[Comments reopened. Deutsche Bemerkungen begrüßt.]
Follow up article on the Linden dollar is here.
In 2005 I began working as a venture consultant for some entrepreneurs and investors trying to develop a fairly ambitious “real-money-trading” (RMT) business idea. My work resulted in my collection of a large amount of RMT market data for most of the popular massively multiplayer games and virtual worlds. Although the new venture was never pursued due to my analysis of the true RMT market, one game caught our particular interest: SecondLife, operated by Linden Research Inc. (privately held, San Francisco CA).
Unlike the makers of nearly all other online games, the operators of SecondLife not only allow and encourage the exchange of game currency for real money, but they actually facilitate it. As early as 2005 I began noticing a rumbling in interest-focused blogs about the exploding market that was SecondLife. Touted as a pioneering future Metaverse on the industry’s most informed blog, TerraNova, an array of journalists, academics, and company executives have claimed that SecondLife boasts an economy complete with in-game banks, multiple currency exchanges, a floating currency exchange rate, and a burgeoning in-game commerce and business base.
The Virtual Economy
Although many people were introduced to the idea that commerce and trade within virtual reality worlds could represent real world money profits by BusinessWeek’s cover story on infamous SecondLife resident and self described “Land Baroness”, Anshe Chung, industry followers had long realized the potential of RMT. Shanda Entertainment (SNDA), operator of the most popular and successful games in Asia, for example, had committed to a strategy of harvesting RMT profits long before Linden Research set up shop. Nonetheless, financial publications such as The Economist and The Financial Times began catching on, running articles about RMT – often citing SecondLife as the phenomenon’s leading model. One Financial Times article, referencing a university professor who makes his career by studying “virtual economies”, suggested the size of the total RMT market was $1bn USD in 2005, and would grow to over $7bn USD by 2009.
And SecondLife was at the forefront of where money was being made. Or, so one would rationally conclude from the buzz. When BenchMark Capital backs a company like Linden Research, it’s safe to assume otherwise smart investors are expecting huge potential market payoffs.
The idea of SecondLife’s economy is simple. It’s just like a real world economy, except
it takes place entirely within the company operated game servers. Customers from around the world connect with
a sort of super-browser, which renders complex graphics, video, stereo music
and other useful utilities not unlike a web browser. But the difference is that SecondLife is a
virtual world. More like a Hollywood representation of the web than today’s mundane
reality. Customers take on avatars which
represent their presence in the virtual world.
As these avatars interact, commerce is conducted. One starts SecondLife with some fairly
mundane clothing, for example. Upon
entered the world, a new customer is immediately assaulted with a variety of
clothes, jewelry, shoes, hair styles; and that’s only the tip of the iceberg. But nothing is free, not even in virtual
reality. New customers are allocated a
few “Lindens” or L$ (SLL being the standard trade abbreviation). Most new customers quickly blow through these
starter L$ as they dress up their avatars.
New L$ are distributed to customers as they pump real money
into the virtual world. Nearly all
customers utilize the game’s built-in “buy money” feature, which allows them to
charge their credit card or PayPal account “micropayments”. Micropayments are a popular, proven business
model first established in the mobile-phone market. All SecondLife does is extend this concept to
a virtual reality game world.
Multiply all these micropayments among Linden’s claim of millions of customers, tens
of thousands of which are online at any given time, and SecondLife supposedly
represents a very real economy generating hundreds of thousands of real dollars
of commerce, daily.
What are People Buying?
Reading BusinessWeek, or studying Linden’s or various other SecondLife blogs, it appears that the largest business of SecondLife is land speculation. Anshe’s claim to have earned over $1m USD from SecondLife is primarily related to her virtual land brokering business.
Another important source of SecondLife commerce is people “playing dress up” with their avatars. Buying clothes, earrings, new faces, or other more private body parts represents a great deal of the readily visible commerce outside of virtual real estate brokers.
