No More Banking!

Saxo Bank opening

If you haven’t heard the big announcement by Linden Lab that they’re finally closing down “illegitimate virtual bankers” in Second Life, you’ve been missing all the fun 🙂

The announcement on their Official Blog states:

As of January 22, 2008, it will be prohibited to offer interest or any direct return on an investment (whether in L$ or other currency) from any object, such as an ATM, located in Second Life, without proof of an applicable government registration statement or financial institution charter.

As you might expect, getting such a charter is pretty much impossible in almost all countries in the world, so this effectively means: no more virtual banks in the “Wild West” of Second Life. More information is available here (you need a valid Second Life account to log in).

Responses to Linden Lab’s decision have been interesting. Prokofy Neva, for instance, turned libertarian for a while:

And so ends the geek dream of a vast international space where money would never become an option…which made it possible for money everywhere to become an option growing out of every prim with a dollar sign hover-text. Money *is* needed to finance this Wild West world. Where will it come from now?

My old friend Eloise Pasteur, turned economics journalist for Massively, just states:

It will be interesting to see if any of the banks survive this transition, and if they don’t, what comes along in their place. It will also be interesting to see if there is a run on the banks now.

You can bet on that — Eloise’s colleague at Massively, Tateru Nino, usually reporting on community issues, statistics, and events that impact the virtual world, covered the protests at JT Financial, one of the leading virtual banking institutions that will now go out of business:

Of course there are panic withdrawals right now, because, at the end of the day the depositors simply don’t trust the banks to be able to repay the deposits, so everyone wants to get their account completely withdrawn as soon as possible, while the money holds out.

Most “banks” have already closed down their ATM networks, of course — at least the most fraudulent ones. They’ve learned the hard lesson from Ginko — it doesn’t pay off to be honest and stay around to try to fix things. Better to cash out and head for the next Caribbean island 🙂 Others, like the World Stock Exchange, have at least tried to keep their customers informed and provided them options to deal with the “banking ban” in the case it affects them.

The legal groups in Second Life, of course, see this as being only natural. Benjamin Duranske writes on his blog Virtually Blind:

My only complaint with this policy is that it has been too long in coming; it is clear and concise, and it undeniably makes the grid a better place. In the long run, policies like this, which acknowledge the obligations facing a company that offers users the chance to “make real money in a virtual world, that’s right, real money” (emphasis in original), will keep Second Life, and the grid in general, healthy and relatively free of regulation.

The irreverent lawyer Jessika Holyoke, writing on the Herald, suggests that different things are at stake here:

Additionally, Supply Linden generates revenue.  Each purchase of Linden dollars is straight revenue. […] No capital investing in world, because they may be crooks, means that to raise massive amounts of Lindens you have to buy it through the LindeX.

An interesting theory. Would that mean that Linden Lab is actually just covering their own revenue streams by “monopolising” all currency-related issues? Does this mean that Raph Koster’s Metaplace, which will be open source and free, but will require people to buy microcurrency from his company, is actually getting it right?

So, what’s a bank? Strangely enough, some people have found out that Linden Lab defines it as “a network of ATMs”, and what they’re going to do is just to remove the ATMs. That’s the strangest definition of banking ever!

So it means that if you accept payments directly to your avatar, place it on a website, calculate some interest on it, and then pay it back to people, you’re not a “bank”. You’re probably a “financial consultant”. And that is allowed? Weird.

Assuming that clearly this wasn’t the intention of Linden Lab (ie. just a badly written FAQ), and that they are really forbidding virtual banking using their virtual currency, the real question, of course, is “why”, or “why now”.

Interestingly, like so many things in Second Life, there are several “levels” of answers.

Let’s start with the first level. To do banking — ie. accepting payments, manage accounts, pay interest on them by investing people’s money wisely and paying it back, etc. — in real life you need to be chartered to do so. Every country in the world has a regulatory body that validates that a bank has a solid reputation and has its accounting in good standing. The size of the bank hardly matters — they can be a tiny savings account bank accepting customers with just $5 in their pockets, or huge investment banks dealing with trillions of Euros. The important thing is: there is no unregulated banking in real life. Not any more.

