The Linden dollar Game

On Schemes Resembling Objects of Intersecting Trilateral Sides upon a Polygonal Base

In a previous article I asked some very tough questions about the Second Life virtual economy.  That article provocatively proposed a case as to why I believe Second Life's much hyped economy resembles a pyramid Ponzi, or more accurately a type of high yield investment program (HYIP) scheme.  After posting that article I was partially convinced by many respondents that Second Life probably is not a Ponzi scheme as a precise legal definition -- at least probably not in most jurisdictions.  Indeed, after learning more about HYIPs, and in particular HYIP Games, Second Life and the game's system of "virtual currency" satisfy many of the attributes of such schemes.  More about HYIPs later.  First, some background:

Brief Background

I covered the background of Second Life in some detail in my previous article.  Second Life is a type of online computer game often referred to as a Virtual World. Virtual Worlds, while marketed as computer games and produced by computer game developers, are thought by many to represent the natural evolution of the web.  In fact, there are probably myriad noble and interesting applications of Virtual Worlds to things like education and community collaboration.

What I am concerned about here is only the virtual economy or virtual marketplace aspect of Second Life.  It is the claims of real gold in the Second Life virtual hills that has caused most of the recent media hype around the game.  The makers of Second Life, Linden Research (privately held; San Francisco; funded by Benchmark Capital et. al., "Linden Labs", "LL") themselves actively encourage this view of Second Life, judging from self-promoting links on Linden's own official Second Life website:

• Second Life: It's not a game Fortune's David Kirkpatrick reports on why IBM's Sam Palmisano and other tech leaders think Second Life could be a gold mine. 
• I got my job through Second Life Looking for work? Your best bet may be an interview in virtual reality. Fortune's Katie Benner explores the cutting edge of corporate recruitment.
• Starting a Second Life Business Find out what entrepreneurial opportunities the virtual world of Second Life has to offer.

Where There's Smoke...

In that now infamous article I concluded that Second Life's supposed economy wasn't a whole lot more than a typical pyramid scheme, where most of the money paid in by new recruits ends up realized by the organizers and a handful of early entrants.  I was promptly assured by any number of the Second Life faithful that I was wrong, and that there were literally thousands upon thousands of real, financially valuable businesses making money, providing jobs, growing at astonishing rates, and redeeming their virtual Linden dollars (L$) for real money.

I challenged the Second Life community to offer forth a typical, average business for quantitative financial analysis.  In fairness, a handful of apparently honest folks came forward with offers to participate; even one of the most well known of the "virtual oligarchs" (one of those in the handful of players at the top of the virtual economy) signaled some interest in the project.

Things took a hard turn when I was forced to cancel that project along with most of my Second Life public discussions and debates.  Perhaps I can discuss the particulars later, but suffices for now to say that many in the Second Life community have zero tolerance for critics and criticism.

Nonetheless, I did become more curious after the severe anti reaction I received. Especially so when even seemingly objective researchers and academics took a see-no-evil attitude, dismissing my analyses without serious treatment.

Even though I played the game myself on and off for more than two years, up until the middle of last year, I was still surprised.  The economic part of the game was always there, but never as a source of practically religious devotion.  What the hell is going on in Second Life?

Redeemable Virtual Tokens

The L$ is often referred to as a virtual currency.  In fact, it is not a currency at all.  It is a micropayment token system.  I have been around micropayment systems for many years in their application to mobile phone carriers.  The Economist (Feb. 17, 2007) features a cover story that includes discussions about micropayments vis-à-vis digital cash. 

Most justifications for why Linden Research had to create the L$ center around micropayment issues.  In reality, telecoms, Apple iTunes, Microsoft, and others have proven that floating an independent currency is not requisite to enabling a functional micropayment system.  I myself am partial to the iTunes batch-billing approach, keeping payments denominated in real currencies.  Even the more prepaid-credit approaches taken by Microsoft in the Xbox Live Marketplace avoid the complications of currency management introduced by independent, pseudo currencies like the L$.

Regardless of the reasons, the fact remains that the Linden dollar is objectively not a currency.  In Linden's Terms of Service agreement, sections 3.3 and 5.3, Linden clearly states that players have no financial or legal claim to their L$, and that L$ are a consumable entertainment product which can be revoked or deleted at any time, without reason.  Not quite up the standard of a fiat currency.

But Linden Research does promote, market, and manage the L$ as if it were a legitimate, independent fiat currency.  They operate an official "virtual currency exchange", the LindeX, on which players can either buy L$ with real money or redeem L$ for real money deposits to their PayPal or bank accounts.  And the redemption rate, or as they call it "exchange rate" implying the Forex equivalent of that term, is floating.

The Wiki on the Linden dollar asserts (emphasis added):

Residents may purchase L$ directly through the client, or convert between Linden currency and U.S. currency through either Linden Lab's currency brokerage, the LindeX Currency Exchange, or other third-party currency exchanges. The ratio of USD to L$ fluctuates daily as Residents set the buy and sell price of L$ offered on the exchange, and fluctuated between L$240/USD and L$350/USD between October 2005 and September 2006.

Virtual Interventionists

There are all kinds of macroeconomic tangents I could take at this point.  Without straying too far, we can safely say that Linden Research has taken on the role as "virtual central banker", and "virtual treasury", in minting and distributing their own "virtual currency".  (The Second Life economy is built upon a system of "sources and sinks" which, while sometimes cited as a monetary control lever, really more represent the virtual economy's fiscal policy.)

The exchange rate is not freely set by supply and demand; it is not a floating exchange rate.  In recent months, Linden Research has sold relatively large amounts of L$ themselves on their own LindeX market.   

