Fighting the L$ downward spiral – a solution

The L$ falls, and there is nothing we can do about it

Readers of these pages know that I have no formal training in economics, and a one-semester-course in macro-economics definitely does not qualify me to talk about the economy of Second Life. Thus, I’m no Castronova wannabe 🙂

But it’s hard to escape the reality of the times. When I joined Second Life, you could get US$5 for L$1000. Since a Premium account costed US$9.95 per month, you would actually receive in stipends the same amount that you spent in monthly fees, so this was a great encouragement to upgrade to a Premium account. I have used that argument in the past quite often for people who were reluctant to sign in.

The day I write these lines, the ratio has dropped to US$3 for L$1000, and naturally, the old argument is not valid any more. And every week, it seems, Linden Lab announces further measures to cut the amount of L$ in circulation (thus hopefully reducing inflation, and keeping a better US$-to-L$ ratio) ? first, by abolishing extra stipends from ratings, then abolishing dwell/traffic, then giving basic accounts no stipends at all, and so on. There has been some serious effort going on to staunch the flow of “minted money” into the resident’s pockets, and one can only assume that this will continue. In fact, for the past few days, the L$ has been remarkably stable ? until something else hits Second Life, and it’ll drop further, no doubt.

Why was the L$ so high in 2004, and why has it dropped over time? The answer is rather simple, and was hinted somewhere (I apologise in advance if I can’t remember the origin of that quote). Around 2004, the ratio of consumers-to-producers (ie. content creators, vs. people that only buy content but not produce it) was 1:1. This mostly meant that consumers did want a L$ as low as possible, while producers would like it high enough to earn the most revenue from their own products (creating amazing things take dozens, sometimes hundreds, of hours!). Since the number on each side was about the same, the Linden dollar held for a long while at a stable value.

What happened since then? The advent of hosts of new users has definitely brought large numbers of very talented individuals to SL, some of them actually quite excellent creative designers, coming from other virtual worlds, having a professional background in design, and so on. But many of the new users are pure consumers, unable to achieve the high degree of mastery and skill that makes a successful producer of creative content. Thus, while in a sense the quality of offered content has increased (to an almost unbelievable degree!), as the number of content creators has gone up by the tens of thousands, the simple truth is that the number of consumers has increased even more. There is now an estimate of just 25% producers to 75% of consumers.

This should not come to many as a surprise. As more and more people come to Second Life, the ratio of content producers to consumers is supposed to go down. Henrik Linden, the author of a blog on SL Creativity, refers that in Wikipedia, only 1% of the regular users have ever produced any content, and contrasts it to Second Life, where 75% of all users have created something in the past 30 days. What this means is that, while Second Life is unusually filled with content producers, compared to other communities (even such a rich one as Wikipedia!), the absolute number of people regularly producing high quality content must diminish over time, as more and more people join SL.

The direct impact of this very simple growth curve has benefitted producers in the short term: it means many more customers, and, to a degree, slightly lesser competition. At some point in time (50 million users? I don’t know…), we will reach a plateaux, where no new producers will enter the market ? and from there on, only consumers will flock to Second Life. More consumers, and the same amount of producers, should be good for the content creators… or not?

Well, in this virtual economy, both actively participate in the setting of the exchange value of the L$. So, as said, the producers will want more US$ per L$; the consumers, by contrast, will want as many L$ per US$ as possible. Since the ratio now favours the consumers, they will devaluate the L$ as much as possible (ie. only limited by the total amount of L$ for sale!), since that’s what they want; and producers will not be able to invert this trend, as they dwindle in number.

… but despite an undervalued L$, there is no inflation in SL

So, why don’t we have true inflation, and prices roughly stay about the same?

There are many reasons for it. One is that more competition is active. For instance, primmed hair, a novelty that earned the first creators offering this item for sale, could “get away” with low-grade products for L$500 a piece. Now you have the highest possible quality (as far as prim torture allows it!) of top-designer hair for as little as L$150. The difference is that now thousands are offering this item for sale, and thus the creators have to raise the quality of their products, while lowering the prices, to stay “afloat” in this difficult market. The consumer benefits ? it gets far better products for a much lower cost.

The producer also benefits from the incessant growth of the economy. As more consumers enter SL, although their prices remain the same (or have to go down due to competition pressures), their sales rise, thus compensating to an extent the low pricing. A “much wanted” high-quality item can thus be sold as a lower cost, since many more people will be willing to buy it, and this offsets any possible “losses” due to price lowering.