What you have, of course, is “underground” banking — ie. sneaky individuals who “offer high interest rates”, popping up a web site or even dealing face-to-face, and disappearing with all your money the next day. RL governments combat them actively. In fact, the more these criminal are captured and put into jail, the more actively a government is placing safeguards on the good standing of their own currency — making it more valuable. (Please refrain from commenting about the “intrinsic value of money” — read a bit about it, the “gold standard” was abandoned in the 1970s by all countries in the world, and currency is just backed up by a country’s government good reputation and international standing. Money is the most widespread “virtual” thing ever invented by us humans and relies only on reputation backing it up.)

So this is rather straightforward: the crooks and petty criminals taking all your money on a website and disappearing with it the next day were putting the whole economy of SL in question. They were actively hurting the economy, by having more and more people completely distrusting LL’s handling of criminal activity (fraud) in SL. So it’s only natural that they would take steps to reduce fraud. Last week we had the warning about the fraudulent L$ exchanges, this week it was about ‘virtual banks’. Good, solid steps to maintain a high reputation on a trustworthy L$. Who can blame LL for doing that? We need a solid L$ to continue to promote the economy using a stable microcurrency.

The next level, of course, is more serious, and passes straight over into real life. People getting defrauded by several venues in SL complain to LL. Abuse reports, of course, do not handle resident-to-resident transactions, and LL ignores them. But then come letters to LL. In some cases, if a really large amount of money is at stake, those complaints might have been written by lawyers. And if LL points out that they don’t regulate transactions as clearly stated by their ToS, what is left for people to do?

Simple: complain with your banking regulatory authorities. Or even file a lawsuit. If you don’t know whom to sue, sue LL to get them to reveal the fraudulent bank’s owner name. This might actually have happened, and in some cases, some of those authorities might have knocked at LL’s door. The possibility is not that far-fetched; we know how LL reacted to in-world gambling. Fraudulent banking would certainly raise a few eyebrows with the authorities, specially because the Ginko case (which very likely was not a fraud, but was seen as one — and perception is often more important than truth) got such notoriety on the RL media.

So this would be pretty consistent with LL’s policies: as soon as they get “a nice talk” with the authorities, they make unpopular decisions (to the residents) to comply with some country’s laws. We’ve seen it happening before, so it’s pretty safe to assume it might be again the case.

But there is a third, “hidden” level. What if Jessica is actually right? Linden Lab has for over a year “dismissed” the income from the LindeX. They’ve always claimed, very strongly, that they just get a very marginal profit from it — it covers the costs of running it as well as the salaries of the Linden employees who manage it. And we were content to take that at face value.

But combine the latest two news — their “warning against other Linden dollar exchanges” and the “shutting down of banks” — and it brings out a strange picture: is Linden Lab “afraid” that the “competition” (other exchanges, banks that hoard L$ and lend money, thus limiting the “need” for users to exchange US$ for L$ at the LindeX) is actually hurting their business?

The question might have profound implications. As Jessica points out, it seems that Supply Linden, the “bot” that makes sure that the LindeX has an adequate L$ supply (not too much to create inflation; not too little to create deflation) might actually be selling L$ — for a profit to Linden Lab, which, after all, is our virtual world “mint”.

In any case, problems aside, an optimist like myself looks upon the new policies, and just sees opportunities. I’m pretty sure that very soon we’ll see real financial institutions entering SL. No, the current, existing ones will not have a chance to get chartered; and you don’t need to imagine that JP Morgan Chase or Citibank are going to enter SL for a handful of L$. But there are lots and lots of small financial institutions, and private financial consultants (who are duly chartered) that might find an economy that turns around over a million US dollars per day interesting enough to “open shop” in SL.

And perhaps this is also part of Linden Lab’s intentions, too!