Clearly a form of seigniorage (selling newly minted currency for net revenues), Linden claims they do this in order to manage L$ / $USD volatility.  In other words, they want to keep the redemption rate stable, right around the L$250-L$300 per $1USD range.  Currency intervention.

More economically astute readers will immediately recognize the conceptual and logical hazards and complications this implies.  Managing exchange rates of currencies is something which is extremely difficult, and terribly expensive to do over any period of time.  The lack of theoretical limits to how weak or strong various interests wish for a virtual currency to become only further complicates an interventionist strategy.

So, Linden Research is selling L$ which they print themselves.  Players buy the L$ with real money, but they don't really own the L$ they bought. And, Linden Research uses the LindeX pseudo-Forex exchange market in order to stabilize the redemption rate of these virtual L$ tokens.  So, will Linden be so willing to buy back L$ when demand falters?

Growth, Growth, Growth

Linden has boasted unbelievable growth numbers, even proudly displaying them on their Second Life home page.  In fact, Clay Shirky didn't believe the numbers, and challenged them in myriad forums (earning him fierce sometimes slanderous attacks from the Second Life faithful).  Eventually, Linden acquiesced ("Overcounts", Shirky) and provided more thoughtful statistics which showed that Second Life, while indeed growing rapidly as measured by first-time-visitors (account creations), in fact has only about 200,000 active users (those investing more than a week of time into the game).

From my perspective, these overcounts and growth exaggerations further aggravate my initial HYIP claims.  Simply, Linden Research cannot count on perpetual growth, given their own reported statistics, to support the L$ / $USD redemption rate.  They will have to start buying back a lot of L$ in the near future.  Or, more likely, the L$ will just devalue rapidly, leaving everyone with money left in the game S.O.L.

Not Just Words

I love narratives as much as any other blogger.  But, the proof is in the numbers.  I've taken the liberty to put Linden Research's own data through my analysis grinder, and I offer my results.

I created all these analyses from Linden Research provided data, using Microsoft Excel, Crystal Ball, SAS and my hp 49 g+.  Click the graphs to see the full size versions.

Conclusion:  The L$ to $USD redemption rate depends upon unrealistic growth assumptions.

The growth (charted in the previous section) depends upon the assumption of an exponential growth curve (yielding a coefficient of determination of 0.70).  Inspecting the actual forecast values clearly demonstrates the flaw in this assumption.

Supporting the current regime in which Linden Research is always a net seller of L$ in order to support (i.e. weaken) the L$ compared to the $USD, Second Life must register around 45 million unique players by the end of 2008; a growth rate of 40% per month by that point.  (Using an exponential growth formula, with conservative initial conditions.  This matches historical growth with R-Squared = 0.70).

Note, this is a ceteris paribus analysis. Linden Research could, and most certainly would attempt to use "virtual fiscal levers" with its series of controlled sources and sinks to strengthen the L$ in the face of diminishing growth.  I maintain, however, that these efforts will probably succeed only for very short durations and, like taxation in real world economies, ultimately produce far worse unintended negative outcomes.  For example, attempting to support L$ strength by forcing in-game deflation would almost certainly result in a serious "virtual recession" by depressing the game's "virtual commerce".

Growth is too volatile to count on going forward.

Absolute player growth, as measured by unique players and by registrations, produce equally volatile growth curves.  

At best, real growth trends experienced within Second Life are sporadic and barely predictable.  In this example, a 2nd order polynomial fit function still only produces 50% predictability.  Such growth is consistent with the type of media-induced hype that has caused a recent influx of new Second Life users, but which may be a short lived effect.

Growth of hours per player (unique) is even more volatile, and does not yield reliable regression predictions.

Summary statistics from Linden Research provided data for Unique Players, Registrations and User Hours, for reference:

Hours per total unique player is weakening even while hours per new player is beholden to spikes in media hype.

Take note of the consistent decline in hours per total unique player, barely breaking even from mid 2005 until only last month (January 2007) in an amazing reversal.  Historical trends predict future months will return to hours per unique player declines.

Hours as measured by allocation only to incremental new players produces more stable results.  Media cycles are more readily visible in this view also, as are periods of system downtime.  Summary statistics, for reference:

Most troubling, L$ Spend per Unique Player is weakening.

This again returns to the conclusion:

This chart shows the rapidly declining L$ purchased per new player as total unique players has grown exponentially.  L$ purchased per all unique players has also declined, although less rapidly, implying that most economic activity is supported by existing players, with growth in total L$ spending coming purely from new players trying the game, then abandoning it shortly thereafter.

One other bit to consider in the context of the above graph is the trend towards seigniorage. 

Unlike economies in the real world, the Second Life economy is strictly zero-sum. Therefore, every real $1 USD extracted from the game comes from someone who put a $1 USD in, whether directly from new users buying L$, or indirectly through internal "sinks", which amount to little more than the redistribution of players' future $USD redemption potentials.

High Yield Investment Programs

After reading and viewing the data and charts in this article, make up your own mind about similarities between the Second Life L$ based economy and a HYIP game.  The following are attributes of HYIP schemes and games.

