Virtual China

Entropia Universe scored a big win yesterday, announcing that it had been selected by China to build a cash-based virtual world for that nation, according to an AFP story. The agreement with China's Cyber Recreation Development Corp. (CRD) apparently took a year to negotiate.

Here are some of the newsworthy facts to emerge so far:

• CRD estimates that this new virtual world (or worlds) will create 10,000 real-world jobs in China.
• Up to 7 million people will be able to access the virtual world simultaneously. (This compares to a typical level of around 40,000 concurrent users today in Second Life.)
• The goal is to sign up 150 million residents globally.
• The virtual economy will generate $1 billion in commerce annually.
• One goal is reduce pollution levels by allowing increased telecommuting in the virtual world.
• The go-live date is September 2008.

This is definitely one development to follow. I suspect that China is doing this in part to better monitor and control what happens in virtual worlds.

Also, I am skeptical about whether a government entity like the CRD can compete with privately-run virtual worlds in terms of adopting the latest technologies and responding to user demands. Virtual worlds are already moving so fast that it's difficult for bureaucracies to keep up.

UPDATE: A story on BusinessWeek.com notes that "virtual police will exist in the Chinese game, and that it won't allow players to protest the 1989 Tiananmen Square crackdown, which killed hundreds of people."

Virtual Terrorism in Second Life

Last night cyber-attackers set off some sort of bomb on the ABC island in Second Life. As the before and after pictures show (hat tip: Kotaku), the bomb utterly nuked the place. While the island was restored within a few hours, ABC did spend tens of thousands of dollars to create the island in the first place, according to News.com.au.

If we place this event in the larger context of virtual worlds (as I am wont to do), this cyber-attack raises the issue of virtual property. What was the damage to ABC? It would seem that ABC simply lost any revenue it might have earned from the island during the downtime. But other questions intrude. What if it wasn't vandals, but an electrical problem with one of Linden Lab's server farms? Would Linden Lab be on the hook for damages? (I suspect there is something in the Linden Lab EULA/TOS that is on point.) Alternatively, what if the real benefit of ABC Island is not a revenue stream, but community relations and branding? How does one place a value (to ABC) on users being unable to download video or interact with others on the island? Indeed, it has been suggested that the main benefit for big corporations is not sales but customer relationships, branding, or gathering market data.

ABC Island is the 3rd most visited commercial site in Second Life, BTW.

Virtual Money, Real Pizza

A recent news story reports that Second Life residents will soon be able to order -- from within SL -- real pizza for delivery to their home. (This ability was once available for players of Everquest, but has been discontinued.) More importantly, residents can pay for the pizza with Linden dollars.

Now, in and of itself, this is not a major development that will dramatically change the nature of virtual worlds. Nonetheless, this service does cross a meaningful line that opens the door for much more complex treatment of virtual worlds: using virtual currency for the purchase of real goods or services.

Suppose I have a Second Life business that generates Linden dollar income for me. Suppose also that I cash out all my profit into US$, and dutifully report that income on my tax return. Now, however, if I spend $20 on this virtual pizza service, does that $20 escape tax-free because it never gets converted to US$. In the real world, with a traditional salary, I could also spend $20, but that $20 is still reported as part of my AGI. (Obviously, the tax on $20 is pretty trivial, but the underlying principle is what’s important. What if I buy a car with Linden dollars?)

What is the proper tax treatment of real-world purchases using virtual currency? Should I report $20 as ordinary income? As barter income? If I do, that could raise my compliance costs since I have to file Schedule C. What about horizontal equity – the tax treatment of individuals in similar economic circumstances? If I don’t report the $20, but my buddy who spends $20 on pizza using salary income does, then I will end up paying less in taxes, even if he and I make exactly the same amount of income.

Cross-Platform Transfers

Now this is interesting: a new venture will soon be offering cross-platform transfers, as in transfers between two different virtual worlds. Reuters reports that Anshe Chung Studios will offer the ability to transfer virtual money from Second Life to Entropia Universe, and vice verse. Now this project still won’t directly offer users the ability to trade virtual currencies for dollars (or other real currencies), but both Second Life and Entropia already allow dollar-to-virtual currency exchanges. Thus, someone could take Linden dollars, transfer them to Entropia PEDs, and then convert the PEDs to U.S. dollars. In fact, Anshe Chung Studios is itself planning to issue an ATM card which would allow Entropia residents to withdraw cash. Reuters posted a correction noting the ACS is not planning to offer ATM cards. However, MindArk, the parent firm of Entropia, is planning to issue such an ATM card.

Why is this interesting? Well, first, as the Reuter story correctly notes, this opens up a wide world of arbitrage opportunities. The Linden dollar is set to a floating exchange rate with the U.S. dollar, while the Entropia PED has a fixed exchange rate (10 PEDs = US$1).

Second, this development is another indicator of how fast these virtual worlds are moving. Before most governments are even aware of the economic value created in virtual worlds or their tax implications, innovators are pushing the envelope to introduce new financial mechanisms.

Third, such cross-platform transfers would seem to make tracking money transfers much harder to do. If funds can freely move in to, out of, and between virtual worlds, it would seem to make the job of tracking down cybercrime like money laundering more difficult. Fortunately, Chung’s Dreamland website, which allows individuals to buy and sell Linden dollars, seems aware of potential problems and offers this limit on the purchase of Linden dollars: “We currently do not execute orders above 300 US$ / 250 EUR per customer per week!”