Of course, anyone lingering in the world of SecondLife for
more than a passing glance quickly discovers the real engine to the SecondLife
economy: sex and gambling. A healthy share of micropayments are pumped
into the system as customers engage in pulling the virtual slot lever or
patronize one of the myriad virtual sex workers.
But it’s Still an Economy, Right?
As opportunists and capitalists, we’re not particularly bothered by indications that SecondLife generates most of its economic “wealth” through a rampant virtual real estate bubble which makes San Francisco, Marina District condo look like a bargain. Nor are we particularly bothered that the virtual playground provides a safe harbor for what is effectively the phone-sex industry reinvented. And internet gambling, despite the US Federal Government’s recent protestations to the contrary, is inevitable. So why not profit off of it? And how better, than in a utopian Ayn Rand open market capitalistic metaverse?
Of course, it’s not all that simple. And what’s true of the real world turns out
to be true of the virtual world: if it
sounds too good to be true…
In order to participate in a legitimate economy, there are a few basic prerequisites. SecondLife has the appearance of a virtual “securities and exchange commission”, virtual banks, virtual currency exchanges, and even virtual venture capitalists and REITS.
In July of 2006 we took a look at two in-game banks which allowed SecondLife residents to deposit their L$, and earn interest on the balance. These are private banks, run by other players, not by the game company itself. I discovered that the interest rates being paid by these banks, when calculate by interest-rate-parity against the USD, were mispriced allowing for a whopping 2,786.32% return arbitrage opportunity. Over some months we sunk the better part of $10,000 USD into SecondLife, borrowing from banks, lending to banks, and entering into various types of virtual financial arrangements with virtual businesses.
The first problem we encountered was one of counterparty risk. Put simply, you can seldom trust those with whom you’re doing business in SecondLife. Even supposedly well established, well regarded business citizens are prone to defaulting on any obligations which prove inconvenient. Whole banks will disappear over night, along with your L$ balance. Private businesses will simply refuse to make good on financial contracts. And individuals, pretty much all of whose real world identities are carefully guarded anonymous secrets, sometimes even will openly default, without recourse.
Justifications for default and non performance are usually wrapped in pseudo-libertarian internet political rants, or SecondLife political hyperbole. The simple fact is, if you arbitrage a bank for over 2,000% return because they don’t understand financial engineering, don’t expect to be able to collect come payment time.
But, that doesn’t mean it’s impossible to make L$. In fact, we were able to make quite a few L$ in a very short period of time, despite disingenuous counterparties.
Enter the second problem, the L$ exchange markets are effectively rigged. At any given time over the past year or so, the SLL/USD exchange rate has hovered between about 250 and 300. That is, for every L$300 you earned, you could expect to get $1 USD. Now recall, there are supposedly hundreds of thousands of real dollars being spent daily; over L$250,000,000. Between Linden's official exchange market and the private exchanges, all appearances suggest a large volume of L$ daily exchange trade.
The catch is, however, these headline rates only apply to small amounts. For small time buyers and sellers of L$ -- be they virtual Johns paying up for sexy avatar escorts, or small time digital jewelry makers cashing out a couple hundred real dollars – this works well. Most of these people will use Linden’s official LindeX exchange, anyway. LindeX is actually not a virtual currency exchange market so much as it is an open auction, anyway. This means LindeX is not particularly useful for big trades.
The private exchanges, however, are owned by the businesses which sit at the top of the SecondLife economic pyramid. The “Virtual Land Baroness” owns the largest such exchange. So it is not surprising that our attempts to trade our L$ for $ USD were met with confiscatory market reflectivity. Or, put simply, every time we attempted to transact more than a couple hundred dollars, the SLL/USD rate would spike to levels approaching or even greater than 500. Example: mid July 2006 SLL/USD was 293.0/279.2 bid/ask on the primary open exchange. Our attempts to trade L$650,000 resulted in settlement bids of 350-450. Interestingly, these trades tended to net returns of right around 4%, which was the prevailing dollar deposit rate.