• It is theoretically possible for a HYIP to be legitimate, and not a pyramid Ponzi scheme.  To date, however, all HYIPs have turned out to be Ponzi schemes.
• HYIPs are normally offered over the internet. 
• Entry costs (initial deposits) are very low, often less than $10USD. 
• HYIPs usually utilize e-currencies or virtual currencies, making it possible to accept very small investments and easily cross jurisdictions and other boundaries.
• HYIP virtual currencies usually introduce psychological "breakage" by being denominated in sub-penny units, making inbound investments, internal activity and unrealized gains feel larger to participants.
• HYIP participants strongly encourage and self-enforce thinking of internal activity only in virtual units, not in $USD translated value.
• HYIPs disclose little about internal strategy, management, or operations.  They often publish financial data, sometimes large amounts of detailed financial data, but they almost always refuse to do so in a meaningful, methodological manner which can be verified.
• HYIPs usually present emotional appeals, appeals to faith, promises of financial freedom, or promises of a new economic reality with active members best positioned to benefit financially. 
• HYIPs often claim returns of greater than 1% per day [that is an order of magnitude per year. Some Second Life banks offer 1% per day interest, incidentally; Many Second Life "businesses" boast 50% per month revenue growth].
• Three types of people typically enter HYIPs: 
  1. Naive, unwary, and ignorant.  These are most HYIP recruits.  They are usually recruited or referred.  They are attracted to the HYIP as a source of income, often one which they are desperate to have.  Once the HYIP fails, this group is often considered to be undeserving victims.
  2. Gamblers. A smaller group are those who know the HYIP is inherently unstable. Some even see it as a Ponzi scam from the start.  But, they calculate that they are early enough or can outsmart the game and earn returns nonetheless.
  3. Cheerleaders and shills.  Some in this group are the organizers or first entrants.  Others are those who've realized small profits from the game, and seek to grow the game in order to push themselves up in the pyramid structure, thereby amplifying their returns.
• Most HYIPs are positioned as low or no risk opportunities, being that little money is needed to start, and time invested is not considered a cost.
• HYIPs are zero-sum games by definition.  All realizable returns come from real money investments. 
• Forum, blog, and email list users will gain trusted reputations, ensuring others they have indeed been able to withdraw real profits.  They will quickly surround, counter and drown out any criticisms to the contrary.
• These games are not defensible as lotteries (although some have used this legal defense) because the odds of winning returns cannot be calculated ex ante.
• Public forms which endeavor to monitor HYIP games and warn unwary investors are nearly always overrun by cheerleaders and shills.
• The mainstream media often mistake HYIPs as legitimate, lacking understanding of internet communications (and thereby ascribing credibility to testimonials by cheerleaders and shills).

It is often argued that the Second Life virtual economy does not qualify as a HYIP type of structure because the nature of internal commercial activity largely involves productive endeavors.  By productive endeavors they are generally referring to virtual item design and creation.  At a detailed level, these are largely graphics design, 3-D computer modeling, computer art, and script programming activities.

I maintain this is false.  While lower-level players may earn some returns, by and large their investments into the game (both capital and labor) are trapped and not monetizable at fair market redemption rates.  Two detailed responses to the productive endeavors objection:

1. It is unclear how much of a percentage of the virtual economy is driven by these "productive endeavors" versus the online gambling, sex and real-estate markets.  The first two are clearly not productive endeavors and likely constitute a significant portion of the internal L$ economy. The latter is by definition not creating financial value because players have no financial claim on their virtual property -- they have no effective virtual property rights under current US and California laws.  Further, there exist no supply or production function restrictions which would enable long-term price stability of virtual real estate.  Over time virtual real estate will be worth only its marginal cost to provide as a product (disk space, electricity, router depreciation, etc.).
2. Productive activities produce real returns for players only insofar as they are able to redeem L$ cash flows for real money -- players have no financial claims on anything which resides on Linden Research's servers or network, including Linden dollars (only on limited forms of conceptual intellectual property). The continual weakening of the L$ by Linden Research is a mechanism by which potentially realizable financial gains instead accrue to the game's organizers, and to others with a similar ability to run their own L$ - $USD redemption exchanges.  Therefore, these players, even while feeling they are engaging in productive endeavors with positive financial returns, more serve to enrich those at the top of the game while also acting as testimonials to attract new game entrants.

Cult Second Life

I learned a valuable lesson my first go around with the Second Life faithful.  Second Life is not a game to many involved.  It's more of a cult.  I attempted to honestly engage all of my critics. Unfortunately, I learned that such is a wasted effort when dealing with the blind faith that afflicts Second Life True Believers.  In the end, it's not all that much different from trying to talk rationally with someone about Amway, Herbalife or Robert Kiyosaki.

OK, one thing really annoyed me.  A few supposedly prominent Second Life blog authors dismissed my first article because I was anonymous.  In fact, I was not and never have been.  But they, like pretty much everyone else in the Second Life universe, were.  [Shouted Elaine Benes style through a hand megaphone] "You're Anonymous!"

And a Disappointment...

I was particularly disappointed by some in the academic community, as a response to my original article.  I understand and appreciate the intense interest among academics in Second Life.  Indeed, many are interested in aspects of sociological, communications, pedagogical, and cultural phenomena related to the Second Life Virtual World.  I cannot speak to these topics with any knowledge or authority.  However, I am baffled by the response from some "virtual worlds economics" authorities.  One response in particular dismissed my first article as "so obviously wrong it was hardly worth discussing".  Further, it went on to claim that harsh criticisms such as mine threatened to destroy the very future of Virtual Worlds.  And, finally, we were told that Second Life is really a lot like fictional "Mayberry", and not the brutal world of markets and numbers I suggested.

That response stretches the credibility of its author.  If one guy can knock over Second Life or the future of Virtual Worlds in general, then they are hardly deserving of our attention.  And, Second Life is "so obviously not Mayberry", on so many levels, that "it's hardly worth discussing".  I cannot help but wonder what vested interest one has in Second Life in order to resort to wholesomely painting it as the black & white home of Any Griffith.  Just a few obvious shots (the Second Life echo machine's endless repeating of the Mayberry analogy set these up for me, even if they are easy targets):

• Mayberry never printed their own money.  No one spent Barney Bucks at Walker's Drug Store.
• If Mayberry started printing Barney Bucks, Andy would have arrested them for counterfeiting.
• There weren't all too many prostitutes and call girls hanging out at the Mayberry Hotel.
• Myer's Lake was not a big casino where people sat around playing rigged Tringo games and got paid to sit in chairs pulling rigged slot machines.
• Explicit interspecies sexual role playing wasn't seen as mainstream behavior, not to mention ageplay.
• Tax evasion, money laundering, gambling, sex trade?  No, all Mayberry had was a tad bit of moonshining from time to time.
• Eventually Wal-mart would have put Weaver's Department Store out of business, despite the protestations of any authoritarian artisan community or overtly anti-capitalist Bourgeoisie.

