L$: Show Me The (Real) Money

I got one more thing to say about Linden Dollars in this string of posts. Back in ye olde 1999, I helped take a few silly companies public. These Internet companies took investors’ money on the proposition that they had a lot of site visitors, and even though they had no revenues, someday they would figure out how to extract money from those visitors – the phrase was “monetize the eyeballs,” and yes you could actually read that in the offering prospectus. Of course, they never figured out how to monetize the eyeballs, and the whole industry went bust.

Then Google came along with its monetization through search advertising. And now everyone thinks that search and advertising are the only ways to make money on the Internet. Seriously, when was the last time you heard of an Internet business model that wasn’t fundamentally about advertising?

Second Life, of course, gets money from usage primarily through hosted software fees. Yep, put aside all the fancy talk about virtual land, avatars, user-created content, etc etc, and our business model is basically a hosted software business. Now, this is no mean feat – but it’s also the case that for our usage to expand as broadly as our ambition, we will have to see diminishing margins in the hosted software business (because other people will have to run SL servers in order for the usage to be as worldwide as we imagine).

But what is the Linden Dollar? Is it somehow another way to monetize those famed eyeballs of yore? I think in a sense it is. Linden Dollars are issued in proportion to the estimated future value of our virtual world. This means we will receive payment for building the economy of our world, and if our world becomes as large as we hope, this is going to correllate to all the eyeballs in SL, it will in the aggregate be a massive amount of real money. What would have happened if Netscape created the Netscape Nickel in 1995, a virtual currency for Internet users to participate in a new global micropayment economy? (One of many fun Netscape whatifs.) This is not a forever business model, it lasts only so long as the world is expanding, but man it’s a big pile of real money nevertheless.

I rarely ever think of our business in terms of money – there are so many mind-expanding aspects to what we do. But one of the really interesting features of our service is our virtual currency, and thinking about its ties to real money is unavoidable.

L$: The (Possibly) Scary Future

If Linden Dollars are a private currencydepending on our implementation – this could fuel the anarchic fantasies of the tinfoil hat crowd to dangerous heights. (Love this WoW hat: -10 Intellect, +10 Spirit)

OK, lemme back down from the funny-scary attempt and restate: The concept of private currency is dearly held by a certain libertarian viewpoint. This viewpoint sometimes overlaps with and is often confused with a type of anarchist view, as both have a deep distrust for the government as a central tenet. I suppose in my mind the difference between a libertarian and an anarchist is that both have guns, but only the anarchist really wants to use them to further his political philiosophy. Anyway, the distrust of government is easily caricatured as a prediliction for conspiracy theory, and that’s why I made the tinfoil hat reference. All the libertarians and anarchists out there: sorry, I don’t mean to insult, and hey, I’m just fooling around, it’s a free country isn’t it? Uh, don’t answer.

I’m obviously feeling a little loopy after reading too much about private currency. A lot of this stuff sounds somewhat, shall we say, Ayn Randian. (Ayn Rand always makes me feel a little loopy, even when I agree with her.) The basic argument is that there’s no reason for us to accept that government-issued currency is the only usable medium of exchange, and in fact governments are less reliable actors compared to private companies when it comes to taking actions that will hurt the economy and the economic positions of individuals. Governments play all sorts of games with money that have everything to do with keeping governments in power and little to do with maintaining a stable economy. Private companies issuing private currency are highly incented to keep those currencies reliable, as the free market will weed out those private currencies that are managed imprudently.

There are several private currency efforts out there, such as the Millenium Dollar, PCX, the Liberty Dollar, and eGold. At least two of those efforts are being prosecuted (persecuted?) by the U.S. federal government.

The eGold case is particularly instructive. The government came after eGold for enabling illicit activities, including child pornography, conspiracy, and money laundering. If you believe the blog chatter and eGold’s claims, the eGold guys had a long history of trying to cooperate with the government, as well as perhaps a little too much ego and belief in their manifest destiny. The history and the ego were no help in Congressional testimony, which eventually was followed by the prosecution.

So who’s scared? Well, it looks like the government is afraid of private currency. And why not – nobody likes to lose a monopoly. But let’s not make the tinfoil hat mistake in this direction either. It’s entirely possible, and in fact probable, that the government has legitimate concerns around illicit activity, and the private currency services did not do enough to assuage those concerns.

There are plenty of sober people who think that private currencies have a real future. But maybe it’s one of those futures that’s always in the future, which you might think from seeing so many failed attempts.

