The Ludwig von Mises Institute, an organization dedicated to the promotion of libertarian and liberal economic ideals, published an interesting essay about the economy of the virtual world of Second Life by Matthew Beller. In it they call for all economists to begin analysis of virtual worlds for what they are, rather than just regarding them as laboratories for research projects.
Of course, the Mises Institute does exist to promote a specific economic theory, and Beller presents it here:
As Ludwig von Mises and others have shown, one interventionist policy creates distortions that must be fixed by other interventionist policies, which lead to problems that require further intervention, and so on, until the state controls every aspect of the economy.
Unfortunately, despite Mr. Rosedale's free-market rhetoric, a look at Linden's actual practices reveals that it has already started down the path of intervening in the economy. One critical example of Linden's intervention is that it has granted itself the ability to manipulate the single-most important commodity in any economy: money.
In part the point here is that Linden dollar's value is entirely controlled by Linden Lab and does not reflect the actual amount of trade going on in the world. Things get a little more sinister from there, however. Second Life has been running a deficit which, according to Beller, may mean big trouble:
These deficits occur when the weekly L$ stipends Linden pays to premium residents exceed its revenues from land rentals and other administrative services it provides to residents. In order to fund the deficits, Linden creates new L$ and injects them into Second Life.
[...]
During the past year and a half, Linden created L$876 million through its deficits, which makes up over 33% of today's L$ supply.
The rest of the essay points out a number of instances where Linden Lab didn't bring in enough USD to cover the L$ that they produced. If that trend continues, we may hit a point where withdrawals through the Lindex exceed Linden Lab's cash reserves. The value of the L$ would have to fall, currency production would have to decline, and a major recession would be at hand. Beller's solution: "abolish restrictions on content, strengthen the ability of residents to enforce their property rights, and, most important, tie the L$ to a real-world commodity money backed by 100% reserves."
All of this is just one person's opinion, of course, and the practicality of some of these ideas is debatable. The point is that essays like this one are sure to spark more focused debate about virtual worlds among economists. The actual form that the debate takes remains to be seen, but there are so many different facets to economics that we can probably expect groups to form promoting specific ideals of all types. The idea of commodity-backed currencies, for instance, is one that has been adopted in several e-gold type services around the Internet and maintains a hardcore following. As Beller's essay climbs Digg's rankings, expect many more experts to join the fray.
I'm not convinced by the conclusion in this article due to several mitigating factors. First, there is the value of land (and to a lesser extent, transferable goods owned by avatars). Personally, I'm currently holding approximately US$31 in cash within the world. Even if a crash happened and cut the value in half... I effectively lost enough for a meal for myself at a middling restaurant (about US$15). For those holding vastly larger amounts, I already wonder why they are not converting the currency back to real world money when it accumulates.
Because a crash in value would indicate that there had already been substantial strain between the value of a L$ and a US$, I'm not convinced that the values of non-cash holdings would change much in the long run. Yes, prices on items would change in the face of the vastly lower purchasing power of a L$ (in terms of perceived value to buyers and sellers), but that's the point... selling land or items will now generate the required extra bucket of L$ needed to make a US$, because people do purchase items based on their real world investment. At least, I do... I see a utility item and it is at L$2,000 and I think, US$7.70 automatically. With a crashed economy, I need L$4,000, but the US$ value is unchanged. For a short while (before prices are changed) there would be a world wide sales event, but prices would quickly adjust, which means incomes adjust as well.
A worse outcome would be something that affected land prices substantially in terms of US$ value; in that case people's holdings are far larger and not liquid. However, it would seem that a pause in the printing of new land would bring demand right back up again. Assuming the Linden's wish to keep customers (a question which should be rhetorical) I would expect that limited land sales would be a fairly immediate action.
Obviously the highest risk group would be those who already seem to enjoy living on the edge in the markets. From the values I have heard being held in some of the exchanges, there are those with thousands of dollars at stake in this manner. However, by virtue of the fact that these amounts are being used for investment and accumulation of interest, these amounts are deposited by those most capable of absorbing such losses. I have my doubts that a market crash will cause real world homelessness or even long term impacts on the success or failure of Linden Lab.
Oh, but I can imagine the forum posts.
There is a flaw in the summary of the theory, in the Linden Lab does not itself fund any of the sales of Linden Dollars back to US Dollars: the money is provided, not by Linden Lab, but by other purchasors of the Linden Dollar.Only when the number of purcahsors exceeds the number of sellers does Supply Linden make extra money. That happens frequently because of a fairly steady increase in the population.
So, if that were to change, Supply Linden would simply stop creating new money automatically, since the number of purchases of currency would decline. Only if Supply Linden stopped producing money entirely and fewer people wanted to buy what currency was available than sell it would the value of the Linden dollar fall. Given the amount that Supply Linden has been producing, it seems that there is a substantial buffer before that starts to happen.
Thanks for flagging this study , Onder, good call. I'm looking forward to reading it and reflecting on just how much intervention LL does do -- and I tend to agree that it over-intervenes -- and whether then intervention in fact means failure (which it tends to mean in real life).
I wonder, however, whether this is a true statement: "the weekly L$ stipends Linden pays to premium residents exceed its revenues from land rentals and other administrative services it provides to residents. In order to fund the deficits, Linden creates new L$ and injects them into Second Life."
The money that Linden pays out in stipends are merely newly-printed money that they in fact issue for a higher-than-market price. There have been many posts in the past explaining that the $1600 in Lindens you can now get in the $9.95 subscription cost less than $9.95 if you buy them on the LindEx. Even factoring in the market value of 512 m2 of tier plus the advantages of 90 day accounts, etc. you still realize that getting $1600 in Lindens is something you can do without the LindEx. So it's not a "sink" or "a loss" for the Lindens to print money, and sell it a higher-than-market rates.
LL does not collect any revenue from "land revenues". That's a mistake. All tier payments come in dollars; those dollars are outside of the SL economy.
Linden sells land on the auction denominated in Lindens; those Lindens coming in are not revenue; they are listed as sinks, i.e. destroyed.
The upload fees for textures and group fees are also sinks, not revenue.
The sinks-and-sources issue therefore is misreported; and Lindens print money on the Linden through the Supply Linden issuance of packets for sale not in an effort to balance sinks and sources -- they don't balance whatsoever if you look at the statistics pages -- but merely in an effort to stablize the price of the Linden at around 266 to $1.00 US -- that's all.
Many people have built entire economic theory on this misunderstanding. The Lindens print money to stabilize the Linden at a lower value than what the market would set it at. They allow sinks to take place to draw excess Lindens out of the economy. Given the number of premium accounts, which is under 100,000 people, even with some $500 stipends, their stipend payouts -- print-ups -- aren't that huge a number as to cause the inflation that everyone imagines. Inflation (or is it staglation? or what?) comes from them printing Supply Linden money to play with. That devalues the cost of our labour, goods, and services. In the same way that printing of land in excess of authentic demand devalues land and also affects the economy.