Corrections and Press Policies

I will make corrections, as discovered by myself or readers, to the original article by annotating such within the original work.  These notations will consist of bracketed annotations "[]" and strikeouts "strikeouts", as appropriate.

Unfortunately I cannot accept requests from "mainstream media" for interviews or commentary.  I will respond to emails which request clarification or explanation about something I have written, although I much prefer use of the open comments section on the blog site.  Mainstream media is defined as newspaper, magazine, radio and television.

Disclaimers

• I have no connection to Linden Research, Benchmark Capital or any other of Linden Research's investors.  Nor have I intended to imply any such connection exists.
• I have no connection to any competitors of Linden Research.
• I have received no compensation, cash or otherwise, for this article and associated research.
• I provide this information free, and do not restrict its usage except to reserve normal author's copyright.  In other words, please don't rip it off and present it as your own work.
• All information contained herein are the opinions of myself and not necessarily the other Capitalism 2.0 authors.
• All information presented here as metrics, quantities, and data are, to the best of my knowledge, based upon factual information as provided by Linden Research.
• I do not make any statements about the integrity of data provided by Linden Research.
• "Forecasts", "Predictions" and "Extrapolations" are statistical methods which endeavor to make rational statements about the future by using properties of historical data.  As with all such things, past performance is no guarantee of future performance.
• I provide all this information to readers free of charge, and without other consideration.  Any decisions made based upon this work [are the sole] responsibility of the reader.

Comments

[randolfe_]

Mark Herpel,

I am not a lawyer, so I can make no specific claims about whether Second Life as currently or previously positioned, is legally an HYIP. My article clearly states that it appears to me to resemble one, and I provide both quantitative and qualitative reasoning to that end.

As to whether all HYIPs are Ponzi schemes, that is not as categorically accepted as you claim. In the examples you provided those schemes were Ponzi schemes and securities fraud, among other violations, from the outset.

The Wiki (I realize by no means an authority, but still indicative of the uncertainty) states:

Overwhelming number of cases suggest that HYIPs are Ponzi schemes

The problem is that not all HYIPs are simple schemes whereby overt securities fraud occurs. Many indeed do disclose their investment activities as required for non-qualified purchasers of securities (as opposed to hedge fund investors). And, they do indeed "invest" the money often true to their disclosure. However, they have in actuality financially engineered a system that will inevitably have the same payoff outcomes as a Ponzi scheme. There are an infinite number of possible such facades that could be created.

And, the SEC is loathe to tell investors what are good and bad investments. They only care about risk disclosure and transparency. I agree, the SEC is becoming more active in this regard, but much more on the other side of things relating to qualified purchasers (ie hedge fund investors) which very often do invest in black-box operations with minimal disclosures.

The SEC does not "approve" every advertisement, disclosure or communication, not even for the big guys. They self regulate and the system is reactive, not proactive enforcement.

Anyway, most HYIPs fly under the radar of registration requirements because they are considered "investor clubs". When 12 retirees get together at the Wednesday Ladies Book Club and decide to pool their money and let Ethil and her super smart son invest in stocks, they don't have to register either. Only if and when that fund exceeds certain limits or meets certain tests.

I would like to see a statutory reference declaring HYIPs are all illegal, and what tests need be met to qualify as an HYIP. Short of that, I accept the general information available that defines HYIPs as facade schemes that evade proactive enforcement.

And if that is correct, then there is a strong resemblance between Second Life's L$ based economy and a HYIP.

[Warda Kawabata]

I'd love to see how those tables look when comparted to some real-world currencies. I suspect quite a few of them would look equally dodgy, if you extrapolate the curves long enough.

I suspect anything can be made to look ridiculous if you extrapolate curves as you have done.

[Hendrik]

Danke für den interessanten Artikel! Obwohl ich eigentlich mehr über Second Life erfahren wollte, hat er bei mir unerwartet eher das Interesse für Volkswirtschaft und Geldtheorie geweckt, Hut ab! :-)

[randolfe_]

Hendrik

Vielen dank fuer den Kommentar. Es freut mich sehr erlernen, dass ich einige deutsche Lesere habe.

[randolfe_]

One of the most troubling indictments from the Second Life defensive squad yet (on Raph's blog):

http://www.raphkoster.com/2007/02/22/doomcasting-sl/#comment-112323

And my reply, for what it's worth.

http://www.raphkoster.com/2007/02/22/doomcasting-sl/#comment-112419

I'd be interested to hear anyone else's comments (here or there).

[randolfe_]

# Crissa said on March 2nd, 2007 at 5:56 pm:

I think the irony is that he apparently doesn’t understand that US Currency works under the same rules - it only has value as much as we all desire it.

Also, isn’t it illegal for a company in the US to establish a currency with the requirements he demands?

The irony is your decrying the irony.

a) Apparently I and many others know quite a bit more than you about the theoretical and technical properties of fiat currencies.

b) The US dollar is fiat by way of a democratic process in which its primary users have direct representation.

c) The US dollar is credible.

d) Owners of US dollars have financial and legal claims on those dollars. Intermediaries or counterparties which fail to honor those claims are subject to myriad penalties, and the victims to myriad remedies.

e) Exactly my point was that Linden should *not* create a currency, not that they should create a dollar rival.

