from Linden to Libra

Join me, friends, in the Wayback Machine …

In 2007, Facebook sent a couple of strategists to Linden Lab to ask us about virtual currency. Of course they would ask us – at the time, we were the world’s leading experts in managing a virtual economy, heading towards a billion dollars of L$ transactions. Yes, that’s a billion real US dollars – unique among all virtual currencies at the time, we supported the exchange of L$ to real US$, so our virtual currency had real world value.

When we heard that they wanted to meet, my colleagues huddled in a room to decide how much we should tell them. We decided to emphasize the difficulties of managing a virtual currency: complexity of implementation, responsibility for users’ financial transactions, intrusive governmental inquiry and oversight, competitive dynamics with banks and payment partners. We went into the meeting and told them this story about how terrible it all was, and how they’d be better off simply issuing credits paid for with real money.

We never heard from them again, but in 2010 they launched Facebook Credits. I laughed at the thought that it seemed our little misdirection had worked – they went down a path that was entirely uninteresting and ultimately untenable, just as we’d hoped. Yeah, I know: that was kinda evil. But at the time, I was just a little evil, trying to stay ahead of bigger evils.

Why didn’t we want Facebook to work on virtual currency? Because I believed that the Linden Dollar was the greatest innovation created by the Lab. Sure, the 3D virtual world was mind-bending – all the avatars and the world building and the art and the boob physics – but for me, the virtual currency was the one element of Second Life that had the opportunity to break out of SL and into prominence in the whole wide world. Facebook had only 50 million users in 2007, and I didn’t want them to get their virtual currency right, so early in the game.

Well, it’s a dozen years later, and blockchain inspired a Facebook exec to figure it out. Facebook has launched Libra, a new cryptocurrency. It is a brilliant implementation: meticulously researched, expertly engineered, broadly partnered, poised for global domination. There’s only two problems: it’s too late, and they’re doing it wrong.

The right time for Facebook to launch a virtual currency would have been, oh, around 2007. That’s right: I’m saying you can thank me and Chris Collins for talking them out of it at the time. As I’ve written previously, a cryptocurrency can only succeed as a medium of exchange if it is a core currency of a powerful platform. Don’t even get me started on Bitcoin. What I didn’t call out in those posts is that the platform must implement currency strategy early in its growth. This is because when you are messing around with payments, you are in a field of giants – global banks and entire nations that have a vested interest in preventing your success. You have to implement your new currency while your platform is still small enough to ignore, or at least dismiss as “merely a game.” Then when you reach enormous scale, it’s too late to do anything about the economy that’s been baked in since the early days.

When a platform already has billions of people, it’s not going to fly under the radar. Facebook is already seeing immediate regulatory interest in Libra. Even with less than a million users, Second Life had to deal with aggressive regulatory interest from Congress and international bodies. I like to think that we talked our way out if it with my silver tongue, but the truth is that we were too small for sustained inquiry. Facebook is far, far, far past that point. Libra will be hounded by regulators until the cost outweighs the benefits.

The part that Libra has wrong is its reserve policy. This is getting into the weeds of managing virtual currency, but to vastly oversimplify: the reserve is a guarantee of currency redemption. If you buy Libra with real currency, you can sell it back to the Libra consortium for a relatively stable amount of real currency. Libra has launched this way in the hopes that a stable currency value will engender trust. The amusing mistake here is that only in the insular world of technocracy could someone believe that Facebook has consumer trust problems that can be cured by a stable rate of exchange on their cryptocurrency. The more serious mistake is that requiring a full reserve limits the utility of the currency.

All major world currencies are fiat currencies, which means that they can be issued at the will of the governing authority. They are not backed by gold or any other asset – though nearly all of them started out backed by a guarantee of redemption in gold. But there is a reason that all of them have moved off of the gold standard: fiat provides the maximum flexibility to manage the currency and its related economy. While it’s true that fiat currencies are more susceptible to hyperinflation, that is only a consequence of bad management. If the manager (i.e. the government, or in this case, Facebook) can be trusted to make good economic decisions, inflation is a limited risk.

Perhaps Facebook is aware of all this, and their plan is to launch with a full reserve, but later evolve into a fiat currency, after some history has demonstrated their trustworthy stewardship. After all, this is actually how all the major world currencies developed: first on the gold standard, then eventually declaring a switch to fiat currency. So if the launch with reserve is a bit of knowing subterfuge, kudos to them.

