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Network effects became a cliché over the past decade. Every new tech company was banking on them. Just grow the business and let network effects take care of the rest...

Obviously it hasn't been enough for many tech 'unicorns'. The clue was in the name...

Anyway, if you talk to people about network effects now, they'll probably look at you like this before quickly making their excuses...

The Veteran's here to remind us that even though network effects aren't the solution to every problem, they are a timeless and valuable commodity 👇

We live and work in an increasingly connected society with all the pros and cons that this entails. Try functioning without access to your phone for an hour if you are in any doubt about that.

Oddly, the theories that underpin the modern world were conceived decades ago. Long before the age of computers, the internet, or even mobile phones. Right back when data was stored in libraries, or even in the minds of subject matter experts and academics.

Networks become more valuable as their utility or usefulness increases. In other words, the more connections within a network and the more active they are, then the greater the utility of that network.

Macrodesiac offered up the perfect example recently.

We're a virtual community, or network, of like-minded individuals who want to learn about, exchange ideas and information, on financial markets and the forces that drive them.

The community caters to professional traders, relative novices and everyone in between. In my view, the power of the community is based on the experience and openness (willingness to share) of its members which can be very powerful.

We were reminded of this by the Networking and Careers channel. It transpired that a post I had shared about job opportunities at one of London's most respected market makers had inspired a youngster to pursue a city career, rather than go to university.

Having passed several professional exams off his own back and impressing at an interview with the market maker in question, he landed a job.

Nice as that story is, what is the relevance to this article and the markets in general?

Relevance can be found in the concepts of network effects and utility.

Network effects were first described by Theodore Vail, the first president of Bell Telephone, back in 1908. Vails observations were popularised by Robert Metcalfe, who co-invented ethernet connectivity and helped to pioneer the internet in the early 1970s.

His work on network effects was later formalised into Metcalfe's law, which states that:

The value of a network is proportional to the square of the number of connected users or nodes within the system.

In its simplest form, Metcalfe's law assumes that all nodes or connections are equally active, which of course is unlikely to be the case in the real world.

Nonetheless, the concept serves to show why networking and communication are so important and valuable, and how they help to leverage the abilities and knowledge of formerly disconnected parties.

Networks such as Macrodesiac, or indeed any communications network exist to share and transmit information. The transfer of information underpins the world's developed economies and is becoming an increasingly important tool in emerging markets as well, where it allows countries with limited or underdeveloped infrastructure to take giant leaps rather than pigeon steps.

The transfer of information can be thought of as the transmission of messages, which often contain meaning, intelligence and relevance to the recipients.

Today we take this transfer for granted thanks to the development of the internet, the world web and cellular telephone networks and devices,all of which enable an always-on society.

Without over-exaggerating, none of this would have been possible without the work of one man, Claude Shannon, an MIT graduate who wrote a thesis on the application of Boolean Algebra to the analysis and synthesis of switching circuits.

Work that revolutionised the science of designing electronic circuits and systems.

Boolean Algebra was developed by George Boole in 1847. It's a form of logical operation that uses three key operators: Or, And, Not, which when combined with other operators, such as True or False become a very powerful and entirely logic-based decision-making tool.

Boolean logic ultimately went on to underpin the operation of nearly all computer programming languages and machines.

As for Shannon, he was only getting started. He wondered if there was there a unified theory of communications. One that worked for all systems, rather than just theories that were centred around a single system or network.

Shannon worked on the answer to that question for a decade, and in October 1948 he published the paper a Mathematical Theory of Communication.

The thinking behind Shannon's breakthrough was quite simple: transmitters encode information into a signal which is then corrupted by noise (Chinese whispers anyone) which then has to be decoded by the receiver.

Shannon had two key insights. Firstly that it was imperative to try to isolate the information from the sources of noise in the design of any communications system or network.

Secondly, and perhaps most profoundly, that you could model these elements in a probabilistic fashion.

A diagram from Shannon’s paper

What Shannon effectively did was create a framework that allowed you to work out how much information, or how much of a message, you would need to receive and decode to be able to decipher the contents of that message.

He also created a way to calculate the maximum amount of information a message could contain, in a given network, and the flow rates that the network could support

Work that paved the way for the process of packet switching, which facilitates the operation of the internet and the world wide web. When you think about it we are all Shannon and Metcalfe's children.

Network effects are the real deal, and as the world becomes increasingly interconnected, the utility of genuinely useful network effects will be increasingly appreciated.  

As traders and members of the Macrodesiac community we spend a lot of time trying to separate the signal from the noise in market data and economic releases, whilst building out the utility of the network as we swap ideas, ask questions and dig for information and answers in conversations with fellow members.

Join us 👇