And the biggest irony:

Why, exactly won't Linden simply use dollar-denominations? I know why no one is willing to answer this question. I'm sure many others do as well. Curious that not a single person in the SL community has been willing to even acknowledge this elephant in the room.

[Simone]

Thanks, randolfe. Interesting post. I'm glad to see a lot of these points being discussed. Keep it up!

[Ray]

First of all, I would argue that talking about the Second Life "economy" is missing the point. At best, it's much more of a flea market than a stock market.

I would contend, too, that the vast majority of SL players don't view it as either an investment opportunity or a means of making a living.

If I were to decide to sell stuff I design in world (as I have in fact considered), it would be to offset my costs of playing the game. I'd hardly quit my 6 figure salary software job to earn a few bucks an hour at most.

All that said, there are in fact a couple of reasons why they can't just use a US$ denominated micro-payment system.

1) The payments are, on average, simply too small and too diverse. What do you do with someone that sells masses of "freebie" items to 10s of thousands of people for 1L$? No amount of aggregation will pay for the transaction costs of transactions in a real currency (see 2).

Your cell phone company's micropayment system is entirely non-analogous, because they are simply *adding* a comparatively small aggregated amount to an already large transaction (your monthly bill). It matters very little to the transaction costs how small a micropayment they have to add (assuming it's >US$.01 in a month they choose to accrue it too, of course).

For Premium subscribers, of course, this also might apply, but they are a tiny minority of all participants.

2) The transaction costs accruing to Linden Labs of selling and buying Lindens are essentially zero, because the real world liability is essentially zero. Conducting transactions in US$ would make LL a *bank*, not just figuratively, but literally, with all the concommitant regulatory and liability costs.

3) Transacting in US$ opens up contractual, if not criminal, liabilities (and therefore transaction costs) that transacting in Lindens does not. If Linden Labs discovers a fraudulant activity, or a hack that allows theft of Lindens, etc., they are perfectly within their rights to arbitrarily invalidate those transactions.

An online virtual world with anonymous players that affords these players any kind of serious power to affect the world or transact with others absolutely has to have this kind of flexibility in place. Transacting in US$ inherently adds legal liabilities that are inconsistent with needing to police against abuse (of whatever form).

Imagine, if you will, a developer that creates a grey-goo-like self replicating object that swarms around people... but leaves alone anyone that throws 5L$ its way (an amount so small that most would just pay it without considering the tragedy of the commons aspects). This is an obvious violation of the terms of service and Linden Labs would be entirely within their rights to revoke the L$ balance of the creator of such a device (and ban his ass).

As a micropayment transactor, they would be in the position of having to negate what are, as far as I can tell, perfectly legitimate contractual arrangements between the griefers and the griefees. They might or might not be found to be within their rights to do so, but the cost of proving it would make it impossible to continue to mediate the world.

Additionally, money laundering is a serious problem for them in a liability sense if they transact in real money (it might still be an *ethical* problem in L$, but the criminal liability in the current legal climate is at least greatly reduced if not eliminated).

[Johan Durant]

While I disagree with your assessment that Second Life is a pyramid scheme, I do agree that it is not an economy, not really.

The term "virtual economy" really only means "the presence of economic activity in a virtual world." Thing is, economic activity doesn't make something an economy. SL is a marketplace, and it is really annoying how a lot of people who should know better are confusing the term "marketplace" with "economy."

That said, SL is certainly a legitamite marketplace. You brought up iTunes; let's make an analogy. With iTunes the majority of people who put money into it are never going to make any money back from it. So what? As with any marketplace, there are producers and there are consumers; producers make money, consumers spend money. That isn't a problem, and it doesn't make things a pyramid scheme.

Incidentally, for what it's worth I sell content in SL and make a lot of money that way. Just, y'know, disclosure.

[randolfe_]

Ray,

Congratulations on being the first to openly describe that which most everyone knows about why Linden doesn't just use dollar denominations (and other localized denominations). I won't say it myself for fear of reigniting the ire of those who leaned on me earlier. But the legal implications are obvious.

My responses:

1) A pooling micropayment system would easily work for SL's marketplace microtransactions. You already submit credit card or Paypal info. Purchases could be charged in minimum increments, with the balance remaining available. Amounts as small as $1.00 are profitable at volume. For Linden's *real* user base numbers, I'd guess around $10.00 would be the scale of minimum transaction. This is similar to Microsoft's point system. Points aren't a separate currency; they are still dollar denominations like gift-card credits.

2) This does invoke the legal implications you describe. My answer: so what? Although this is a truism it is hardly justification for a flawed business strategy. Instead, fix the things that threaten legal action. That is the harder answer. It also happens to be the right answer. A business can only exist on the fringes of legality for so long. Sometimes the law catches up, recognizes and allows those business practices to endure. That is a huge long shot. More often, the law catches up and regulates the bejeezus out of, or outright prohibits the fringe activities.

3) The "griefers and griefees" argument doesn't hold up under practical analysis. Extortion or other forced extraction of payments under coercion, are already illegal. This is why people can't write computer viruses that destroy your hard drive if you don't give them your credit card number. In fact, I can think of nothing particularly unique to virtual world interactions that isn't already broadly covered by existing internet/digital laws. I'm sure there are a few details the legal hyperexperts will find, but by and large what you're likely to see will already run a foul of existing statues and case law.

4) Linden probably isn't ultimately protected by the "Linden dollar shield" and their ToS anyway. It's only a matter of time before judge and/or jury don't buy the logic.

