Products with network effects must overcome the cold-start problem. In this week’s deep-dive, we’re going to look at how Web3 can help with this. We’ll dive into what the cold-start problem is, how it’s been solved in the past and how Web3 can offer a unique solution. We’ll also touch on what Web3 can’t solve.
As part of this deep-dive, I had the opportunity to chat with Alex Kehr, CEO and Founder of Superlocal. We’ll run through the Superlocal product and how they’re solving the cold start problem with tokens.
The cold start problem
A product has network effects when:
The product’s value increases as more people use it.
Users want a social media network only if their friends and family are on it. A marketplace like Ebay is useful to its buyers when there are enough sellers, and vice versa.
It’s a chicken and egg problem. When you’re at zero, how do you get your initial users? Why should sellers come to your platform if there are no buyers, and vice versa?
The cold start problem is as much about quality as it is about quantity. You don’t need any user, you need highly engaged users who use the product and make it useful for the next set of users.
How it’s been solved in the past
The cold start problem isn’t new. Facebook, LinkedIn, Pinterest and Uber are examples of businesses that have solved the problem. Let’s dig into some of the traditional levers businesses use to overcome the cold start problem.
Come for the tool, stay for the network
Solve a problem for customers that does not require their network.
When Pinterest started, the product was intended to be a place where users could organise their visual content. The product is independently useful for the user, even without a network.
In the graph below, notice how the total unique visitors metric increases at a much faster rate post September 2011 — this is network effects kicking in.
Plug into an existing network
The platform could serve as an entry point into an existing network until it builds up a sufficient user base of its own.
Instagram started out as a product to take photos, apply filters and publish them to Facebook.
Keep it local
By focussing on a small set of users, the platform could create network effects faster.
The user group may be restricted in terms of geography or a different attribute (e.g. focussing on members of a family). Facebook concentrated on Harvard to get its network off the ground. It’s easier to create network effects by focussing on a subset of users and this exactly how Facebook started.
Splash the cash
If there’s a competitor with a substantial network, one way to acquire users is by offering a subsidy.
Bolt (the ride sharing company in Europe) launched in 2013, 4 years after Uber. Their playbook was simple — don’t be the first to launch and charge a lower commission for drivers. Drivers were ready to switch because they earned more. Customers switched because they were able to get a taxi faster than Uber or other platforms.
Cold start with tokens
Tokens offer a new model to bootstrap a network.
This is because they offer:
- Ownership for users: With tokens, a user buys into the success of the network. If the network grows, their token will become more valuable. This creates an incentive for the user to market the network. The closest analogy in the Web2 world is the member-get-member growth strategy. In this case, users are rewarded for referring someone in their network. Tokens are much more powerful because they have unlimited upside — if I buy a token for $1, the price can rise by an uncapped amount based on the demand for the token.
- FOMO: FOMO is a time-tested marketing tool. How often have you wanted to go to a restaurant or bar because of a queue outside the door? It’s possible to do this without tokens — one could simply have an early access list. But NFTs (where value is driven by scarcity) are like a superpower because users could benefit from financial upside.
- Liquidity: tokens offer liquidity. As a user you can sell anytime and exit. In the next section we’ll look at why this can be a curse too.
Here are a few examples of networks that have been bootstrapped with tokens:
- Helium is building a peer-to-peer wireless network for businesses. People who supply the network are rewarded with tokens, and people who consume the network pay for it.
- Arweave is a decentralised data storage solution. People who store data are rewarded, and people who need data stored pay for it with tokens.
In both these cases, getting a network off the ground is expensive. In Helium’s case, you need enough equipment to ensure you have a network that is actually useful. In Arweave’s case, you need have enough capacity to host data.
Both of them used token incentives to bootstrap the network and reward early users. If you earned Helium tokens in June 2020, you could have made between 27.7x (today’s price) - 167x (all time high) your original investment.
What Web3 can’t solve
Token incentives are great, but they can’t solve everything:
Tokens are an acquisition tool, not a retention tool
Tokens are great for getting users through the door. But they cannot retain users. In theory, tokens alone could be used to retain users but this is not sustainable. Ultimately, your users will stay because they want to use your product.
Tokens can go down as fast as it can go up
With tokens, you can bootstrap a network quickly. Equally, your network can crumble quickly too. If the price of the token plummets, most users with tokens will choose to sell and exit. This leads to a downward spiral and makes the token less valuable for the next user. Liquidity is a blessing and a curse.
Acquiring the wrong set of users
It’s inevitable that your token will attract users who are after pure monetary benefit. This can be really harmful, especially in a product’s early days. One way to get around this is to offer incentives only when active participation in the network happens. For example, if you build a tokenised version of AirBnB users get tokens only when they take a valuable action: list a property, stay at a property or leave a review.
As part of this deep-dive, I had the chance to chat with Alex Kehr - the CEO and founder of Superlocal.
Superlocal is a social network that rewards users with tokens for checking in to places. I chose Superlocal because it’s a consumer product, it had its beginnings in Web2 and is bootstrapping a network with tokens.
Here’s a paraphrased summary of my conversation with Alex.
How did Superlcocal start?
Superlocal started as a network for college students. It helped them find social activities and connect with other students. Unfortunately, Covid hit and most social activities came to a halt. Superlocal needed to pivot, and whilst doing so, realised that Web3 would be a great way to solve the cold start problem.
How is Superlocal using Web3 to solve the cold start problem?
Superlocal solves the cold start problem using gaming and token incentives.
First, there’s an element of gamification and fun. For example, users can become the “Mayor” of a particular location. As part of this, they receive an NFT that is unique and transferrable. Users are also eligible for “perk drops” (i.e. a token reward for using the platform consistently).
Second, users earn a token every time they checkin (called $LOCAL). This token can be traded and sold. This is the financial incentive.
There are other incentives as well and I encourage you to check out their whitepaper if you are interested.
Is the model sustainable?
Superlocal currently has two revenue generating events:
- When users join the platform, they need to mint an NFT to participate. This costs 0.04 ETH and all proceeds from the mint go to Superlocal.
- When an NFT is resold, Superlocal retains a 10% fee.
Based on the above, Superlocal is able to cover all outgoing token expenses (i.e. to reward users for checking in and perk drops).
The team believes there are others ways to monetise in the future. Once they have a network of users and their check-ins, local businesses will want to leverage this for marketing. The team is keen to avoid an advertising model, and plans to find other methods of revenue generation. For example, a local business could provide a “loyalty pass” where users get discounts via Superlocal.
The cold start problem is a real challenge for any business with network effects. Web3 can help solve this problem using token incentives. Ultimately though, token incentives are a tool and users need to find utility in your product to stay. If you’re interested in checking out a product that’s trying to do this, check out Superlocal.