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Free banking in Second Life
Yes, economic activity in Second Life continues to rise. I am interested in the Second Life currency, Linden Dollars, which trades against the U.S. dollar at a market-determined exchange rate.
Free banking economists used to debate whether a private sector fiat currency could succeed. Hayek, in his Denationalisation of Money, said yes but most other people said no. The obvious problem is time inconsistency, namely that the fiat currency issuer will at some point inflate away its value to the seigniorage-maximizing margin, noting that such a margin changes with the passage of time and not necessarily in a favorable direction.
Who would have foreseen that maximizing income from "land" sales might check this outcome? I think of Linden Dollars as akin to legal tender currencies: you can't buy anything in Second Life without them. Since the goods and services in Second Life have value the currency does too.
Who had expected that the next generation of private currency suppliers would make it work by, in God-like fashion, supplying accompanying worlds as well? What other problems can be solved this way? Or are Linden Dollars the next bubble waiting to burst?
Posted by Tyler Cowen on May 30, 2008 at 08:31 AM in Economics | Permalink
Comments
About a year and a half ago, there was a very good discussion about this here:
http://randolfe.typepad.com/randolfe/2007/01/secondlife_revo.html
Posted by: Michael Webster at May 30, 2008 9:01:28 AM
Linden dollars have currency controls: each player can only exchange a limited amount back and forth to US dollars each month on the company-operated Linden exchange ("billing and trading limits"). In practice this has resulted in a nearly fixed exchange rate for a long time now. The small number of currency traders who have been granted high trading limits are able to keep it that way and make a bit of money from the bid/ask spread.
The company can and does confiscate Linden dollars if it believes they were created through fraud, even if those Linden dollars subsequently end up in the hands of an innocent third party (ie, unlike real life, "receiving stolen property" applies to cash as well). And naturally, since everyone is completely anonymous and can use multiple avatars and identities, there is no way for anyone to know who they are really dealing with. This ties the hands of private third-party currency exchanges, who must use a company-provided Risk API or risk financial loss, and so will not exchange large amounts. In any case, those third-party exchanges have much smaller trading volume than the company-operated exchange, and so cannot affect the exchange rate much.
For these and other reasons (complete anonymity and lack of accountability, fear of money laundering and fraud), Second Life doesn't really have a working financial system and Linden dollars shouldn't really be considered a currency in its own right. However, they could be considered an interesting experiment in micropayments, since virtual items are routinely bought and sold for fractions of a US dollar.
Posted by: at May 30, 2008 9:15:05 AM
I think Hayek's booklet should be much more widely known in libertarian/Austrian circles; I think part of the problem is that Hayek can be difficult reading, especially when he's talking about a topic like this.
I haven't had the time to get into these virtual worlds, so I confess I don't really know what I am talking about. But a while ago there was some issue where people would pay teenagers in Vietnam or wherever to go around killing monsters in a MMORPG and generating inflation in the virtual world (since the game would endow the dead monsters with some money).
Relying on Hayek's ideas, I suggested that people in the world of the game could set up their own private fiat currency, which would be stable in purchasing power of some bundle of important goods (in contrast to the game's default currency).
The way it would work is that the people running the new currency would keep records in the real world (on Excel or whatever), and then the players in the game would trade knowing that their bank balances (in the Excel spreadsheet in the real world) would be changed accordingly.
(To understand the incentives for why someone should bother to set up such a private fiat currency, read the article linked above.)
In general I think radical libertarians should look more into virtual worlds to conduct experiments with their theories that would be far too unpopular / risky to try out in the real world.
Posted by: Bob Murphy at May 30, 2008 10:19:52 AM
The history of currency in multi-player video games is an interesting topic. In games that have a bartering system, some type of currency always develops (gold, items, land, services, etc), and an exchange rate could be determined from the currency being sold outside of the game.
Seeing how the video game specific events (cheating, updates, stability, international players, etc) affect the value of that currency might provide insight into how a decentralized monetary system could work in the future.
