Economy of Second Life

The virtual world Second Life has its own economy and a currency referred to as Linden Dollars (L$). This economy is independent of the Pricing, where users pay Linden Lab. In the SL economy, residents buy from and sell to one another directly, using the Linden, which is exchangeable for US dollars or other currencies on market-based currency exchanges. Linden Lab reports that the Second Life economy generated US$3,596,674 in economic activity during the month of September 2005, and as of September 2006 Second Life was reported to have a GDP of $64 Million. A Virtual Economy Analyst at the Metastat statistics bureau in Second Life estimated Second Life's 2007 GDP will be between $ 500 million and $ 600 million, about nine times that of 2006. This data is of 23 February, 2007.

Basis of the Economy

The basis of this economy is that residents (that is, users, as opposed to Linden Lab) can buy and sell services and virtual goods to one another in a free market. Services include camping, working in stores, business management, entertainment (which prominently includes adult entertainment), custom content creation, and other personal services. Virtual goods include buildings, vehicles, devices of all kinds, animations, clothing, skin, hair, jewelry, flora and fauna, and works of art. To make money in Second Life, one must find customers who are willing to pay for the services or products that one can supply, just like in real life.

Because of the existence of virtual land, there is an active virtual real estate market. Originally all land comes from Linden Lab (which is part of the pricing and a revenue stream for them), but after that it is bought and sold much like real-life real estate. Mainstream media has reported on SL residents who earn large incomes from the SL real estate market.

In addition to the main economy, some residents receive a small weekly stipend, depending on the kind of account they have, and when they joined Second Life. There are also the virtual equivalent of minimum wage jobs and charitable organizations that try to introduce new residents to the consumer economy.

Another option for making money in Second Life is "camping". Throughout the virtual world are locations where SL members can earn money by either sitting, doing an activity such as dancing or painting, or another similar activity; payment is offered consisting of so-many Lindens for time spent. (The amount of Lindens paid and the time interval varies from place to place). Since this could result in some users leaving their avatars "camping" for days at a time, accumulating thousands of Lindens, most locations forbid 24/7 "camping" and some camp options limit the amount of money that can be made in a location over a period of time.

LindeX Currency Exchange

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, with average rates between L$260/USD and L$320/USD between October 2005 and September 2006.

Economic Issues

A Pyramid Scheme

In January 2007 Second Life was criticized for resembling a traditional pyramid scheme where only a very few persons are harvesting money from the large masses of players. Although the normal player also can make and exchange Linden Dollars into US dollars, these sums are dwarfed compared to what a very few SL casinos owners and virtual real estate owners cash in.

No Government

Second Life residents mostly do not have a government. In part this is enabled by the fact that there is also no physical damage, and in principle no possible theft of property, nor is there war on a large scale, other than between military groups or other role players restricted to 'damage enabled' sims like Badnarik, Salamis, Dorien, Titan and other similar areas. Thus, many of the functions of government are not required.

On the other hand, there is always a need for dispute resolution.

At the lowest level, property rights reign supreme. A building's owner makes the rules, and can simply eject or ban any resident he or she wishes to, with or without cause. An owner of 512 square meters is lord of that manor, just as the so-called Land Barons are the lords of their much larger ones.

There are some groups of people in Second Life that have created small scale political structures. For example, they might band together, purchase property in the groups' name, and agree to follow in-group rules and regulation, elect officers, support a monarchy etc.

At the highest level, Linden Lab is the true owner of Second Life, and within the Second Life Terms of Service (TOS), they are the ultimate authority.

Legal position of the Linden Dollar

Linden Lab has been criticized for marketing SL as a viable business channel for making real money, while at the same time including provisions in the Terms of Service which give Linden dollars no intrinsic value as a form of currency. Linden Lab is not required to pay any compensation if L$ is lost from the database.

Monetary Policy

In addition, recent articles published by the Ludwig von Mises Institute warned that while Linden Lab maintains a currency peg of about L$270=US$1, it is only partially backed by Linden Lab's revenue in US Dollar, as there is a perpetual deficit between Linden Dollar creation (from stipends, see below) and USD revenue received by Linden Labs. The difference is made up by Linden Labs creating Linden Dollars out of nothing (just as governments turn to the printing press to create money). This might lead to a recession if Linden Labs is forced to tighten its monetary policy, or an outright economic collapse if people lose confidence in the peg's sustainability.[1] [2] (see hyperinflation).

In light of this, Linden Lab has been gradually lowering the amount of the Linden Dollar stipend paid out to residents. In the past, basic accounts received L$250 starting money plus a L$50 stipend every week that they logged in. The weekly stipend was ended.

In similar fashion, the Premium stipend has fallen from L$500 to L$300 over time, though for each individual the stipend in effect at sign-up time remains in effect.

Currently, Lindex exchange rates run L$265 per USD$1 on average, with variations of about 5% at various times. On SLX exchange, and other independent exchanges like ACE and BNTF, rates run higher, L$275-285 per USD$1, possibly because Linden Labs process credit system takes 5 days to deliver the withdrawn funds, while independent exchanges pay out much quicker, indicating a premium for prompt delivery.

