Santiago Roel Santos, the founder and CEO of crypto investment firm Inversion Capital, posits that cryptocurrencies do not benefit from true network effects, a claim that has sparked disagreement among analysts.

In a recent post on Substack, Santos stated, “crypto is priced for network effects it doesn’t have.” He referenced Metcalfe’s Law, asserting it fails to substantiate crypto’s valuation and rather exposes its flaws.

Santos attributed various adverse network effects to cryptocurrencies, like increased fees and slower transactions. He noted, “Facebook didn’t deteriorate when it welcomed 10 million new users.”

Pushback from Experts

While some analysts concur with the notion of crypto being overvalued, others argue that Santos is misapplying the analysis framework.

Santos acknowledged new blockchain technologies enhance transaction speed but maintains that this just reduces friction without adding value. He emphasized that liquidity, developers, and users can migrate while code can be forked, resulting in weak value capture.

Jasper De Maere, desk strategist at prominent crypto market maker Wintermute, commented that evaluating layer 1 blockchains as overvalued due to unfavorable network effects is improper. He elaborated with the Facebook analogy, stating, “Facebook’s back-end also had congestion and outages early on; those negative effects were simply internalized and abstracted.”

According to De Maere, layer 1s are not meant for direct user interaction, making metrics like monthly active users and user retention less significant. He emphasized that the genuine network effects for a layer 1 occur at the layer of validators, security, and liquidity, where compounded value accumulates.

Tomas Fanta argued against Santos’ claim regarding fees deteriorating as usage increases, asserting that high-performance blockchains see fees transition from negligible to similarly negligible, with liquidity and yields improving as adoption rises.

Ben Harvey of Keyrock echoed some of Santos’ views on the overvaluation of L1 blockchains but clarified that this does not apply uniformly, highlighting factors such as protocol scalability and AI integration.

Valuation Logic Discourse

Santos pointed to rough calculations regarding the value an on-chain user brings to a blockchain. Given the current total crypto market cap, excluding Bitcoin, of $1.26 trillion, this prices estimated monthly active users at between $18,000 and $31,500 each, according to a venture capital assessment.

Another report states that 716 million individuals own cryptocurrency, translating to a nearly $1,760 value per user, though this figure overcounts due to Bitcoin’s inclusion. With Santos’ estimated 400 million users, that figure would adjust to $3,150 per individual.

Comparatively, Facebook’s 3.1 billion monthly active users and Meta’s market cap yield a per-user valuation of around $516.

Martin Kupka, a former investor at Web3 firm RockawayX, remarked that current crypto network effects are visible in stablecoins, centralized exchanges, and decentralized exchanges. He argued that the usefulness as a medium of exchange and collateral enriches liquidity,

As De Maere illustrated, “Web3 is modular, making underlying network effects easier to identify compared to Web2,” highlighting how these dynamics manifest across layers.

Sourced from Santiago Roel Santos’ observations.