Rebecca Kirkland
2 November 2007
Research Essay Draft
English 202 – 9:05 am
Dr. Sherwood
First world economic principles intersect with Second Life.
John Zdanowski - Chief Financial Officer
John oversees all the financial and accounting activities … John has extensive experience building and growing profitable internet companies. …John was CFO at HouseValues where he led finance and accounting as the company profitably quadrupled to over $100 million in revenue in 3 years. John also arranged the company’s first institutional financing round of $15 million and its $94 million IPO in 2004. Prior to joining HouseValues, John co-founded Affinity Internet, Inc. raising more than $60 million to build a highly profitable Web hosting and services company serving more than 200,000 small and medium sized business customers. John has worked as an investment banker and a management consultant and began his career as an engineer in GE’s highly acclaimed management training programs.
John holds an MBA from Harvard Business School, an MS in Electrical and Computer Engineering from Syracuse University, and a BS in Electrical Engineering from Clarkson University. (Management | Linden Lab. 3 October 2007).
This sounds like a description for someone on the board of director for a fortune 500 company or a huge banking conglomerate right? … sort of …but not quite. Zdanowski is the chief financial officer of Linden Labs. Linden Labs is the owner of the virtual gaming community Second Life. Second Life is a three-dimensional world built by hundreds of thousands of users over the Internet. It is said to currently be more than 700 square kilometers–about eight times the size of Manhattan. (Trouble) Why does an online game need a chief financial officer you might ask- because they have their own currency of course? As a student in business I became curious of commerce occurring within Second Life earlier this semester after learning of the virtual culture through an article in my research writing course. My curiosities lead me to wonder about how the economy in second life intersects with the first life money systems. The currency in Second Life is the Linden dollar. There are several ways of earning the Lindens. You can use your credit card or PayPal account and purchase them from a bank within Second Life or you may earn them by working within Second Life. Second life occupations are an easier way to earn a living them traditional First Life vocations. You could engage in the same trade in both worlds although one will distinctly require a bit more physical labor. In today’s digital culture is full of online business opportunities. Many businesses are using the world of Second life as a way to reach certain types of clients. By setting up virtual counterparts of their business many corporations feel Second life is a wonderful way to advertise and great way to keep up top of the mind awareness.
Second Life is a fun way to spend time relaxing and making new friends. It’s a virtual reality role playing simulation. In second life you recreate yourself by using an avatar. It’s your choice if the avatar resembles you or is a totally fictitious character created exactly to your specifications. You roam around the virtual streets chatting with people, shopping, sight seeing, all things you do in first life. All accomplished without ever having to leave your home. “Second Life is also being used for education, meetings, marketing and more obvious game playing. It’s a wide world with a lot going on, in multiple languages, and it can be real-life enhancing for populations who are isolated for physical, mental, or geographic reasons.” (Boss) The one key factor that matters regardless of which Life you’re in is money.
Noticing that residents’ behavior, in respect to money, is strongly affected by the direction of the exchange rate, Linden Lab has for more than a year put a ceiling to the value of its currency. It’s done that by selling Linden dollars on the currency exchange for around 270 lindens to the U.S. dollar, and that’s where the exchange rate has stayed since then. In a year, the company has made about $5 million on this trade. Zdanowski is quoted as saying “we basically manage the supply of our currency so that the exchange rate stays fixed against the U.S. dollar.” With residents taking money out of the virtual world because of the gambling shutdown, Linden Labs has simply stopped selling its currency to compensate for the greater supply of Linden dollars for sale on its exchange Lindenx. (Svensson) Mundane items such as clothes, gadgetry, night life, and real estate are what really drive the economy in Second Life.
As I’m sure you’ve guessed, all the commerce occurring within Second Life has come to the attention of the tax man. The US House of Representatives has set up a committee to investigate how and if virtual assets and incomes should be taxed. “Right now we’re at the preliminary stages of looking at the issue and what kind of public policy questions virtual economies raise - taxes, barter exchanges, property and wealth,” says Dan Miller, the senior economist for the joint economic committee. “You could argue that to a certain degree the law has fallen [behind] because you can have a virtual asset and virtual capital gains, but there’s no mechanism by which you’re taxed on this stuff.” ( Qtd. in Kerevan) My first thought after reading that quote were it’s virtual! make believe! pretend! Could the government be being a little over zealous here?