Posted by: Colin at May 30, 2008 10:22:26 AM
'The company can and does confiscate Linden dollars if it believes they were created through fraud, even if those Linden dollars subsequently end up in the hands of an innocent third party (ie, unlike real life, "receiving stolen property" applies to cash as well).'
That's a bad analogy. A better analogy would be that of counterfeit bills, and, in that case, the government is allowed to take those away with no recompense, even if the person found with the bill received it in exchange for a legitimate good or service.
Posted by: quanticle at May 30, 2008 10:26:16 AM
I dont see it as a private currency. Second Life is more of a country in its own right. If these linden dollars had developed independently and privately within the game I'd see them as an example of private fiat currency.
Posted by: Sune at May 30, 2008 10:44:05 AM
You might find Charles Stross' "Halting State" interesting. Once of the conceits in the book is a corporation that makes its business regulating virtual economies. In the real-world, Iceland's "Eve On-line" has had a staff economist running the virtual economy for three or four years.
Posted by: David Rotor at May 30, 2008 11:13:01 AM
I had never heard of Second Life until reading this post - thanks for pointing it out.
I agree with Sune, it seems like playing the game is like taking a vacation abroad and whoever is in charge of the virtual world is sort of a government, so calling Linden dollars "private sector fiat" might not be accurate. It seems very different to a case where Google or Wal-Mart or some other private company started their own currency that could be used nearly anywhere by anyone.
I wonder if the folks in charge of Second Life would allow social scientists to perform policy experiments on their world? Would such experiments be ethical? (People do get pretty attached to their virtual lives in these virtual worlds, but perhaps facing the challenge of different economic institutions could be part of the game's appeal.)
Posted by: Jesse at May 30, 2008 12:25:06 PM
There's no reason why real-world businesses couldn't do something similar. Imagine a train or bus system that paid its employees in tokens -- the more demand from riders, the more your salary is worth in dollars.
Posted by: Don Marti at May 30, 2008 12:40:34 PM
Note that the Air Mile, a private currency which was (at launch) even linked to a commodity standard, hyperinflated years ago.
Posted by: dsquared at May 30, 2008 12:43:14 PM
If Linden Dollars hyperinflate to the point of damaging the Second Life world, Linden stands to lose money from tremendous loss of playership.
On the other hand, airline miles are only a minor promotional incentive for airlines, and should airline miles have "currency failure", airlines will still fly.
Posted by: Mr. Econotarian at May 30, 2008 4:06:27 PM
quanticle,
The "counterfeit bills" analogy doesn't really hold. Linden dollars do not even exist as virtual objects in-world; they exist only as a numerical account balance displayed at the corner of your screen, a database entry on some company-operated server.
A better analogy would be if someone uses a stolen ATM card to withdraw genuine Canadian dollars from a bank, then goes to a currency exchange shop to exchange them for US dollars, and then absconds... and then a few days later, the Canadian government by magical remote control reaches into the cash register of the currency exchange shop and turns the Canadian-dollar bills sitting there into pumpkins. Not possible in the real world, but easily accomplished if all money is just a database entry under centralized control.
Posted by: at May 30, 2008 5:56:07 PM
Second Life is not a sovereign country; the company that runs it (Linden Lab) is headquartered in the real world in California and is very much beholden to both the US federal and state governments and to the FBI. In-world gambling (including poker) was banned almost a year ago for this very reason; more recently, in-world banks (mostly Ponzi schemes) were banned unless operated by organizations with a real-world banking charter. Until such time as the company and all its employees set up shop in a floating data haven in the middle of the ocean, libertarian experiments will have to remain a fantasy.
In any case, virtual worlds are an extremely poor venue for libertarian experimentation because by their very nature, they are (or can be) surveillance societies. In theory, every single instant-message conversation, every single financial transaction to a fraction of a penny, every movement in-world, all can be logged, recorded forever for posterity, and datamined at leisure.