[randolfe_]

Johan,

I agree it is a marketplace. I only agree to call it an "economy" because of all the huffing and puffing from the Terra Nova crowd. But I agree, economists, academics, and professionals should (and I suspect do) know better. It is a marketplace, within a greater economy.

Also, this article draws parallels to HYIPs, not classic pyramid schemes.

As to iTunes:

1) Apple does not promote iTunes as a way to make money, but as a way to buy products. Steven Jobs never said "use iTunes, pay your rent" as Rosedale did about SL.

2) iTunes payments are denominated in dollars. Apple doesn't print iTunesBux and sell them to iTunes users for net profit.

3) I do indeed have legal claim on products I buy with iTunes. If Apple denies me proper use and enjoyment of my legally purchased product, I have legal recourse. (They're in some hot water of this in fact in Europe right now). By contrast, Linden owns everything on their servers, and can cancel, revoke, delete or deny you access without reason, without notice, without recourse.

Money "put into iTunes" must fulfill a transaction or be refunded. Money put into SL immediately fulfills a transaction, as per the ToS. If I want to be very technical, this factor itself probably implies that SL _isn't even a valid marketplace, per se_, but more of a, well, game.

[tim]

Randolfe,

Nice analysis. I have periodically had serious doubts about the viability of the SL business model, and your analysis confirms those doubts. I am not an SL player.

The only thought I have about the use of a non-dollar fiat currency in MMORPGs, is to analogize with nation states that use a currency peg.

They are concerned that their economies (China, and some of the smaller African countries like Eritrea come to mind) need to be protected from the volatility of a freely traded currency. I am sure you know this already.

By analogy, perhaps an MMORPG author/admin would feel that it needs more control over its developing internal economy than it can get if internal trade were denominated in dollars (or euro for that matter).

I am not an economist...so this is all sheer speculation on my part.

[Matt Beam]

Just a question:

If anyone around the world can play 'Second Life' and exchange his currency into Linden-Dollars and back, so can two users fake a deal like followed and transfer real money for a real threat:

Sleeper in US builds trivia in SL and offers financier in Middle East for a fantastic prize. Financier exchanges amount into LDs, pays sleeper in LDs, who exchanges them into USDs, commits the crime and no one can prevent this transaction.

Am I right ?

Regards
Matt

[randolfe_]

Matt,

See the newest thread. Your comment I felt deserved a thread of its own to discuss.

[Ombrone aka Albert Falck]

Very interesting article, I guess you got the right question?

LL it's actually making money minting new L$ taking profit of the actual growth of population and of teh economy. Will they buyback L$ using real US$ to substain the exchange rate in case of a slowdown?

That's the real point, and actually there was no need of so much math to find it.

L$ it's not fiat money and that's clear from the beginning (but ok, a fiat money didn't helped Argentinian some years ago), and it got some strong marketing reason for being in existence. When people has not "feeling" of putting money out of the pocket usually spends more (never tried a Credit Card?).

Advertising SL as a gold mine for becoming rich is of course ... b*llSh*t, it's a very risky enviroment, but not devoid of possibilities.

Unfortunately it seems you are more interested to dig numbers trying to find a new way to demonstrate your first ipothesis that SL is only a scam and SLers idiots than trying to understand how things are working, or how they could be managed.

A pity 'cause as I said, u found exactly the right weak point.

[LAbskaus]

Very interesting investigations, Randolfe.

I tried SL long time ago in dec 06, when the mediahype was growing day by day. I am very skeptic with systems, that claim that everybody can get rich. In fact, it issn´t an attribute of such zero-sum systems like you discribed them very accurately.
In my opinion there are analogies to the crash of the stock market in 2000. Before that time, all media were full of cheerleaders, that shouted: "Spend your money, get rich, come on, dare." But in the end, everybody could see, that exactly these late guys were needed, to save a couple of others, who wanted to get their money out of the sinking ship. If Sl will be that way, nobody knows.
But one of my first replies to the question of having a business here (in Sl) was:"No, we`re to late."
Everybody can imagine, that the big part of the money will find his way to the guys of the first hour.
Your numbers and the feeling of many others I got to know (in Sl, too!) are showing the same trends. So I decided that I will never spend any real money to the game. The people I got to know mostly had the same feeling I had. In my opinion using it as a kind of chatroom with little animations, trying to build up things for fun with skripts inside, while working in the free of charge basic-account is a great thing.
Owning virtual land (including using the advanced accounts) for me its unnecessary, so I dont need to spend money for having little fun there.
But in any event there`ll be no long-time-motivation for me to act there.
If the numbers of active players explode that way, they did until now, if nobody of them would spend any real money to the game, then we all will be an eyewitness of the things, randolfe might saw in the numbers released by the lindens.

By the way, the miracle of ebay for example issnt, that I need the things, that I got. its the feeling of getting something, that someone else wanted, too. I think, that a huge part of that illusion is implemented in Sl. The money I can get is the money that the other guys lost. And thats the engine for the system. Its deeply involved with greedy, arrogant and capitalistic structures nobody can explain in detail.

Call me a philosopher or a lunatic. The theme here is only economic, I should know. But one sentence in this case of view. Look at the world out there.
Sl is everywere.

[Jakob]

Could it be, that something is happing. Happing now and yet.
Happyning is wonderful.
Still wonderful

[Kevin]

Right on! See- South Sea Bubble

[Manfred]

I am now playing SL for only 1 week and I completely agree to your article because the principles are so obvious. It is interesting to see that what I already knew can be shown with hard numbers and diagrams.