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About Gwyneth Llewelyn

I’m just a virtual girl in a virtual world…

  • i do not have the smallest idea on the number of virtual banks operating under Second Life, neither the amount of money their account have right now.

    Don’t even know what percentage of that banks, is in fact fair business…

    Well… Let’s suppose 10% of this banks are not Ponzi schemes, and tehy were legal for all this years.

    After all, 15 days to give money back and close the doors is something stupid, unfair, and is itself a fraud.

    There is no way, for someone normal to agree Linden Lab in this second “Ban Project”.

    Other important point, in all this, is the fact that Linden Lab, itself, is the central Bank that makes the L$ CCurrency…

  • Hello Gwyneth,

    ta for your insights on possible rationales for LL’s move against in-world « banking ». Interesting as the three levels of explanation are, I’d venture to say you can probably safely dismiss the notion of LL banning banking to assert the LindeX’ supremacy, or install a monopoly, simply because the ban does not encompass financial bodies duly regulated in their RL country of origin.

    Now I’m not aware of any RL banks actively doing business in-world (though I think a few have representations there), but the playing field is still open for them, and compared to the Lindens running the LindeX, these are the real thing. Had LL wished to monopolize the financial sector Metaplace style, would they not have banned all banking activities outright ?

    [Completely off-topic footnote : you might want to know your OpenID login module is not letting me validate my post through my OpenID URL. :(]

  • @Rui, according to Linden Lab’s blog post, “not a single one of these entities had a valid charter”. This means: 100% of them are illegal.

    While it’s worth discussing if “15 days” are enough or not — and I agree that a longer period would be much finer! — there are complex legal issues around. When someone does something illegal, in most cases, you don’t even get a warning — you just get fined/arrested. Being given notice and a fair warning is actually very nice.

    The issue worth discussing — and I’m with you on that — is if LL’s own operation is “legal” by itself or not. On their ToS, they claim “the Linden dollar is not worth anything, it’s just play money, and by signing the ToS we accept that it’s not worth anything”. That’s ok. But the very same company that signs this agreement with every user of their service also provides a “currency exchange” where people are allowed to exchange L$ for US$ — and they charge a commission on it!! So, what gives? Is the L$ “worthless”? Then why is LL charging comissions on people willing to buy L$? 🙂

    This is definitely walking on very thin ice. Either the L$ is worthless — and Linden Lab should not be running a currency exchange — or it’s worth something (like casino chips, that are just pieces of plastic, but certainly worth money!!), and LL might need to be chartered itself to operate a microcurrency. I have no idea, from a legal point of view, how this works.

    @Rheta: Yes, you’re right, legal banking was not “outlawed” (in fact, I believe that LL could not ban legal banking in “their” virtual world even if they wished; a bank chartered to do banking cannot be prevented to do so, if they want!) However, as you pointed out, there are no legally chartered entities offering banking services in SL… for now. And LL possibly hopes that none will enter. Or, perhaps, it’s exactly the reverse: they might be aware of a dozen legally chartered banks wishing to enter SL, and these might have complained that the whole market was crammed full of scammers operating without a license… and kindly demanded that LL shut them down before they started their operations. It could be possible, since I’m definitively aware of a few financial institutions that are studying the idea 🙂

  • Oh, as for the OpenID plugin not working, I do apologise 🙁 I don’t know why it isn’t working for some people…

  • I am not an expert in financial services law, but I have not seen anywhere a clear analysis that shows that Linden Lab has a responsibility to police in-world financial services. The position is quite different from gambling: the laws in the US are oppressively draconian on the point, and extremely aggressive in requiring all kinds of service providers to expend their own resources to police their users. Indeed, when the gambling ban was announced, Linden Lab made it quite clear that the reason for the ban was to comply with US law and none other. Here, the position is different. The reasons given in the announcement focus on a desire that residents not be defrauded. This is what is written:

    But these “banks” have brought unique and substantial risks to Second Life, and we feel it’s our duty to step in. Offering unsustainably high interest rates, they are in most cases doomed to collapse – leaving upset “depositors” with nothing to show for their investments. As these activities grow, they become more likely to lead to destabilization of the virtual economy. At least as important, the legal and regulatory framework of these non-chartered, unregistered banks is unclear, i.e., what their duties are when they offer “interest” or “investments.”