At this point, I could launch into an extended discussion about the relationship between virtual currencies and MMT. But I’ll leave that exercise for another day. In the meantime, for Linden historians who have stayed with me this long through the discussion, I’ll give you a little blast from the past: a record of posts from Linden Lab as we decided how to think about our currency, and whether to implement fiat sales of L$ into existing exchanges. Enjoy!

virtually great currency

The acquisition of SuperRewards by Adknowledge is a notable milestone in the evolution of virtual currency business models. This is the first time an independent virtual currency platform has been acquired by a company outside of the virtual goods category, and so the first time that a virtual currency has achieved monetization for someone other than its creators and users. We’ve moved into the peak of the third phase of business models for virtual currency.

The first phase was a sort of prehistory where virtual currency was a gameplay feature of massively multiplayer online games – points that players could gain through the completion of tasks, and use to acquire in-game items that were valuable for further progress in the game. Although points have been a feature of most videogames since the inception of the medium, the relevant new thing about MMOGs was the operation of a “persistent” online economic environment. That meant that even when particular players weren’t online, the service constantly maintained an environment where items of value could be acquired and traded. Much of the trading of items for value was “off-service” – often against the game rules – but this was the first step in virtual currencies breaking free of gameplay rules.

The second phase started when online services that were not solely game-oriented used virtual currencies to encourage trading of service assets – this time trading currency for service items wasn’t against the rules, but specifically designed to encourage sales within the service. Korea’s Cyworld was a pioneer in this use, with “Cyholics” using “acorns” as a medium of exchange for digital presents that users could buy for themselves and each other. Chinese Internet portal Tencent built QQ coins into a $900 million economy, while in the U.S., Second Life users are heading towards $450 million (in U.S. Dollars) of Linden Dollar transactions. The authorized use of virtual currency within these services led naturally to implicitly or explicitly authorized use of their virtual currencies outside of the traditional boundaries of the service, demonstrated by Chinese users buying real-world items for QQ coins and Second Life users setting up 3rd-party currency exchanges and virtual goods stores. (As an illustration of the differences in culture, it’s interesting to note that the Chinese government eventually banned the use of virtual currency for “real” items, and that Linden Lab rebuilt or acquired the third party services.)

In the third phase, we have businesses that were natively built as a platform for virtual currency to be used on other services (rather than a feature of an economy within a more comprehensive service). Some have stayed closer to virtual currency’s MMOG roots, like PlaySpan and LiveGamer, while others have tried to ride the wave of social media apps platforms, like TwoFish and SocialGold. SuperRewards and OfferPal brought a new twist by using marketing offers as the underlying value to the virtual currency.

This part takes a little bit of explaining. For any currency to gain favor with a user base, there must be some underlying value to the medium of exchange – from a consumer point of view, this is sometimes expressed as a demand that the currency be “backed” by something of value. In ye olden days, governmental currency was backed by precious metal; in theory you could turn in your dollars to the government in return for equivalent value in gold. Most governmental currencies came off the gold standard decades ago, and are now backed by the declaration of the government that the currency is legal tender. The meaning of this declaration is a little murky both in theory and in practice.

Suffice to say that there are virtual currencies that emulate most of the historical models of real governmental currencies. e-Gold tried the gold-backed model, to disastrous result. Some virtual currencies are run as essentially stored value systems for governmental currency, so ultimately they are backed by the same declaration of the government. QQ coins to some extent, and Linden Dollars to a greater extent, are free-floating media of exchange that are backed by the commercial viability of their operators – a private rather than governmental declaration of value (this is not as revolutionary as it may seem, since in many ways it’s similar to airline miles and other customer loyalty programs).

By using marketing offers as the underlying value, virtual currency operators can sidestep some of the difficulties involved in demonstrating that a currency is sufficiently “backed” to satisfy customer demand for stable value. This technique introduces significant complexity and cost by introducing many additional parties to the value chain, but now SuperRewards has demonstrated (to its investors if not yet a skeptical public) that this kind of backing does create a valuable virtual currency. OfferPal is not far behind, and of course is now far ahead in terms of its ability to maintain an independent business.

So what’s coming for the fourth phase of virtual currency business models? That’ll have to be the subject of another post. But for now the developments to watch are the competition between Facebook and MySpace in their own virtual currencies, app developer currencies from companies like Zynga, and the continued progress of OfferPal.