Fourth, this venture underscores the international nature of the business of virtual worlds. Anshe Chung Studios is based in Wuhan, China, while Entropia is based in Sweden and Second Life operates out of California. Anshe Chung, who along with her husband is the woman behind Anshe Chung Studios, lives in Germany. Given such diverse geographical bases, it begs the question of which nation's (or nations') laws apply and how to enforce them.

Where to next?

U.K. Report on Financial Crimes in Virtual Worlds

A new report from a British group has concluded that there is a growing risk of financial crimes in virtual worlds, according to Reuters. The panel also recommends that governments treat transactions on MMO websites "as genuine financial instruments covered by existing laws and regulations." The report specifically discusses the potential problems with credit card fraud, database vulnerabilities, money laundering, tax evasion, and international currency transfers. The report comes from the Fraud Advisory Panel of Institute of Chartered Accountants in England & Wales.

Unfortunately, the report does not appear online, but you can check out the press release.

For my own part, it should not surprise anyone that the threat of cybercrime is legitimate. Any time there is a new medium of economic exchange, it is unavoidable that cybercrime will surface. That fact, however, should not stop efforts to prevent such crimes from taking place.

Interestingly, the press release did not appear to call for any new laws or penalties, merely the application of existing ones to the virtual world space.

Rolling Stone article

There's an interesting article in Rolling Stone about Second Life. The article includes a noteworthy quote from Linden Labs founder Philip Rosedale:

“I’d like to see it get to a point where it’s all irreversible. It’s all a little bit too under our control. That power shouldn’t be in our hands. We don’t want to make mistakes. For me, there’s a critical point that we’ll get to where everyone can take this stuff and run with it.”

What makes this attitude remarkable is that most people already feel that Linden Labs has a pretty small footprint in Second Life as is. According to a 2004 Linden Labs paper in the New York Law School Law Review, well over 99% of content in Second Life is user-created, and it takes a fairly laissez-faire attitude toward resident activity.

Of course, it's also worth noting that Jim Saxton, JEC's Ranking Minority member, was quoted about how taxation of virtual worlds remains unresolved:

“Virtual economies are still at the early stage of development, so it is difficult to predict how tax policy toward them might evolve over the next five or ten years.”

WoW credit card?

A Gamespot.com article reports that Blizzard is now offering a World of Warcraft Visa card, in partnership with First National Bank. Called the World of Warcraft Rewards Visa, applicants can choose from 13 different artistic designs. Users of the card will earn free game time at the rate of 1% of purchases. Applications can be made online.

As the story notes, such a move by Blizzard carries a degree of irony. Blizzard has taken a strong stance against linking in-game activity to real money transactions. While this card does not in any way appear to sanction RMTs, it does establish a formal link between the real world and the virtual world.

Second Life Nationalities

A new study from comScore estimates that 61% of active Second Life residents are European. As reported by Reuters, Germany alone has (slightly) more active SL users than the United States.

• Germany 209,000 (16.3%)
  
• United States 207,000 (16.1%)
  
• France 104,000 (8.1%)
  
• Britain 72,000 (5.6%)
  

comScore also found that the number of U.S. residents in SL grew by 92% from January to March. The European growth rate was a relatively paltry 32%.

comScore's figures differ somewhat from Linden Labs own numbers released for March. Those numbers show that close to 27% of active residents were in the U.S., compared to 13.5% from Germany, 8.2% from France and 6.7% from the U.K.

Sony's Experience with Its RMT Site

Alone among the major MMORPGs, Sony Online Entertainment (SOE) maintains a sanctioned RMT site, called Station Exchange. There, players can buy and sell in-game items, currency, and characters.

Station Exchange launched in 2005 on two Everquest servers and in February SOE released a white paper detailing its experience with the first year of Station Exchange.

Although this white paper, “Station Exchange: Year One” by Noah Robischon, has been discussed elsewhere, I thought it was interesting enough to post a link to download the paper from Gamasutra.com. Anyone interested in the topic should also read Gamasutra.com’s interview with SOE’s CEO, John Smedley here.

You can also check out SOE’s press release on the paper here.

Among some of the more interesting findings in the paper:

• Total cash that passed through Station Exchange in its first year was $1.87 million, averaging nearly $2,600 per day.
• Sony generated $274,083 in revenue during the first year of Station Exchange. About 68% of that amount came the 10% commission on successful transactions, with nominal listing fees constituting the remainder.
• A single platinum piece in Everquest 2 was equal to $7.35 averaged over the year.
• The large majority of completed auctions were for in-game currency. Of the nearly 40,000 transactions, 68% were for currency, 18% were for items, and 14% were for characters (though characters had by far the highest prices).
• A high level Everquest 2 character sells for as much as $2,000.
• The top single seller on Station Exchange completed 351 auctions to earn $37,435.

Robischon also reaches some interesting conclusions about why players engage in RMT:

• “The majority of people paying real money for virtual items are not part of a criminal underground that is preying on the player base at large. They are not ‘farmers’ looking to make a quick buck.”
• “Station Exchange traders are not radically different from the rest of the EverQuest II player base.”
• “Station Exchange is not an extension of game play. It is a utility. It offers a fundamentally different approach to play: a means of skipping the boring parts.”