The Ponzi Scheme Epiphany
As we scratched our heads trying to figure out if there weren’t a more clever way of disguising our trades, or perhaps creating our own in-game banks and exchanges in order to arbitrage the other direction, it suddenly dawned upon me.
This game was just a pyramid scheme.
SecondLife is not a dramatic taste of our future, in which markets are virtual, currency is free from government control, taxes are non-existent, and normal people can become real millionaires simply by clicking their mouse a few times.
SecondLife isn’t even a simple virtual economy, with legitimate buying and selling, and opportunity for those who would compete.
No, SecondLife is a classic pyramid scheme. Or, more of an Amway-like pyramid: partially legitimate, partially ponzi. Sure, there are plenty of legitimate SecondLife customers who just like to go there to get their kicks, spend a couple dollars, and be on their way.
But, the buzz isn’t that Joe Sixpack can sit at his computer and gamble a little before bed with a smashingly attractive avatar. The buzz is that Anshe and others are making real millions. And a short visit to the world of SecondLife will reveal the frighteningly large portion of residents who “know someone who makes his or her living” doing something in SecondLife. Just the other night I had an interesting conversation with someone claiming to be a single mom of three, who spends her days turning virtual tricks and arranging for E-Bay payments through SecondLife L$. She didn’t seem to have any idea why her mysterious benefactor would pay her a commission to simply arrange PayPal transfers. More cynically intelligent readers will immediately recognize these transactions for what they are.
Again, the fact that tax evasion, organized crime and money laundering exist in the virtual world doesn’t distress me all that much; these things exist in the real world, and have for a pretty long time. The distressing part is what this single mom said later; the same thing one will hear over and over from SecondLife residents: she was just doing the cybersex and E-Bay stuff to fund her virtual jewelry store. She was a jewelry designer, and had already opened a little shop in a virtual mall. And, to her amazement, she’d already made over L$50,000 after only a month (about $185 USD). I didn’t bother to point out that she hadn’t counted her expenses for renting her virtual shop or accounted for taxes, let alone the fact that she was earning less than 1/100th of what she could get just flipping burgers in the real world. [This statement was an error. I should have said "let alone the fact that she was earning much less than she could get..."]
And that’s the story of SecondLife. Like the paid promotion infomercials that run on CNBC, sadly SecondLife is a giant magnet for the desperate, uninformed, easily victimized. Its promises of wealth readily ensnare those who can least afford to lose their money or lives to such scam in exactly the same way that real estate investor seminars convince divorcees with low FICO scores to buy houses sight unseen with no money down.
Even some corporations have dedicated marketing budgets to creating a presence in SecondLife. While few will shed a tear for the frivolousness of these companies’ spending, such adds a false legitimacy to SecondLife. Interestingly, no legitimate, real world corporation has earned net profit from SecondLife activities.
That’s because there are but a very tiny handful that profit off of the SecondLife economy. A handful of casino owners, large scale virtual land flippers, and brothel owners are responsible for nearly all of the real money extracted from the game. And they continue to attract new recruits to the bottom of the pyramid.
After all, Anshe Chung herself started
out as a virtual whore, so you too can become a SecondLife millionaire, right? [I apologize to Anshe for what was a very poorly considered statement. I deeply regret any ill will it has caused. Please consider it retracted. I also thank Prokofy for enlightening me to some of the bitter realities experienced by those on top of Second Life's economic order.]
Retractions and Corrections:
Acknowledging an error in my original article: A “burger flipper” does not earn 100 times more than a Second Life income earner, at least not as I intended express. I double dipped on my analogy and merely meant to demonstrate that a “burger flipper” earns significantly more than a similarly skilled Second Life income earner.
When I typed “market reflectivity” I meant to type “market reflexivity”. I am sorry for any problems this caused in those seeking definitions.