We have to add a further aspect to the equation: the cost of setting prices. Most (but not all) creative artists in Second Life set their prices on textures for their vendors, something that really takes a lot of time to do. And this day, a major designer has thousands of articles for sale (just compare things at IMVU, which has an equivalent population to Second Life, but only around 100,000 items for sale, when you have over 20 million items being offered in Second Life!). Adjusting prices for thousands of items is far too costly ? in labour costs, it simply doesn’t “pay off” to change the price of a L$200 hair piece to L$250, and then to do the same the next week to L$300. Rather, the content designer has to evaluate the trade-off in losing a bit of money from a few sales and the tiring work to reset all prices on all vendors. It’s simply not worth the time! It’s far better to invest the time in developing new products instead, which will earn more sales ? and more income! ? than resetting prices. And this is what all major content designers do!

These days, you get more new users in just three days than the whole population of SL in mid-2004!

This reasoning makes our economy look very strange indeed ? comparing the L$/US$ ratio, what this means is that we have constant deflation (ie. things getting cheaper and cheaper all the time), although, technically, there are too many L$ in circulation (which is one of the criteria of inflation). While content designers can balance this equation by constantly adding new items, other professionals in SL cannot do the same. An example are the real estate agents. New land bought from a sim is constantly devaluated; fresh, new sims cost about L$ 6/m2, but in some cases people are not willing to pay that, and we’ve seen new land being offered for L$ 5/m2 or even less. Real estate agents are start to dump land just to avoid paying tier fees at the end of the month; and rentals have to raise prices all the time, since the L$ drops and drops. The consumer, however, is happy ? every day, he can get more L$ per US$, and while they might pay the same for rent, they’ll get cheaper items all the time.

The solution!

Well, at some point, there will be a rupture in the economy, and I think that the time has come (although, as said, these past few days have shown the L$ to be rather stable!).

Enter Sol Columbia’s solution: a vendor that allows price-marking in US$ (but payments are done in L$).
Sol Columbia's VendeX

Her VendeX system is one of the first that I have seen. It works in a rather simple (and low-lag) way: it looks up the current exchange rate of the L$ vs. the US$, and updates prices accordingly. This means that the owner of the vendor ? that is, the creator selling content ? will set their prices in US$, but, when a customer comes in and wants to buy an item, the value in L$ on the “Fast Pay” button will automatically convert the US$ to L$, dynamically.

This means that the creator will now think about their content as costing “US dollars” ? say, a hair piece is set to cost half a dollar. They usually have a pretty good idea on how much their sales are on average, and now they can figure out how many dollars that is. This is naturally great for figuring out tier costs, or rental costs from landowners who use precisely the same system. In short, your hair might be for sale one day at L$140, the next at L$165, then for L$114, and the other day at L$137 ? but the content creator will always get the same: US$0.50.

For users this might be slightly confusing at first ? I can imagine them telling their friends that there was a bit of hair very cheap to be bought for L$112 on a certain shop (when the L$ was on the rise), but when the friends go there, the hair is priced at L$173 instead (when the L$ is falling). But it’s a question of time. They will very quickly say: “oh, the hair costs half a buck, I don’t know how much that is in L$ today”, since most people don’t bother to check the US$/L$ rate every day.

Starley Thereian, one of my long-time all-favourite clothes, hair, and shoe designers, has already started to test this model on a large scale.

Starley Thereian's offerings at Celestial Studios
Hard to find something I like… so many choices!

The choices are already quite impressive, and she promises her faithful buyers that she’ll expand them to cover all areas. From what I’ve gathered, she’s not the only one ? only one of many who has already a lot to offer using this new business model. Since her shop Celestial Studios is set in the Celestial City sim, where other great designers already have their shops as well, it’s not hard to imagine that the other content designers there will quickly follow her steps. And this will very likely become the de facto standard for the major content designers ? the ones that truly live from their income as creative designers, and the ones that are more affected by the constant L$ devaluation.