When it comes to thinking of Linden Dollars as private currency, there is one other complicated field to look into: electronic money and digital cash. Now, this starts to get a bit complicated, but the idea of private digital cash is a crypto-anarchist‘s dream. According to the National Security Agency, properly implemented digital cash would be untraceable and anonymous. Combine those two characteristics with the fact that the issuer is a private company, and just how long do you think the government would allow this to exist in an unregulated state? Only until they figure out what is going on, and as slow as they can sometimes move, they’ve been thinking about this stuff for longer than I have. (Dammit, where did I leave my tinfoil hat?)

So, if Linden Dollars are a private currency, we’d have an interesting and scary question as to how much untraceability and anonymity we could implement without getting shut down by the people we scare.

L$: The (Possibly) Interesting Future

I threw around some terms in that last post, as if we all know what they mean: money, currency, medium of exchange. Is it really that clear? It wasn’t clear to me when I first started looking into all this. It’s makes just a little more sense to me now, but that’s possibly only because I’ve started to form my own opinions, and have started to fit everything else I see into my own little prism. But anyway here’s my quick gloss:

“Medium of exchange” is perhaps the easiest term to understand, it’s sort of self-explanatory. Investopedia says a medium of exchange is just an intermediary item used to make economic trade easier. The modern medium of exchange is currency.

But wait, what’s “currency”? Er, Investopedia says currency is money, generally accepted as a medium of exchange. And what’s “money”? You guessed it, Investopedia says money is currency, an official medium of exchange!

Ah, I’m overemphasizing the circular nature of these definitions. I think the key concept with currency is that it’s generally accepted among a certain group, whether that group is described by geography or tribe or contract. And I’d say the key concept for money is that it’s officially redeemable from the issuer. But at this point, I have to admit that I really am just making up my own shorthand, which I formed after reading (or trying to read) many lengthy and confusing, boring articles on these topics.

So what’s the point? I need two more concepts to make my point, these are easier. The first is the concept of “fiat” – as in fiat currency or fiat money. This time it doesn’t matter that those terms might mean the same thing, because it’s “fiat” that makes them the same. The modifier fiat means that the currency or money is issued by the government, backed by whatever government authority or promise of redemption that the government chooses to provide. You might think then that fiat currency is the most stable, reliable kind of currency available.

But I’d guess your belief in that would depend on your belief in the particular government that issued the currency, and perhaps also on your belief in any government at all. The concept of private currency is applied to a generally accepted medium of exchange that is not issued by the government.

And this is where it gets really interesting. What if Linden Dollars are private currency? This is such an interesting what if? that I’d like to think about it even before I try to answer the question, Are Linden Dollars private currency? Because the latter is kind of a hard question, probably beyond my ability to answer. Not that that ever really stops me from offering an answer . . . but for now I’ll just say that if Linden Dollars are private currency, that could be a very interesting future.

L$: The (Possibly) Boring Reality

I’ve said time and again that L$ != $, i.e. Linden Dollars are not real money. I keep emphasizing this because real money is subject to banking regulation and money transmitter laws, and we don’t want L$ to be confused by regulators for real money, at least not until we find reliable partners to do the portions of our current business that could become subject to these regulations.

I’ve done a poor job in explaining what Linden Dollars actually are. This is because I don’t actually know what they are, not exactly, and it’s really tiring trying to hide my ignorance. So let me just tell you what I know. The first part of what I know is kinda boring, and it goes like this:

Linden Dollars are a license right, defined in our TOS. As of this writing, the current TOS says:

You acknowledge that the Service presently includes a component of in-world fictional currency (“Currency” or “Linden Dollars” or “L$”), which constitutes a limited license right to use a feature of our product when, as, and if allowed by Linden Lab. Linden Lab may charge fees for the right to use Linden Dollars, or may distribute Linden Dollars without charge, in its sole discretion. Regardless of terminology used, Linden Dollars represent a limited license right governed solely under the terms of this Agreement, and are not redeemable for any sum of money or monetary value from Linden Lab at any time. You agree that Linden Lab has the absolute right to manage, regulate, control, modify and/or eliminate such Currency as it sees fit in its sole discretion, in any general or specific case, and that Linden Lab will have no liability to you based on its exercise of such right.

Wha? I sometimes explain it this way instead: Linden Dollars are a feature of the virtual economy portion of our service offering. See, people enjoy participating in a virtual economy, and this is one feature we provide to make that participation easy. We didn’t have to use the fiction of a license right. We could have used, say, a box of special Linden toothpicks instead. We could have said to everyone, “Hey, if you want to buy and sell things in-world, we want you to use our special toothpicks as your medium of exchange. You don’t have to do this, we just want you to. We want you to write us a letter, include a check to buy these toothpicks from us. We are the only ones who can issue these special toothpicks. You can set prices for the things you are selling in these toothpicks, and you can buy and sell these toothpicks with other users at any price you want. But we will never buy toothpicks from you, or give you anything else for them. Once you buy a box of toothpicks from us, you can’t return it. S’ok?”