Acts of Linden

Linden Lab, as the actual owner of all the software and server side hardware that makes up Second Life, has unique, almost god-like ability to change all aspects of the world, from the economy to the physics to the morals.

Changes made or proposed by Linden Lab are thus like Acts of God. Some changes have had the effect of creating new markets, but also have on occasion destroyed or removed the value of existing ones, or inadvertently given a market leader at a particular time unique advantages that entrench them as a market leader in the future. Skeptics point out that unless this power is very tightly controlled and transparent, the Linden economy is unlikely to attract very large investment. .

One example is InfoNet, an in-world newspaper and information delivery service run on a for-profit basis, and formerly (as with many such systems in SL) of limited effectiveness due to a limited range of access points. When the old concept of "telehubs" was removed from the game, Linden Lab replaced them with "InfoHubs" each of which including an InfoNet access point which was hosted for free on system owned land; it also placed InfoNet access points in the Welcome Areas where new users arrive, where no user is normally permitted to leave business-related objects. This had the effect of giving InfoNet an instant and substantial advantage .

Recent Linden Acts of greater economic import include the banning of wagering on games of random chance or on real life sporting events with L$. As soon as the rule change was announced, casinos were given a few days to close . Casino owners and game makers either found other avenues of business or went bankrupt . The fallout of this was the largest bank in SL, Ginko Financial, which had its ATMs in most major casinos, saw its reserves drained completely within hours, and was never able to catch up with withdrawal requests, which eventually amounted to L$55 million out of deposits of L$180 million. Ginko's assets were primarily invested in things of either poor to no liquidity, or virtual securities that were then trading at significantly under their purchase price. Ginko was forced into insolvency and converted their depositors into Bond holders on the World Stock Exchange (one of several inworld stock exchanges).[3][4]

Most recently, Linden Lab has announced[5] it will be adding the EU's Value Added Tax (VAT) on top of membership, land purchase, and land maintenance fees paid by European members, where it says it had been absorbing this cost previously. Now that VAT is being added on, many Europeans are either talking about, or leaving, SL, or else transferring their lands to American partners, or getting into lines of work that do not involve fees paid to Linden Lab in Euros. American Land Barons are now in a position to offer tax shelters to Europeans. This however has been argued against by many European SL users by saying that Linden labs forced this tax on them without notice and is charging tax on property that does not really exist (and thus should not be taxed under EU law). This viewpoint is completely incorrect, as VAT is a tax on both goods and services, with a 2003 E.U. directive covering the collection of VAT on digital services. However, the same EU directive is written in the context of wider European VAT law, which states that European businesses should be able to reclaim VAT paid for business items, and thus avoid the additional costs of VAT crippling their ability to compete in non-European markets. VAT laws apply regardless of transaction size; the issue here is that Linden Labs have chosen to legally define the Linden dollar as a digital service rather than a digital currency. Second Life offers no mechanism for a business holder to establish if a customer is European or not, making it impossible for the business to collect VAT from Europeans, however it is unclear whether the law requires them to do so - since Linden dollars are not legally classified as a currency, it may be the case that capital gains tax would be more appropriate. If Linden dollars were a recognised currency, then normal money exchanger laws would apply to Linden Lab, and VAT would only be chargeable on the money exchangers conversion fees and not the entire amount of the transaction. The downside for Linden Lab is that this would expose them to a large amount of oversight by European financial regulators, and would require in particular compliance with the Electronic Money Directive (2000/46/EC) and associated anti-money laundering and anti-terrorist financing legislation.

Economic Bias

Based on economic statistics released by Linden Lab, the economy of Second Life is extremely unbalanced. Users on the Second Life forums have calculated the Gini coefficient of Second Life to regularly exceed 0.9, with 90% of the money within the world controlled by the richest 10% of users. Although economic inequality is not a dangerous social problem in Second Life, since there is no need to buy food or earn anything in order to survive, it does make the world unappealing to more competitive users.

Threats to the Linden economy

A greater concern is that the Linden economy may itself be endangered by external forces that can satisfy the bulk of demand within Second Life while bypassing the in-world economy. The most common of these is the intrusion of companies that can supply content within Second Life for free because their revenue model exists outside Second Life. For example, the SLIPPcat advertising system encourages companies to provide content in Second Life which can not only be obtained for free but which generates income for its owner by displaying advertisements to other users when clicked [6].

A similar threat has come from the use of cheap labour, the wide scope of some Second Life businesses. In 2007, Anshe Chung was criticised for marketing a line of furniture in which every item was sold for 10 Linden dollars (approximately 4 cents) [7]. Selling such items was viable for Anshe because the majority of her income came from the sale and maintenance of land, used to host houses within which the furniture was placed; but posed a threat to furniture makers as such low prices would make it impossible for stores not supported by an auxiliary business to compete.

Because of the lower costs in Second Life, it suffers from a greater level of irrational economic behaviour than real economies. A business using a model which has proven economically unviable may be kept open for months or even years using the owner's real money, because the cost of doing so is so low and some business owners are more motivated by a sense of "winning" than monetary profit. (For example, some businesses spend more on marketing than they earn.) These businesses compete with, and potentially damage the market for, other businesses that are striving for economic viability.

External links

• Second Life Economy Stats
• Investing in the online property boom