Even if the company itself doesn't do surveillance, that doesn't stop eavesdropping and spying by third-party avatars or their (arbitrarily-tiny or transparent) scripted objects. For instance, if two avatars wish to have (what passes for) sex in Second Life, it is in general impossible to guarantee that they are not being observed, since an avatar's "camera" (its visual point of view) can be moved independently hundreds of meters away from the avatar's "physical" location. Unlike avatars themselves, the camera's range of motion cannot be blocked by opaque objects or by "no trespassing" ban lines at the borders of plots of land.
Conversely, informal institutions and organizations are much harder to set up in virtual worlds. For example, democratic groups can't really be set up, because it is trivially easy to create multiple avatars and thus vote multiple times. How do reputations work, when identity itself is fluid and unreliable, and actions are generally consequence-free? The company running Second Life generally washes its hands of delinquency, griefing, harassment and petty fraud. You can't even have the kind of rough frontier justice or community peer pressure that operates in the real world in the absence of formal law and order. It would be like punching smoke; even banned users can usually come back immediately in a brand new guise.
I think some problems are inherent to virtual worlds, by their very nature. Consider this analogy: when it became possible to send e-mail for zero cents instead of sending junk mail for a few pennies, then spam became possible (and therefore, perhaps, inevitable). When literally everything in the world is free of costs and consequences -- travel from one point to another, creation of scripted objects, cloning of existing objects, creation of brand new anonymous identities, creation of bot-controlled avatars -- then to the extent that the in-world economy grows sufficiently to make it worth someone's while, I suspect the inevitable consequence will be increasing amounts of "spamlike" in-world behavior, which the company running the virtual world will be both unwilling to police and unable to control.
Posted by: at May 30, 2008 6:30:31 PM
The most prominent virtual currency in any case is not Linden dollars, but QQ coins from the very popular (in China) QQ instant messaging service run by the Chinese company Tencent (a high-flying stock on the Hong Kong exchange with an inflated P/E ratio). These have actually gained sufficiently widespread use outside of QQ itself that the Chinese authorities have considered cracking down. Might be a topic of interest to economists, but lack of ability to read Chinese would be a handicap.
Naturally, the Chinese government would never allow this to develop into a true alternative currency. However, wishful thinking aside, the same is true of the US government and Linden dollars.
Posted by: at May 30, 2008 6:42:47 PM
Tyler,
I'm not sure what you mean about land sales keeping inflationary tendencies in check (if that's what you're saying). How so?
Note that Linden Lab (the company that runs Second Life) can and does create new "land" at will, simply by bringing new servers online. This newly created "land" is sold wholesale in 256 x 256 meter chunks (for good old US dollars only!) at auction to "land baron" speculators, who then turn around and subdivide it and resell it to other Second Life players for Linden dollars.
Anyone who "owns" "land" pays monthly fees to Linden Lab (again in US dollars) based on how much land they own. A full 256 x 256 meter parcel costs $195/month for "mainland", or $295/month for "private islands" that allow greater control. You could think of this as property tax, except in Second Life you end up paying as much in property tax every 6 to 12 months or so as the land cost you in the first place. Thus, speculatively buying and holding empty land long term in the hope that prices will go up would be a ruinously pointless strategy. There is little real necessity to own land in any case, since avatars after all have no physical needs for sleep or shelter.
In general, there are only a few things that Linden Lab accepts Linden dollars as payment for: taking snapshots costs the equivalent of about 4 US cents each; in-game classified advertising; auctions of sufficiently-small abandoned parcels of land.
They also control the money supply by creating Linden dollars and selling them on the Linden exchange for US dollars, as needed for the use of a growing player population and to ensure stability of exchange rates.
Note that Linden Lab explicitly does not redeem Linden dollars for US dollars, ever. You can sell your Linden dollars for US dollars on the company-operated Linden exchange, but the buyers are other Second Life players.
Posted by: at May 30, 2008 8:36:49 PM
Actually most developed countries have laws forbidding payment of wages in kind (such as tokens). In the UK it is the Employment Rights Act 1996 ss. 13-27, which replaced the provisions in the Wages Act 1986 which replaced the various Truck Acts which had largely outlawed payment in kind.
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