Conceptually, Linden Dollars are exactly the same as those toothpicks. But of course it would have been insanely stupid to try this with physical toothpicks when we can use a simple license right that will serve the same purpose with much, much lower friction in use.

I’ll make another point: We didn’t have to call them Linden Dollars. We could have, for example, called them Linden Bunnies. We could have made the LBunnies visual in the virtual world, so that when you carried the LBs around, say, you would wear them on your head. (I suppose a stack of bunnies on your head would eventually get really unwieldy, but we could have used different color bunnies to indicate denominations – a white bunny named George would be one LBunny, a green bunny named Benji would be 100 LBunnies, maybe we’d have a blue bunny named Sammy for 10,000 LBunnies. Instead of it being all about the Benjamins, it would have been all about the Sammies.) Had we used virtual bunnies on heads, I believe very few people would confuse our virtual currency for real money.

But what is real money anyway? This is actually a complex question with more than one perspective for an answer. (That, btw, is what I say when I’m not really sure what I’m talking about.) However, one of the key factors that makes money money, from the perspective of regulation, is that money is redeemable for monetary value. Now, that’s a bit tautological (I like to use big words and then undermine my appearance of familiarity with these words by linking to a definition) but the key statement there is “redeemable” – this is why we continually insist that Linden Lab will never give anyone real money or any other value for Linden Dollars.

Note that this is not the same as saying that Linden Dollars have no value! I have heard many people, including myself, get confused on this point. Linden Dollars obviously have market value – there is no conceivable way we can deny this when we ourselves run a market in Linden Dollars, and moreover we have talked about this many many times publicly. And never mind whether or not we can deny anything, it’s just true: people ascribe value to Linden Dollars. But that has never been important to our position. What is important is that we do not redeem Linden Dollars, we do not give you any monetary value for them.

So, in case you aren’t already bored, you may be wondering why the title of this post says this is only possibly boring. Well, it’s because this stuff is only boring if everything I say above is right. If it’s not, we are going to have some very interesting problems. But not only do I not know if all of it is right, no one does. At least, no one that I have been able to find so far.

Broken Record

I had a lot of things in mind in my last post about working together, please don’t assume I had any one individual or situation in mind.

We now return to our regularly scheduled programming . . . which means I’m going to talk about LindeX again. The exchange rate has been trending down (stronger L$) since about May 25 or so. Peter theorizes that if we do nothing, we’ll see sales this weekend at the strongest rate ever, L$200/US$1 or better. Should we be happy about this? Isn’t a monotonically decreasing rate as damaging to [virtual] economic stability as a monotonically increasing rate?

If we believe that we shouldn’t let the L$ get so strong that people end up mistakenly buying (on market orders) into ridiculously strong rates, we should post a big block as an effective rate stop. Both Lindens and residents have suggested this before. We could post, say, US$100,000 of L$ at a rate of L$250/$L. Note though, that just leaving that block up there is our statement that we are fixing a maximum L$ value. Whether or not that is a good thing is not something I’m convinced we’ve thought through.

However, I’m also convinced that we ought to experiment, because we will never get to the end of our thinking if we want to think everything through about LindeX. We experiment with all sorts of areas of our product in terms of features, and as you know we experiment with all manner of internal company tools and processes. Our ability to experiment intelligently is one of the great strengths of Linden Lab. It is critically, critically important that we experiment with our revenue model. I understand that this thought is open to the criticism that we are jerking our customers around. This same criticism applies to our changing feature development, our registration process, etc. Nevertheless, we recognize as a company that if we do not experiment, we will lose.

Experimenting with our revenue model is just as important as any other kind of experiment we do here. Our long term success versus competitors is absolutely dependent on this. As companies become successful, it is harder and harder to experiment – you’re always afraid of killing the goose that lays the golden eggs. And this is what paralyzes larger companies, and allows small competitors to come in and win. The future of 3D online environments is immense and complex, I don’t think I have to sell anyone here on that. We have terribly poor odds of capturing the best opportunities in this expanding opportunity space if we are not continually experimenting. We are at continual risk of burrowing down into some business model that will get evolved out of existence.

So this does, now, wrap around back to my previous post. Please don’t think that all I think about is the money. We’re all working on the same complex system, and we all care about every part of it. We’re not going to have customers if the product doesn’t work. We don’t have enough people to give everyone what they want. We’re not going to be able to hire people if we’re not making money. But every growing company faces constrained resources. We have a choice: We can regard constrained resources as a vicious cycle and say there’s no hope. Or we can regard the demand and opportunity as a mandate to experiment. Obviously, it’s not really a choice – the first “option” flies in the face of every successful technology company of the last 20 years and more.

So, when are we going to start selling L$?