Nevertheless I think that one important aspect has been forgotten. More and more RL companies and artists are using SL as a marketing platform to generate RL revenues instead of spending real money for virtual value as most users do. This is a group of users that are not considered in your article. Is is clear that those companies don't care much about the value of the L$ because they calculate in hard currencies and the amount of L$ they own probably is negligible. Those users should be interested that SL survives as an attractive platform for their customers and maybe they would consider to invest more money to keep it that way. This is a development that just has started and I think it is too early to predict how it will influence the future of SL but it will have influence.

What I like in SL is that it can be used by programmers who can develop adventures and other games. This content has no economical influence because it normally is completely free. It is difficult to find because of the overwhelming and boring gambling, sex and make money fast content but it is still existing. I hope that this somehow will survive if the Linden company or the L$ or both collapses, but I doubt it will be for free anymore.

[Marshall Clark]

Great point Manfred.

SL development companies like The Electric Sheep Company are building SL corporate campuses billed at over $100k USD.

This is virtual work that is paid for in real-world dollars. Does this affect the notion of SL as a zero-sum system?

[Danny Sichel]

I'd be interested to see what you think of the virtual economy that's developed in Kingdom of Loathing.

[randolfe_]

I haven't been tracking virtual economies much anymore, to be honest.

I'll write some more in a full article soon, but the two ventures I was evaluating in this area have both decided to exit the industry.

[BrianMcAboy]

Is the Linden-dollar going to appear on the Forex markets if it keeps growing in popularity and influence? Interesting thought... Banks, investors and countries have all figured out how to fabricate "money" out of thin air, so why can't an individual organization do the same? Oh yeah, Visa and MasterCard have already shown that it can be done!

[randolfe_]

Brian,

Your argument is based on a pretty limited understanding of how seigniorage works.

Anyway, printing money is illegal in the US, and eventually the Treasury will exert its authority over any play-money-turned-real that becomes too big. Popular wishes of the SL Fanbois Cult aside, Linden Lab is not a nation state and Second Life is not a sovereign country.

Visa and MasterCard do not create any money. They create credit. Credit is fully controlled and accounted for by the Federal Reserve System of the United States in the money supply. So it is money, yes. But that money is dollars, not Virtual Mayberry BarneyBux.

[Rodolfo Carpintier]

A very interesting post, Randolphe.

I am not an Economist and will not discuss the figures, but allow me to provide a different view.

SL is creating a powerful network (by definition, mine...:-) PN are those that get people, involved in their network, more loyal to it than to the companies that pay their salaries)

eBay, has their power sellers, Amazon its associate sites, Microsoft its Masters, Cisco its certified engineers or SAP its consultants)

If, out of the 7 million + claimed by LL as number of users, there are already 200.000 "powerful networkers" today, as you probably will agree, there are, their world is here to stay. The currency? I do not see why they insist on it. Probably, they will end up "paypalling" it to eBay.

The game is: Do they have a powerful network or not?

I believe they have and I guess much of the "Empire building" is done by the regular press.

I am a user of SL and do not have much time to engage on it. Mostly, 3/4 hours a week and no I do not spend money but boy I see many aspects of SL that will revolucionize many parts of our daily life.

Remember what happended last time IBM decided PC´s where sound investments?

[John]

An intersing article - however, I dispute your assertion that the Linden economy is zero sum. After all, it's like any area of wealth creation where assets created and which persist will draw money into that sector of the economy. Obviously, like all bubbles, it is likely to experience serious setbacks in the future, and some assets within the virtual world will doubtles become worthless, and I agree that the idea of LL buying back $L is unlikely and devaluation the most obvious scenario, but I do think there are good reasons to believe the virtual world has a viable long term future.

[John Lopez]

I think we need to face the fundamental fact: the L$ exists so Linden Labs maintain the legal status of being "just a game".

While they play the "virtual economy" card to the press, they clearly play the "game service" card in the terms of service. They can seize anything at any time for no compensation, just like Blizzard can for World of Warcraft. The problem is that the line between virtual and real is becoming blurred. In China there has been successful lawsuits for "loss of property" over in-game swords... in a game that bans trading for real world currency. Here in the states Linden Labs faces a lawsuit where the courts have declared that the Linden Labs Terms of Service does not give total immunity against the claim that they seized "land" from one of their customers. How that suit resolves is still to be seen, but the value of virtual things is being more and more accepted in the courts. More ominously, the government has been paying attention to the virtual goods market, rumbling about taxes for virtual goods.

It is a tough road to travel: trying to keep the immunity of a service provider (and thus avoiding real world claims of value against virtual goods), while promoting the world as a gold mine for entrepreneurs. The L$ acts as a fig leaf that Linden Labs is trying to use to avoid the scrutiny of activities that would otherwise create real world liability (such at the many casinos that flaunt US Internet gambling laws). It also allows them to implement the "circuit breaker" on the economy that prevents trading of L$ if the value moves too far in a short period of time, a clever move that gives them an early warning system. When the L$ value collapse comes (and I have no doubt that it will: the system is bubbling over dot-com style right now) there really isn't much reason for Linden Labs to do much more than let the circuit breaker trip over and over again while the L$ exchange rate plummets.

It seems silly to think Linden Labs will try to correct the crash. I see no motivation on their part to do so: they can point to the Terms of Service and say that there is no real world value anyway. Yes, they will anger many, face lawsuits and generally lose credibility and status. However, after the collapse, perhaps people will focus on the *real* value that the system (or the one like it that rises from the ashes to replace it) represents: a prototype for the 3D web; a place for virtual education; a common space for collaboration across the globe; a fun play space. It is a place where people can explore nearly any concept for a fraction of the cost that doing so would have in the real world, whether that cost would be financial, social or even legal in nature.

