When Virtual Crises Turn Real

Inside the banking offices of Ginko Financial, an eerie crisis has developed. A collection of almost impossibly strapping men and buxom women, along with various furry creatures with wagging tails, crowd around a cash machine. But no cash can be drawn, and the teller windows are empty.

"The threat [of fraud] is there…[but] in Second Life, it just so happens that we know everything that happens."

— Avatar of John Zdanowski, CFO of Linden Lab

This is one of the virtual banks in the "online universe" of Second Life, a fast-growing computer simulation designed by San Francisco–based Linden Lab. The virtual world runs on "Linden dollars," which the lab currently provides at the rate of L$270 for every real dollar. And more than $20 million worth of Lindens changed hands in the last quarter, making Second Life serious business.

For those stuck in real life, Second Life is populated by account holders who design "avatars," characters that can resemble their real-life personae (or not, depending on what the subscriber desires). These avatars interact in many ways, including through commerce. And many account holders seem intent on getting rich in Linden dollars, and thus in real-world money as well. Starting an account is free, although for a charge the avatar can be endowed with any number of special enhancements to make it more attractive in the online world. (Some choose to make their avatars animals, or "furries," in the jargon of Second Life.) Using purchased Linden dollars, subscribers buy private islands or other land, and create businesses, including banks and even stock exchanges — anything that can be used for fun or profit in Linden dollars and therefore in real money. Last year an avatar became the first to earn $1 million worth of the local currency.

But as Second Life has grown in size and complexity since going live in 2003, many are seeing the need for regulation to protect against fraud, money laundering, tax evasion, and other scams. How should such financial regulation work, though? Such schemes are only some of the "virtual criminality" that threatens to overflow into real-world lawbreaking. Second Life also has concerns about avatars stealing from or otherwise harming other avatars, and most recently a controversy over imaginary-sex software has spurred a lawsuit.

Linden Lab tries to stay above the fray, allowing what it considers a natural experiment to play out and develop. But when it made a foray into regulation last month by banning gambling to comply with local laws, the user backlash and subsequent financial crisis showed that regulation of virtual worlds must be handled with care. And now experts from the real world are beginning to weigh in on issues involving what Second Lifers call "in-world" affairs.

"These things have languished below the radar screen," says Steve Prentice, chief of research at Gartner, a technology consultancy. "They were probably viewed by regulators as games. But as they grow, there's a greater understanding that they're not games."

"A Full-Blown Panic"
The Ginko crash demonstrates how risky Second Life markets can be — for virtual investors and potentially for Second Life itself. Many users who chat feverishly in online forums have argued that Ginko was a Ponzi scheme all along, offering ridiculous returns and paying them with other investors' money. Last Thursday the bank posted a note on its Website acknowledging that its coffers of Linden dollars were empty. A wave of withdrawals led to a "full-blown panic depleting even our last line of cash reserves," wrote Andre Sanchez, the real-world individual whose avatar is Ginko's CEO. Now the bank is handing out cheap bonds and asking customers to hold tight until it recovers. Ginko owes upward of $750,000 (yes, real dollars), and some customers who invested heavily — hoping to reap whopping 48 percent annual returns — lost as much as $10,000.

The bank's collapse came as the Second Life economy was stalling. Users started logging off when they could no longer play poker, baccarat, or slot machines. Banning gambling, which represented up to 15 percent of the Second Life economy, led to a drop-off in usage among Second Life's nearly 9 million registered "residents," John Zdanowski, chief financial officer at Linden Lab, told CFO.com in an interview. This was compounded when an avatar staged a heist at Second Life's World Stock Exchange, an equity market of in-world companies. When an ex-employee of the avatar-run exchange used inside knowledge to steal deposits, several newly listed companies were scared off and users saw how their investments could quickly vanish in a world without regulations.

"There are not regulations because the real world already has regulations and laws," said Zdanowski, who also runs the Second Life economy. "It's the responsibility of every individual to make sure they're complying with their own laws."

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