All ready a ban on online gambling has occurred with the legislation (The Unlawful Internet Gambling Enforcement Act of 2006 H.R. 4411) passed by the house this passed summer. (Mark) Second Life falls in to the category covered by the bill because you have to go online via the internet to participate in Second Life. Second life advocates argue that what takes place inside the virtual world is up to Linden Labs discretion because they own the virtual realm. According an AP report, Second Life’s economic activity was nearly halved in the immediate wake of the gambling ban. Zdanowski said Linden Lab briefly stopped selling currency to compensate for the extra supply of Linden dollars as casino owners cashed out of the virtual economy. (Reuters) Linden Labs invited the FBI to investigate casino activity, after the law was passed. (Gardiner) Rumor has it though that the gambling has just gone under ground since the ban. In an article by Reuter’s this is confirmed by “Miss C., a Dutch citizen who declined to be identified due to the illicit nature of her business, ran a poker room before the ban, but had trouble competing with the larger casinos. When her competition closed shop, she started reaping new customers. “Nobody wants to stop playing,” she said. C’s current operation is on group-owned land, and she’s building new gaming rooms, like one in the sewer, on other sims. The idea, she said, is that if one speakeasy gets raided and shut down, the others will keep running. Business is booming. Just since the ban, Miss C has hired seven new dealers to handle the overflow traffic, and reports her profits are up by a factor of twenty. She takes a rake, or casino commission, of three percent of every pot.” (Reuters) Before the gambling crackdown, residents in Second Life exchanged about $2 million US dollars a day in Second Life. That dropped to $1 million shortly after the ban. (Svensson) The currency and exchange rates of second life, the central bank which governs these transactions and its chief officer are so realistic it unnerves me a little.
Due to these similarities to first life economies the government is inquiring into the tax implications stemming from second life careers. Under current tax law, it’s clear that earnings in real U.S. dollars earned within virtual realities are reportable to the IRS. If you sell virtual world real estate and make a killing, you’re liable to pay income tax on any profit that’s been exchanged into real greenbacks - just as an eBay seller is responsible for reporting income generated from an online sale. Tax law is murky, however, when it comes to dealings that occur solely within Second Life or other computer-simulated environments. For instance, is a transaction that occurs only in Linden dollars and doesn’t involve any US dollars in the exchange taxable? Questions like that have the tax community buzzing about the issue. (Wong) Even in Second Life the same basic rules of finance apply to investments and financial institutions can find themselves on shaky ground.
In August of this year, Ginko Financial, a virtual investment bank, announced that it was closing the doors based on insolvency. “The declared insolvency meant the bank would be unable to repay approximately 200,000,000 Lindens (U.S. $750,000) to Second Life residents who had invested their money with the bank over the course of its three and a half years of existence.” (Gardiner) In First Life if something of this nature occurred the CEO and the CFO would be under criminal investigation. The difference in Second Life is that no one knows who owned and managed Ginko for it was run by a faceless owner whose identity is still a mystery.
Recently in statement Linden Labs said “we do not intend to recreate or subvert real-world laws in any way,…We caution our residents to be wary of anyone offering extremely high interest rates at no risk, either in the real world or in Second Life — if it sounds too good to be true, it probably is.”. (Qtd. in Gardiner) This statement was a odvious one considering Second Life currently has 20 to 30 banks that operate essentially the same way Ginko did. That fact, plus the large losses associated with Ginko, has led to a growing call for even more transparency and regulation among Second Life residents.