    There is no workable alternative. The so-called banks are not operated, overseen or insured by Linden Lab, nor can we predict which will fail or when. And Linden Lab isn’t, and can’t start acting as, a banking regulator.“.

    Reference is made to the law, but no suggestion is made that Linden Lab itself is under any duty to prohibit banking operations in the way that it is with gambling: the references to the law are references to the fact that the customers of these banks may have very little legal protection. It would be very surprising if Linden Lab truthfully cited legal requirement as the reason for the gambling ban, but, although it is in fact compelled by law to prohibit unlicenced banking, it pretended that the reason that it was so prohibiting was to protect its residents from fraud. It would also be odd if Linden Lab, believing itself to be legally obliged to prohibit all banking operations, nonetheless gave the banks a grace period before it closed them down: it did not do that with gambling, either. As Gwyneth pointed out in her article, if the law requires one to do something, it requires one to do something right now, not in a fortnight.

    So, whatever the real position in respect of financial services law, the likelihood is that concerns for its own legal liability are not high on the list of reasons for prohibiting in-world banking.

    Elouise’s reason also does not make a great deal of sense to me: the suggestion is, if I understand it, that, because banks in SecondLife might offer credit to people starting their own businesses, etc., then people would borrow money rather than purchase it through the LindeX, thereby reducing Linden Lab’s profit on LindeX sales. However, Linden Lab has not prohibited moneylenders (which are also regulated, at least in the UK, albeit not quite as strictly as banks, or “deposit-taking” businesses, as the legislation refers to them), but in-world deposit-taking. In real life banks, of course, the loans are paid out of investors’ money; in SecondLife, it is undoubtedly cheaper, by a considerable margin, to buy money on the LindeX (or other exchange) than it is to set up and run a bank, including website, etc., as well as pay the interest at a competitive rate on everybody’s deposits. If, therefore, one’s business model is to make money by offering loans, one’s business will be far more profitable if one is a straight money-lender without all the panoply and expense required for taking in-world deposits, operating ATMs, paying interest, attracting investors, etc.. Indeed, similarly for anybody seeking credit, it is cheaper to convert first-life currency into L$ on the LindeX than it is to pay interest, perhaps for a lengthy period, on a loan.

    No doubt, that is why SecondLife banks focus far more heavily on savings and investments than they do on loans: there is far more of a market of people with Linden dollars to spare wanting to make money for nothing by investing it than there are people so poor that they can’t afford a few thousand Linden dollars, but who know that, if they invest those few thousand Linden dollars into an in-world business, they will be able to make enough money in that in-world business to repay the loan and interest within a reasonable period of time and have a profit left over.

    Indeed, the very fact that SecondLife banks are almost all investment and almost no loan itself is a cause for some suspicion: what are the bankers doing with the money, if not lending it, such that it can earn interest of 130% per annum (as is offered by BCX Bank, for instance)?

    Moreover, investment by itself does nothing to lessen the demand for the LindeX: that there is money sitting in in-world bank accounts that people have paid a commission to purchase that the bankers might well be paying a further commission to sell, if anything, increases L$ churn, and therefore the LindeX’s profits. If Linden Lab wants to eliminate the competition, therefore, the thing to prohibit would be the loaning money, not taking deposits, not to mention the existence of rival exchanges, which also operate from ATM points in-world and, because they simply exchange currencies and do not offer a return on investment, will continue to be able to provide those services.

    The rather mundane and un-news/rantworthy most probable explanation for the prohibition is simply that the presence of a large number of institutions many of which, as far as Linden Lab can tell, exist only to perpetrate frauds causes serious disruption and upset to residents of SecondLife, and the failure of one of these institutions potentially harms the whole SecondLife economy to such an extent that further such incidents might adversely affect the popularity/economic stability of SecondLife as a whole.