One might not forget that some very talented designers have been frustrated and already abandoned their creative impulses just because it was impossible to establish a fixed income from their sales. Consumers apparently dislike the idea that producers fix new prices to reflect the devaluation of the L$; on the other hand, Sol’s new model does that automatically, by fixing prices in US$ instead. The consumer will not feel cheated; they’re just using a strong currency that does not fluctuate (much) instead of a weak one that is constantly devaluating. You can go even further. A new user, these days, does not have any idea on how much they’ll need to spend to get a “nice” avatar ? with a skin, a good outfit, primmed clothes and hair, and the usual assortment of attachments. But using Sol’s device and shopping at Starley’s, well, they can know exactly how much they’ll spend ? say, US$10 for everything. This is something that can be advertised: “Your fabulous avatar for just US$10 ? a bargain!” And this advertisement will be true even in 2050, when you can buy L$ 10,000 (or ten million!) for one dollar.

People will start (again) to think in content being worth real money, since prices will be shown in a real, stable, strong currency.

US$ as the strong currency in SL?

Now imagine that Sol’s vendor system (and possible future, competing ones) start slowly to become the norm. All content creators will finally break free from the tyranny of the consumers always wanting a devaluated L$, and, as a result, everybody will now do all their transactions in US$. The L$ will be just a “micropayment” solution, not a virtual currency. This is not unlike what happens on developing countries with a weak currency ? they do all their payments in Euros or US dollars, although they’re vaguely aware that they have a national currency as well, but nobody uses it except for small change. Or like the “credits” system used on many dating sites, they’re not “real money”, just a way for people to track transactions, but all of those ultimately are made in dollars.

I’m not exactly sure what this means in terms of Second Life. On one hand, I’m glad that people start to appreciate that you can’t have an ever-devaluating virtual currency that only benefits consumers but ruins producers. If the producers do not get a fair compensation for their talented work, they’ll pack and go ? I have met some people that get mad at them and yell: “L$ 4,000 for a pair of skins! That’s highway robbery!” They forget that some skins have taken two-people teams over six months to create! And they sell it for just US$10?! That’s not a bargain, that’s, as Terry Pratchett’s character would say, “cuttin’-me-own-throat”. 🙂 It was not even long ago that for a slight surcharge, you could even get a personalised skin, which, in turn, would set you back an extra US$5 or so. Who is the graphcial designer these days that charges in real life US$5 for several hours of work? Nobody!

(Yes, I used to ask for unique items of clothing long time ago; it was a fashion for a while; these days, almost only Torley asks for that. I did that mostly because it was tremendously cheap. Now content creators can’t bother to spend hours doing unique items, concentrating their efforts in much more profitable mass-marketed products with a higher degree of customisation)

A very close friend of mine does logo design in SL for 6 or 7 US$, with full copyright permissions, and several open formats, so that the customer is able to tweak it to one’s taste. In real life, she would charge at least US$250 for that, depending on the use of the logo.

We cannot forget that talented creators in Second Life are terribly underpaid, too hard-working, and subject to many pressures: competition, innovation, style, fashion. When a new trend settles in (for instance, the tines, during the summer of 2005), they have to be very quick on the market to change all their products ? or disappear in the attempt. To keep up the constant production of high quality products takes much more than time, skill, technique, and patience ? it’s an act of love ? but it also means that these professionals are not doing anything else which might provide them a better income in RL. Even the many that view SL as “just entertainment” will have to think twice ? how much time are they spending in creating new things, how much can they afford to have their shops open, how much tier are they willing to pay for all those shops, and is it worth all the trouble?

My guess is that if you can factor out the devaluation of the L$, the creative artists will have one less thing to worry about. And this is a good thing.

The future ? SL’s US$ economy

Let’s now extrapolate a bit, and fast-forward a few years into the future (probably not many) where basically all products and services are offered in US$ (or Euros, for that matter). People will change their mindsets and know exactly how much they’ll spend today and earn tomorrow; the L$ value will be irrelevant. You could be exchanging half a billion L$, but in your mind you’ll be giving away just one or two US$. So all the usual talk about the economy in Second Life will be just around US$, not a “weak currency” that nobody really cares about.

We will lose one important thing in SL ? a virtual country should have a virtual economy! ? but we will gain something else instead: people will now trust the transactions, correctly estimate the value of those, and be prepared to offer reasonable prices (a recent example: a reasonably recent user was willing to offer US$2 for two weeks of complex scripting, perhaps totalling 40 or so hours of work. In RL, a professional programmer would perhaps charge US$2000…). This will make Second Life more credible. Readers of Prokofy’s blog will have read often how he complains that he has to work for US$1.48 an hour in Second Life, doing the same things that would more likely earn a hundred times more in RL.

