Institutionalization = Network Success

“Better technology doesn’t always win” is an old adage in entrepreneurship with numerous well-studied examples from business history: standard vs. wider and more performant railway track gauges, combustion vs. electrical engines for inner city car transport, Qwerty vs. Dvorak as keyboard layouts, VHS vs. Betamax as videotape formats, etc. Similarly, while it is true that solving technical problems related to scalability, privacy, cost, and user experience is essential for driving the adoption of blockchain networks, the long-term success of individual networks is not only — and, in some cases, not even primarily — a function of their relative technical merits. It’s also a function of their relative institutionalization.

There can be many reasons why a particular product attains and maintains market dominance, even when technically superior alternatives are readily available: favorable timing, sticky consumer habits, regulatory or distributional advantages, vendor lock-in, technological path dependence, high switching costs, compatibility with existing standards or other popular products, better marketing, and even random chance events that end up contributing to, for example, ecosystem or network effects. Competing products are never presented simultaneously to all perfectly knowledgeable target customers with identical tastes, or brought to market within a vacuum, unaffected by the context around it. To the contrary, knowledge about products is unevenly distributed, individual consumer preferences may vary even when developed upon identical information, and producers are all embedded in pre-existing social and market structures that may affect their competitiveness independently of the quality of their products.

In the context of public blockchain networks, one particularly important non-technological success factor is the network’s degree of institutionalization. Here, I’m not referring to software protocols as the codification of rules for administering information and transactions associated with that information, which itself is a type of institutionalization (see here and here). Rather, I’m referring to the degree to which a particular network becomes embedded in the mental models and social practices of its developer and user communities, as well as in external technological and institutional structures. Typical sources of this type of network institutionalization are:

• First-mover advantage. For instance, being first to associate a specific use case with a particular network can make it difficult for other, including technologically superior, networks to compete if the association is so strong that the network and the use case become almost synonymous (for example, Bitcoin as digital gold). Similarly, being first to successfully reach a particular developer or user group can generate loyalty to the network, especially if it’s linked to substantial investment of resources or public commitments by these groups which ties their identities and social or economic fortunes to the success of the network. As a result, they develop a strong disposition to continue participating in and defend the network, even when presented with criticisms based on an unfavorable technical comparison.
• Internalization of narratives which leads to the development of shared ideology about the network’s role in society and position vis-à-vis its competitors. Blockchains are not just software protocols and technological infrastructure but also communities of people connected through values, ideas, and objectives. As such, they are infused with collective myths — whether factual in origin or not — that help them to maintain a sense of common purpose and continuously mobilize resources required to grow and sustain the network. The more compelling and widely internalized the network’s narrative mythology, the higher its degree of institutionalization, thus making it more resilient against both competing networks and internal crises.
• Professionalization among network operators and providers of infrastructure services, especially if linked with substantial investment funding and the ability to run a profitable business within the network. This creates an ecosystem of mutually reinforcing economic interests which, once sufficiently large and diverse, contributes to the continuous development and reproduction of the network as a social and economic system. In some cases, if the user base and business ecosystem of the network grows large enough, economic incentives to continue operating and building on the network can override concerns over its strictly technical shortcomings.
• Network effects around open-source libraries, programming languages, tooling, etc., which attract entrepreneurs and builders to the network and continuously enhance the developer experience. Developer network effects are associated with the emergence of best practices that lead to increasingly habitual forms of thought and action. Over time, habits become second nature, leading to choices that are instinctive rather than based on deliberate objective analysis. At the level of individual developers, as their familiarity with a particular network, programming language, or set of tools grows, so do the individual career risks and costs associated with switching to a different network or ecosystem. While it is certainly possible for entirely new languages or open-source technology stacks to emerge and popularize, for an aspiring blockchain network, it does represent a much more challenging path to success than tapping into already thriving ecosystems by ensuring maximal compatibility with their technology.
• Consumer habits and brand recognition. By being regularly exposed to particular networks, user interfaces, and the associated brands, consumers develop trust and behavioral patterns which can eventually acquire an almost rule-like status in how they engage with blockchains. The more deeply ingrained these habits become, the higher the learning and switching costs associated with exploring alternative networks. This can even lead to a situation where reproducing a poor user experience that consumers are already familiar with, or building on a technologically inferior but highly trusted network with a large consumer base, is a more successful user acquisition strategy than offering an objectively better but unfamiliar product or experience. Brand trust and habitual consumption also contribute to the ecosystem and network effects described above through a positive feedback loop between the number of end users and application developers. The best way for aspiring networks to also start benefiting from this dynamic is by successfully onboarding entirely new groups of users that have not yet developed habits around using incumbent blockchains.
• De facto standardization. The establishment of technical standards has high coordination costs not just in the blockchain industry but in any field of technology. It is particularly challenging in a vibrant and competitive environment with numerous concurrent but technically incompatible attempts at solving the same problem. As a result, standards are often established not through industry-wide agreement or by a dedicated standards organization but, instead, through achieving a dominant market position. Such de facto standards are not always technologically optimal and, over time, they may or may not become officially formalized. Either way, they play a role in determining the long-term success of particular networks and technology stacks.
• Adoption and legitimization by external institutions. If the recordkeeping and other services provided by the network are utilized by existing organizations, especially if these organizations are prestigious and powerful, the network becomes more legitimate and thus more likely to attract other institutions to start using it. Similar to individuals, institutions also develop habitual forms of conduct which can be extremely difficult to transform once they become embedded in organizational culture and core functions, or result in substantial financial profit or other benefits. Large institutions in particular tend to exhibit high degrees of inertia, making institutional adoption a major driver of sustainable network usage.

None of the above is meant to suggest that technological innovation is not important. It is extremely important and there are use cases for blockchains and smart contract applications in which the most decisive success factor among competing networks will be technological differentiation. However, for the most part, good technology is only a necessary but not sufficient condition of success as incremental innovation in technology stacks embedded in a highly institutionalized ecosystem with strong network effects can easily win over more radically innovative technology within a lagging ecosystem that fails to sufficiently institutionalize. And if blockchain networks realize their full potential, those that institutionalize the most will also emerge as the most globally impactful for decades to come.

The author’s work is funded by Placeholder, a venture capital firm that invests in open blockchain networks and Web3 services.

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Middlemachines (January 2022)

How Crypto is Shaping the Digital Revolution (October 2021)

Blockchain Networks Are Bureaucracies Par Excellence (May 2019)