaction throughput with the advent of new blockchains but maintained that this merely reduces friction rather than adds value. He further noted that while liquidity, developers, and users can shift, the ability to capture value remains weak.

Jasper De Maere, a desk strategist at crypto market maker Wintermute, noted that applying traditional consumer-based logic to infrastructure is misguided. He explained that “users are not supposed to interact with L1s directly,” which makes metrics like monthly active users less relevant. In his view, the real network effects for a Layer 1 blockchain operate at the validator, security, and liquidity levels, where true value compounding occurs.

Tomas Fanta, principal at Heartcore, argued against Santos's assertion that increased usage results in higher fees. He highlighted that on high-performance blockchains, "the fees shift from being meaningless to… still meaningless," while also suggesting that as adoption grows, liquidity and yields also improve.

Ben Harvey, a digital asset researcher at Keyrock, generally agrees with Santos's critique regarding Layer 1 overvaluation but cautions that the situation differs across various Layer 1 protocols, emphasizing the importance of scalability and artificial intelligence integration.

The Complex Landscape of Crypto Valuation

Santos pointed to some rough mathematical estimates calculating the value of on-chain users for a blockchain. Considering the current total crypto market cap (excluding Bitcoin) of $1.26 trillion, it would result in a pricing per user ranging from $18,000 to $31,500, based on an estimated 40–70 million active users.

While a report noted that 716 million people own cryptocurrency, this inflated figure leads to an approximate per-user value of about $1,760, which oversimplifies the reality since Bitcoin was not excised from the calculations. Santos’s estimate of 400 million users leads to a per-user value of $3,150.

For comparison, Facebook’s 3.1 billion active users yield a per-user valuation close to $516, taking into account Meta's wider range of platforms and services.

Market cap per user comparison. Source: Santiago Roel Santos

Martin Kupka, a former investor with RockawayX, argued that crypto’s current network effects lie substantially within stablecoins, centralized exchanges, and decentralized exchanges. He explained that the utility of crypto as a medium of exchange enhances trader participation, liquidity, and overall execution.

De Maere added that the modular nature of Web3 makes underlying network effects more visible compared to Web2. He elaborated that these effects manifest across layer one via security and validator concentration, stablecoins through liquidity, and various exchanges within the application layer where user aggregation occurs.

“Because these layers are separable rather than bundled, you can clearly observe where compounding happens," De Maere said. He also pointed out that traditional valuation metrics might make certain crypto assets appear overvalued, similar to the challenges experienced in valuing Web2 platforms, which eventually required tailored models.

Conclusion

The conversation surrounding cryptocurrency valuations and network effects remains active and multifaceted. As investors seek clarity in this space, understanding the different perspectives is crucial in navigating the complexities of Layer 1 assets and determining their future potential.