    Those who heard Robin Linden speak at the recent Metanomics event will recall that she said that Linden Lab’s policy has always been not to act in resident to resident disputes generally, but always to act where it believes that residents are perpetrating frauds on other residents, because of the harm that those frauds can cause to the popularity of the platform and the SecondLife economy. As Linden Lab sees it, the only way that it can effectively prevent all the fraudulent banks is by prohibiting all banking, since it has not the resources to tell the fraudulent from the genuine, and it probably does not believe that there is any demand for real internal banking services that operate in the way that first-life financial institutions do in any event.

    As I have written elsewhere, this approach is an horrendously blunt instrument, and it is a very great pity that there does not yet exist some internal regulatory framework, independent of SecondLife, that is able to tell which, if any, banks in SecondLife are fraudulent and which genuine: see the comment linked above for full details. Nevertheless, unfortunate (and possibly short-sighted) though it is, Linden Lab is highly probably telling the truth when it claims that the real reason for the policy is to protect residents from fraud.

  • Excellent comment, Ashcroft. Yes, between those three scenarios (protecting residents from fraud, legal compliance with some laws, or increasing LL’s profit), the “protecting residents from fraud” seems to be the more plausible of all.

    As for:

    Indeed, the very fact that SecondLife banks are almost all investment and almost no loan itself is a cause for some suspicion: what are the bankers doing with the money, if not lending it, such that it can earn interest of 130% per annum (as is offered by BCX Bank, for instance)?

    the answer is simple…

    They’re buying Google shares 🙂

  • @Ashcroft : now that is what I call en enlightening argument. You provide a far better reasoning that I could for my gut feeling, viz. that Linden Lab has actually acted as a regulatory body, without being forced to do so by legal constraints, and without base economic interest of its own. Which in itself is pretty novel, like it or not.

    @Gwyneth : as a footnote to our own exchange and to Ashcroft’s arguments, and without being a legal expert, I would still presume that LL could very well ban all banking activity from SL, seeing that the ToS clearly stipulates the L$ is « play money » solely owned and controlled by LL. You can’t stop a regulated banking institution doing business in its RL country, as long as it complies to regulations (you are obviously right on that), but stopping it from doing banking in something that is the sole property of a single company, with money that is a virtual pseudo-money also owned solely by this company, hardly looks like a contendable proposition to me.

  • And as another off topic footnote : your gravatar plugin does not seem to work either, or, at least, it refuses to retrieve mine :(.

  • IMO, LL itself already acts as a bank (Raph Koster says something similar on his blog). No point speculating whether that was a factor for the ban, but the result is that LL now has a de facto monopoly on handling the funds that lie idle in our accounts. Those funds represent RL money, BTW, just the way it has been for the in-world banks that are now banned.

    I am all for having only RL regulated institutions acting as in-world banks so I am not bashing the ban. But LL also has to open the door to those institutions and give us some better options than the services that we are getting from the “LL bank”. Of course, that is based on the assumption that the SL economy is to be taken seriously, and sometimes LL indicates that they don’t think of it that way.

  • BTW, I also seem to have some problems with the OpenID plugin. I could not redirect it to my blog although I’m pretty sure it is set up as a delegate.

  • Note to Rheta: I believe that your gravatar had not been correctly loaded; the plug-in I use has a rather long timeout on the cache. It seems to be working now 🙂

    As for the OpenID plug-in, it is a known limitation of the plug-in I’ve got that it doesn’t deal with delegates properly. I have the same issue myself. Development has stopped in late 2006 or so, so I might try a different one instead. Sadly, my blog has gone through a lot of changes over the years, and keeping it up-to-date with the latest plug-ins is becoming more and more difficult, mostly because the theme I use is way out of date, requiring a lot of manual patching to add any further plug-ins…

  • Pix Paz

    This was pretty much inevitable, right?

    Remember that little voice in the back of your head the first time you saw a Ginko Financial ATM or the WSE Boards?

    Little Voice: “This is all going to end in tears…”