Steps to Selling L$

So when are we going to start selling L$? It occurs to me that I skipped this discussion when I jumped right away to selling strategies. A number of people raised concerns that we shouldn’t sell L$, further (in theory) devaluing the L$ at a time when residents have been pummelled by recent changes in Second Life. When we first started seriously talking about selling L$ earlier this year, we said there are at least three steps to get there:

1) Reduce stipends. This is necessary so that the money supply isn’t bloated with L$ we sell, which would devalue the Linden Dollar. We’ve already knocked off nearly all basic user stipends, it’s time to start reducing stipends for Premiums.

2) Allow basics to buy land. Basics who own land have a recurring revenue relationship with us, and no stipend. This is the end state relationship that should be the default for all users. Some people will continue to desire a “premium” relationship, and we should continue to fashion an attractive product offering for that relationship. For the time being, the easiest way to make premium membership attractive is to give them discounted Linden Dollars. But we ought to be working on a lot more ways to make premium attractive.

3) Implement a recurring LindeX buy program. There are lots of premium subscribers who don’t own land (approx 30% of premiums). These people are effectively paying $10 for L$2000 per month – that’s a bad deal. Having them sign up for a recurring buy program would be less revenue for us, because they’d be buying L$ from other users rather than from a subscription with us. But it would put demand pressure on LindeX, which should further strengthen the L$, which should let us sell L$ on the exchange.

I’m not 100% sure what order these three should be done in, but I suppose that ideally it should be in the order set forth above. However, (1) and (3) have some negatives associated with them, and (2) has almost entirely positive benefits. So I’d like to see us proceed with (2), since it is on the path to selling L$.

LindeX Selling Strategies

We’ve got to start selling L$ on LindeX. There have been a number of holdups until now, mostly related to the spiraling LindeX rate and panicky market. But the exchange has been stable now for almost a month. That stability could be due to a lot of reasons – Greenspanian pronouncements, reduced sources, transparency of economic info, etc. – but I think the biggest reason is just what Peter always said: We finally have buy limit orders to normalize activity, and now that they’ve had a chance to bake in, the market is stable.

In any case, the market is stable, and we’ve said that once the market is stable, we’d start selling L$. Sure, it will panic the market again, but if we do it right, we have enabled an incredibly high-margin revenue stream. So how do we sell? How much do we sell? At what price?

Quite a few folks argue that the amount sold must correlate exactly to some L$ charge, like upload fees or classified ads. I think the idea behind that thought is that the market will accept L$ sales that translate directly to services that the user community believes is beneficial, or at least believes has a direct relationship to system resources. I disagree with this for at least three reasons:

1) The market doesn’t think clearly enough, or monolithically enough, to accept that any particular L$ sink is a good candidate for L$ sale.

2) There’s actually no rational relationship between the amount of L$ we can or should sell and any one particular sink.

3) Someday – as we reduce the free sources of L$ – we need to be selling 100% of our sinks, and eventually even more than 100% our sinks. (It’s tautological: When there are no free sources, new L$ can only go into the L$ economy through sale of L$.) So we shouldn’t let the market get into a mode of judging whether any sinks should be sold, since someday we will need to sell all of them, regardless of whether the market thinks they’re “worthy” of sale.

So then, here is the selling strategy I’d propose instead:

Make an announcement on the forums to this effect: “At noon tomorrow, Linden Lab will place a sell order on LindeX in a US$ amount equal to [X]% of the L$ sinks over the last 30 days (including today). At the average sale price over that same period, this would be about US$[Y]. The offered sale price for this block will be the average sale price over the last 5 days, ending with today, or approximately L$[Z]. At the same time, we will place a buy order for exactly the same US$ amount, at the highest selling price for which there has been more than one sale over the last 365 days, currently L$[361? Peter to confirm]. After this sell and purchase order, Linden Lab will not buy or sell on LindeX for a minimum of 14 days, at which time we will evaluate whether the Linden economy requires additional L$ infusion.”

In other words, “We’re selling Linden Dollars. It’s a small amount of the last month’s sinks. If you want to panic, go ahead and panic. But if you panic through the highest price of the year, you’ll be selling right through our buy block that is the same dollar amount we just sold, so it’s like nothing happened.” Of course, the market could panic right beyond the block, but there’s no logical reason to under almost any theory. And since there’s no reason to panic through the high block, the market probably won’t panic at all. Well, let’s not say “probably,” let’s say “shouldn’t . . . but might anyway.”

I’d target the X% so that the $Y sale amount equals about $5000. And to the extent this proves a stable selling strategy, we’d slowly move that X% up. And eventually move to automated sales every week, then every day. Eventually, once the market is accustomed to the activity, we won’t need to put up the buy order block at all.

There are many many variations that could be as good or better selling strategies. Please feel free to comment away . . .