This will probably not change much ? I hardly expect people to be willing to pay US$100 for a new outfit in Second Life any time real soon now ? but at least something will change: we will be paying with real money to content producers, not with “funny money” that you don’t know how much it’s worth anyway. Definitely an important change!

There might be even an interesting side-effect. As more and more people adopt solutions similar to Sol’s, and more and more content producers like Starley add “US$ vendors”, people will be less inclined to devaluate the L$ more, since at some point, this will become utterly irrelevant. I can understand the thrill to be a “billionaire in Second Life”, but what’s the point if those billion L$ will hardly get something else than a new pair of blinged shoes? The incentive that many have to force the L$ down artificially, to be able to pay much less for content, will simply disappear, as the content producers will work with fixed prices in US$. After all, this is what also happens over the world in developing countries, where the governments don’t understand how to regulate their economy properly, and the businesspersons have to “get out of the loop”, so to speak, and offer products and services using a strong currency. Which is naturally accepted by everybody wanting to do a living in a real country.

I’ll skip the discussion if SL is or not a “real country”, but one thing is certain: there are real people, really talented individuals, that are setting up their businesses in Second Life. And these individuals have a choice: they can either stay inside this virtual economy and get money out of it, or they can move elsewhere, where there is no fear that their skilled talent is undervalued. If they are in SL, they expect that they can get at least some compensation for their efforts, and a real compensation. Designing a full outfit with photoreallistic texturing in SL is as time-consuming as doing it for a 3D modelling tool (say, Poser, or Maya, or Lightwave, or 3DS). There is a market for those ? communities like Renderosity or DAZ constantly sell clothes and props for 3D avatars, for a few bucks. And that market has its own share of consumers, consumers who are used to pay those few dollars for high-quality content. Moving many of those talented individuals into Second Life requires that SL, as a platform/game/environment/community rewards them more than using a simple website, and this is true from a concept perspective: only Poser pros are interested in paying, say, two dollars for a ready-made hair for Poser. On the other hand, Second Life offers 260,000 consumers that don’t even know how to spell “Poser”, but are very eager to pay those very same 2 dollars for hair. It’s a huge market, since the total number of Poser users who regularly buy and sell 3D content are perhaps a few thousands (and still enough to sustain a virtual content economy on those communities!), while things like Second Life provide an incredibly much large consumer base, growing at a fast pace (and yes, even alts need new hair and shoes!). Better than that: hair, in the Renderosity/DAZ model, is a professional item sold to professionals. In Second Life, it’s a mass-marketable product for the the regular user, you don’t need to have a college degree in 3D modelling to be able to attach hair to your avatar.

Unnecessary to say, Second Life has an enormous potential in creating a market that simply didn’t exist before. Actually, I’m rather surprised that this market isn’t being explored much more. At a time, doing volunteer duty on Help Island, I saw batches of new talented artists, that asked not the usual question ? “how do I make money here?” ? but instead told things like: “I want to sell content here, what should I do?” There was an incredible amount of them coming to Second Life. And these are not the type of people who get goggle-eyed at reading BusinessWeek, Wired, or Slashdot; but the ones that live from their talent in creating 3D models, and that now had a way to reach a much wider audience for their products and services.

Ultimately, my hopes are that in the near future, people will not find it worthwhile to further “game” the value of the L$ (in the sense that more L$ meant more things to be bought for US$). The L$ would then fluctuate according to a real supply-and-demand equation, not as a cool “hack” to provide people with more money to spend. Still, our RL experience shows that once a country’s currency is abandoned because people cannot trust their government’s efforts to make it stable, it’s very hard ? or even impossible ? to go back. At this point, we probably need to really recruit Castronova and ask him what he would advise in this case 🙂

You can’t “force” people to stop “gaming the L$” ? people will “game” things if they see an advantage in doing so. This is rather an explanation of what happens when you game things too much, and people need to overcome the limitations of “gaming”, thus making “gaming the L$” basically worthless. Remove the incentive for “gaming”, and it won’t be games. So the answer seems to be simple: if the L$ does not provide an useful virtual currency for trade, producers of content and services will simply fall back to the Mighty Dollar.

Hopefully some will understand the implications of this. Then again, human nature being what it is, a few will try to reap the benefits right now before it’s too late ? ie. before all producers in SL move quickly towards an US$-only-based economy.

Many thanks to both Sol Columbia and Starley Thereian for their permission in using snapshots from their in-world shops. And, as a side-note, thanks to both of you (as well as others) for leading the way in this upcoming paradigm change of our economy.

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