Second Life Bank Collapse: Threat or Validation?

Jack Myers Virtual World Report

It's been a long hot summer for the financial markets — real AND virtual. While the sub-prime market totters and investors demand that Fed Chairman Ben Bernanke intervene, virtual world Second Life has endured its first bank bust.

During this past weekend's Second Life Community Convention (SLCC) founder Philip Rosedale ventured that the virtual world "will be bigger than the Web." If that is so, the tale of Ginko Financial offers object lessons that all participants — residents, advertisers, investors — should heed.

San Francisco-based Linden Labs launched Second Life back in 2003. But while its 2-D environment was a pastoral departure from rivals like World of Warcraft, it was the ability for members to own their intellectual property that was truly radical. Second Life was and is "living" proof that user-generated content is viable.

Apart from building out the technical infrastructure of the virtual world, and a mandated Terms of Service, Rosedale likens himself to economist Adam Smith's "invisible hand." The SL economy, which has been estimated to generate approximately $1.5M US per day, is roiling with innovation. But it was the intrusion of the natural world (not the media backlash over SL) — the FBI investigating SL since Congress passed last fall's Internet gambling ban — that led to July's gambling ban within the metaverse. What happened next affected at least 18,000 members of Second Life.

Ginko Financial is one of close to thirty lending institutions within Second Life. During its first year of operation it offered the unheard of rate of .19 percent daily, or 100 percent rate of interest; the following year this declined to .10 percent daily or 44 percent yield per annum. Even in a land where the laws of physics need not apply, for some this rang alarm bells. Naysayers like "Anshe Chung," SL's first millionaire, decried the bank a Ponzi scheme, even as bank CEO "Nicholas Portercarrero" assured that investments (afterall, SL was growing exponentially) would allow returns that the boldest hedge fund managers would envy.

In early August, perhaps ignited by casinos pulling out their money after the SL ban went into effect, small investors found that they were unable to withdraw Lindens ($270 L = $1 US). Just as Ginko had placed a daily withdrawal cap of $5K L (approx. $19 US) Portercarrero was cornered by Benjamin Duranske, an intellectual property lawyer who edits the blog, Virtually Blind. In his interview with Duranske, Portercarrero admitted that he could not cover withdrawals. During the press conference that followed, Portercarrero laid out an audacious bailout scheme. But Second Life residents balked.

In an exclusive interview with Jack Myers Media Business Report Duranske expressed his belief that the denouement of Ginko Financial was a triumph of resident community action: [ ]... "A lot of people kept the pressure on them for eight or nine days and made it impossible for them to lie any more. They tried moving the shells around (making a deal to 'buy' a stock exchange in Second Life, putting an IPO in their bankrupt company on another stock exchange to try to raise funds, borrowing money from big financial players in Second Life) but people called them on it at every turn, publicly. I think this happened this time because there is now a critical mass of people in virtual worlds who are realistic about the application of real world laws and financial principles to these spaces. Remember, it was like this on the Web at one point too.People started the dumbest businesses, some of which were outright scams but they got a break for a while because 'maybe the Internet is different!' The same effect is occurring now in virtual worlds."

Last anyone heard, Portercarrero (possibly one Andre Sanchez from Sao Paolo) had converted individual Ginko financial holdings to "Ginko Perpetual Bonds," currently yielding pennies on the dollar. For their part, Ginko depositors have formed Financial Heartache United; a class action lawsuit is under consideration.

Once upon a time, Linden Labs' Rosedale was flying high on Ginko, comparing it to the Nobel Peace Prize-winning Grameen Bank of India. Rosedale remains hands-off, but now he's more circumspect, offering that if a bank's interest rate seems too good to be true, it probably is. Necessity being the mother of invention, SL residents are in the midst of creating the Second Life Exchange Commission, an SEC-like body.

The Ginko Financial scandal reasserts that Second Life investors and brands cannot expect to take short-term profits; their presence demands a long-term commitment. Despite avatars that may bear no resemblance to one's real world personage, going forward there must be tools to gauge and reward in-world integrity, just as there are reputation systems on eBay and Amazon.

But while this episode is a successful exercise of Democracy in Action, it doesn't offset long-term issues with the Second Life economy. According to Matthew Beller, an SEC economist who studies the virtual world, Second Life's economic boom is "unsustainable." He points out that Linden Labs has manipulated its currency, increasing monetary supply six percent per month, doubling each year. Beller insists that it's not enough to peg the Linden to the US dollar, but that it has to be backed with an actual money supply. But as Beller warns about a recession within Second Life, a bit of perspective: Former Treasury Secretary Larry Summers is also cautioning about a recession... in the U.S. economy.