On the flip side even before Ginko’s collapse, public opinion had turned against Second Life. This was in part because of the media backlash typical with an over-hyped technology, but also because reality has intruded online. Many users experience this parallel world as a lonely one, despite the existence of 7.7million registered residents as of June. Only 10% of new users are still active after 30 days and at any given time only between 20,000 and 50,000 are logged on. (Trouble) Most corporations hardly attract any online visitors, which is why some firms have already closed their branches. Real money is being made by only a happy few. Still Second Life is unlikely to experience the same hard landing as the market for sub prime mortgages did in First Life. Compared with other virtual worlds before it, Second Life’s economy and its currency have been tightly managed. Linden Labs keeps a close eye on the exchange rate at all times to ensure that the Linden dollar does not stray too widely from an exchange rate of $270 Linden dollars to the American dollar,. It also intervenes on a Second Life currency exchange, called LindeX, which even features automatic circuit breakers if trading gets too frantic. The real economic policy tests, however, are yet to come. Will Linden Lab be willing to prop up its currency if growth slows down (which it apparently already has begun to do) or if many users start selling their Linden dollars? Will the firm, which so far has preferred a laissez-faire approach, introduce regulation, to avoid further bank runs, say? If Second Life has trouble answering such questions, it can take solace from the fact that they are proving pretty tricky in real life too. (Trouble)
I find it interesting that people can actually make a living in second life. Ailin Graef has been heralded as the first person to become a Second Life millionaire. According to Hof’s article she is the first person to claim becoming a First life millionaire solely from activities in Second Life. She did this through small scale purchases of virtual real estate which she then subdivided and developed with landscaping and themed architectural builds for rental and resale. Her operations have since grown to include the development and sale of properties for large scale real world corporations, and have led to a First Life “spin off” corporation called Anshe Chung Studios, which develops immersive 3D environments for applications ranging from education to business conferencing and product prototyping.(Hof)
Another example of Second Life employment is Janine Hawkins. Hawkins is a student at Nipissing University in Ontario where she works as part-time job as a French translator, but in the online world of Second Life, where she is managing editor of the fashion magazine Second Style. She receives her monthly salary for her efforts in Linden dollars. Living it up in Second Life is a break from Ms. Hawkins’s First Life as a student, but she works just as hard in the virtual world. Last month, she earned 40,000 Linden dollars ($150), for interviewing designers, arranging fashion shoots and writing about trends in Second Life, called SL by frequent users. “I usually spend what I earn,” Ms. Hawkins said. “It’s entertaining.” (Boss) I find it fascinating that people pay money for drinks they can never drink and clothes they can never wear and enjoy it. “Why can’t we break away from a consumerist, appearance-oriented culture?” said Nick Yee, who has studied the sociology of virtual worlds and recently received a doctorate in communication from Stanford. “What does Second Life say about us, that we trade our consumerist-oriented culture for one that’s even worse?” (Qtd. in Boss) I concur with Yee’s feelings whole heartedly.
If you look at Second Life as a Petri dish for examining what makes many of us tick, it reveals just how deeply ingrained the need to fit in is. Looking good and getting ahead in a material world is what is important to many individuals. Many people have lived the American dream in Second Life, and built Linden-dollar fortunes through entrepreneurship. In what could have been an ideal world, however, Second Life has an up-and-down economy, mortgage payments, risky investments, land barons, evictions, designer rip-offs, scams and squatters. It’s no wonder the government is now looking at Second Life as new source of revenue. Even peer pressure is present in Second Life. “Second Life is about getting the better clothes and the bigger build and the reputation as a better builder,” said Julian Dibbell, author of “Play Money,” which chronicles his year of trying to make a living by trading virtual goods in online games. “The basic activity is still the keeping up with the Joneses, or getting ahead of the Joneses, rat race game.”(Qtd. in Boss)
As I researched these intersections it amazed me that people spend so much hard earned cash on things they can’t even touch. When I make a first life purchase I try to judge if the item is a want or a need. If it’s a need I then consider is it a good value for its price by taking in to account with the quality of the workmanship and the material the item is made from. This is irrelevant in Second Life because the item is virtual. I also factor in how much use am I going to get from the item. Use is valid consideration in Second Life although the way clothes and shoes are used is done in a slightly different context. If a purchase is something that I will use only once I don’t want to pay a lot for it unless it falls in to the “want” category. We all know when you really want something price is irrelevant. When considering a purchase it seems to me that Second Lifers are only using the fact that they want some thing to justify the purchase. “It also says a lot about the real world, especially when it comes to earning and spending money. When people are given the opportunity to create a fantasy world, they can and do defy the laws of gravity (you can fly in Second Life), but not of economics or human nature. Players in this digital, global game don’t have to work, but many do. They don’t need to change clothes, fix their hair, or buy and furnish a home, but many do. They don’t need to have drinks in their hands at the virtual bar, but they buy cocktails anyway, just to look right, to feel comfortable. Second Life residents find ways to make money so they can spend it to do things, look impressive, and get more stuff, even if it’s made only of pixels. In a place where people should never have to clean out their closets, some end up devoting hours to organizing their things, purging, even holding yard sales.” (Boss) It seems to me that the entire realm of Second Life falls in to the want category. I believe that this is partly due to the fact that you get so many linden dollars for a single US dollar. As of Thursday November 1st $100.00 US dollars would buy you 26,779.34 Lindens (Reuters). I think this facilitates the play money phenomenon similarly to how people spend with credit cards without considering the repercussions. From a personal consumer viewpoint the economy in Second Life has many similarities to First Life. As much as Linden Labs wanted to flaunt convention and play up the differences between Second Life and First Life I feel they are to be forever plagued with similar problems because human beings are capitalists at the heart.
Bibliography
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