Perhaps some have joined Second Life expecting to make a real world killing in US$. However, I'm not convinced that the number who do so is large. I joined because I see it as a cool way to interact with my distributed customers: a geeky business toy that gives me some virtual geek-cred. When people come over and find tables that create a chair for each meeting attendee on demand, when I can "rez" prototypes of real world design ideas on the table and discuss them, mold them and let them keep a copy of the final virtual product... it builds a new dimension to our business relationship. They see "this is the future" and "this guy is there now".

Many, many others have joined simply to socialize and do virtual shopping... at a vastly discounted rate to real world shopping. My wife joined and I have never enjoyed clothes horsing as much as I have in a virtual world. I'm more than happy to shell $1 US currency out for a new dress if it makes her happy and avoids the hundreds of dollars real world dresses cost.

It is "just a game", but one of the most intriguing, flexible games yet created. In 2017 I suspect that Second Life will be looked back upon much like early websites look to us today. Garish, ugly, primitive... and a taste of what finally became a global phenomena that won't go away. And yes, the L$ will have vanished, government regulation will have been imposed and quite a bit of the "fun" will be replaced by "stuffed suit" normality. It sure is fun to be on the frontier while it is wild though.

Feel free to reply to my e-mail, I'm interested in your thoughts.

[SL Player]

Very interesting subject raised here that the mainstream tech-media aren't up to speed on. As a sideshow to this AOL Pointe at SL are giving away Liden dollars for Quizes and Skateboarding - but for the most part, at time of sending this, simply neglecting to credit the users accounts. I tried to IM the supposed big winners on their board - and none were talking - schemes within schemes??

[Peter42y]

Thanks for your article.
I apologize for my english.
I am portuguese.
I do not know much about economics , but I have been posting in web boards for 6 years.
Something I learned in the world wide web. When we have a point , when we are right exactly because we are right , very often , people do attack us with extreme agressivity.
I understand why so many SL people do attack you.
They attack with extreme agressivity exactly because they do not have arguments.
Second Life users have invested time and money in that virtual world.
They do not want their world , their illusions to be destroyed.
They hate that someone does come along and does say : Wake up Fellows. Your world is a ponzi pyramid. Sooner or later it will burst !!".
People in love with SL will not enjoy to hear that.
They want you to shut up because they dont want to hear second live might be a bubble waiting to burst.
But you are completely right.
Recently the largest SL bank did default.
The SL users are not as many as sugested.
Please click in my name to check a very interesting article called:

How Madison Avenue Is Wasting Millions on a Deserted Second Life

Thank You for your article once again.

[Uvas]

So where is the horrible crash of the Linden?

You sound like a doomsday prophet. Your year old predicted meltdown of the economy of SL has not materialized.

The Linden has been extremely stable in the face of some very large economic shocks, such as the end of gambling in SL, the failing of the largest bank in SL, and the intoduction of the European flat tax. It has remains around 270 per dollar.

This is fair proof that the SL economy is strong. It is also continuing to grow. The platform is much more stable than a year ago, which I think is a major factor in keeping people happy and active in their little virtual endeavors.

[randolfe_]

Ask everyone who lives in the Eurozone or UK if that's working out so well for them. (a) The L$ was supposedly a _floating_ exchange rate currency. Still says that on Linden's page, no? But apparently it's a pegged-rate currency, which makes it really irrelevant except for a legal facade. (b) Pegging your virtual Mayberry bux to a rapidly collapsing real world currency isn't exactly a stroke of genius. Well, except for the artful execution of deception.

But the whole Linden thing is seriously over. I just randomly happened by my blog tonight to see the first non-spam message on this subject in months. Seriously, if you're in the Eurozone/UK then invest your time in a virtual game world which pays you in real money not US Pesos. If you're stuck here in the US like me, then you've got much much much bigger worries than some stupid refuge for about 40,000 overly artistic introverts with sexual peculiarities or vampire fetishes.

Try the fact the Federal Reserve is driving us right into a horrible decade or more of stagflation. And meanwhile our spineless politicians are falling all over their own asses trying to give away money to the greedy and stupid who bought houses at bubble prices.

[GK]

randolfe,

"Try the fact the Federal Reserve is driving us right into a horrible decade or more of stagflation. "

Is it really that bad? The FF rate was at 5.25% for over a year, and is still 4.5%. Isn't that the moderate range?

"And meanwhile our spineless politicians are falling all over their own asses trying to give away money to the greedy and stupid who bought houses at bubble prices."

Yes, this I can't believe is happening. I am surprised that the business news and other free-market groups aren't more vocal in their opposition to this. The only good part is that it seems to be a relatively small bailout.

I still think that it merely lengthens out the correction, rather than avoids it. Nothing can force buyers back into the market, and nothing can postpone a reversion to historical price/rent ratios.

[randolfe_]

In fairness I don't blame the Fed entirely for what's occurring. I think everyone is an armchair Fed governor -- a job which I think is exceptionally hard. My comments were more in context of the whole Linden fiasco.

The Fed, I fear, is progressively losing the power of the official rate lever. This is, in my own humble opinion, not because they are inept at reading economics, modeling econometrics, grasping economic theory, or even setting rates. It is instead because they refuse to take a harsh stand against the fiscal side of the equation.

Our Congress is out of control and has been for a couple decades now. So long as the Fed plays enabler and continually runs around paying for their incompetence by squeezing the public with inflation they get away with it. I'd much rather see the Fed draw an inflation line in the sand.

[michael webster]

Interesting turn of events in Linden Land:

http://www.techcrunch.com/2008/01/08/virtual-banking-banned-in-second-life/

[randolfe_]

My favorite quote:

Banking joins bestiality and gambling on the banned in Second Life list.

...because the "banking" in Second Life was concocted by the same vermin who brought you those other fine institutions, and at the same level of professionalism. Actually, at least the gambling folks had to develop some "software" in order to run their games.