SimJapan: Second Life’s banking crisis

Second Life’s, er, idiosyncratic approach to banking has been visited in these pages, previously. As the von Mises Institute detailed (and any economist would have agreed), it was time to bail on the Linden.

Now?

Yesterday, the San Francisco company that runs the popular fantasy game pulled the plug on about a dozen pretend financial institutions that were funded with actual money from some of the 12 million registered users of Second Life. Linden Lab said the move was triggered by complaints that some of the virtual banks had reneged on promises to pay high returns on customer deposits.

The banks of Second Life were operated by other players, who enticed deposits by offering interest rates. While some banks paid interest as promised, others used depositors’ money for unsuccessful Second Life land and gambling deals. Under its new banking rules, Second Life says only chartered banks will be allowed — though it isn’t clear any real chartered banks will operate in the virtual play world.

The shutdown has caused a real-life bank run by Second Life depositors. Though some players managed to get their Linden dollars out, others are finding that they can no longer make withdrawals from the make-believe ATMs. As a result, they can’t exchange their Linden-dollar deposits back into real dollars. Linden officials won’t say how much money has been lost, but a run on another virtual bank in August may have cost Second Life depositors an estimated $750,000 in actual money.

Some of the virtual banks? This is very humorously apropos – not unlike our Central Bank’s position, when in fact it was the Fed’s (lack of decent) financial regulation that built the petri dish in the first place. Linden Labs designed the cock-eyed, thoroughly unsustainable system within which Lindens were created: printing money at will, but pretending it was worth the same in US dollars.

Linden announced plans for yesterday’s shutdown two weeks ago, and since then Second Life players have been streaming into the fantasy banks to withdraw their deposits, which are convertible into U.S. dollars at a floating rate. Yesterday, one U.S. dollar was worth an average of 269 Linden dollars, its typical exchange rate.

Devalued Money Supply, a run on banks and short-term holds in withdrawals. With all this money being pumped into our economies, hey – you just never know. We have the advantage in that a lot of it is, as discussed recently, mostly debt. This means it both generates problems like the current one, but it also helps correct it (as long as the debt itself is allowed to be destroyed, taking its share of the Money Supply with it – i.e., so long as the Central Bank doesn’t persist in trying to shore everything up with more Money and low, low interest rates).

The irony (or stupidity), of course, is this:

“When virtual environments first started, they were viewed as libertarian dreams with no interference,” says Behnam Dayanim, a lawyer who specializes in Internet law at Paul, Hastings, Janofsky & Walker LLP in Washington. “As companies that sponsor these environments become more accountable to investors or regulators, they are starting to encounter real-world limitations.”

The problems, here, were not real-world limitations: Second Life is, insofar as Central Bank management goes, a bloody long way from a Libertarian dream. Such strict, and economically non-sensible, control over the Money Supply was never going to end up any other way – precisely why the von Mises Institute posted their criticism in the first place.

My dream-move: the IMF intervening in Second Life! Offering Linden Labs the cash to pay out the deposits, but demanding a series of virtual-world concession and reforms. There’s no reason why it wouldn’t work (besides the IMF being crap at this sort of thing in the real world, of course).

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