Recent fraud allegations are ominous for those who see virtual worlds as future centers of e-commerce.

Stephanie Roberts is a 33-year-old parks service employee in a Chicago suburb where she lives with her brother and mother; in the winter, she drives the Zamboni at a public skating rink. But she’s also Zania Turner, of glowing skin and impossibly luxuriant black hair, who sashays in silk dresses through the booming virtual world of Second Life, which is run by the San Francisco company Linden Lab. In her life as a 3-D cartoon, Roberts gathers with other avatars to role-play reënactments of obscure Star Trek cartoon episodes, build and buy digital homes and furniture, and hang out on digital beaches.But Second Life is more than a game or a social-networking site; it’s also a venue for financial transactions. The currency used within the virtual world, called Linden dollars, can be converted to U.S. dollars at a rate of roughly 270 to 1. More than $13 million worth of Lindens are in circulation, and 318,742 residents of Second Life–including Roberts–participate in its internal economy. “It’s a fascinating and exciting place, because people are doing business in the absence of a lot of legal and regulatory structures,” says Robert Bloomfield, a Cornell University accounting professor who studies virtual economies–and coined the term “metanomics” to describe the field. But life on the lawless frontier means risks as well as opportunities, as Stephanie Roberts found out last summer. And what happened to her is a bit ominous for those who expect to see 3-D immersive environments become centers for e-commerce.

Trouble started at the Ice Dragon’s Playpen, a recreational island in Second Life. With her movie-star looks–Roberts chose an avatar modeled after Catherine Zeta-Jones–Zania Turner had no trouble landing a job hosting a game of Slingo, which is something like bingo. She made 100 Lindens (37 cents) an hour, plus tips. And while steering Zania through various Second Life venues –such as the Moonshine Casino, where residents gambled, and FurNation, where they frolicked in the guise of animals (she was a white tiger at one stage)–Roberts saw places to deposit her money. “There were these machines. They said ‘Bank,’ ” she says. The machines handed out notes to passing avatars, promoting account signups at something called Ginko Financial, which advertised high interest rates. “With Second Life, you need money to get land and stuff that other people build,” she says. “So I thought, ‘I might as well put something in there, especially with the good interest rate, and pull it out when I need to, and help get me some stuff in-world.’ ” A few mouse clicks later, she was an account holder. She enjoyed watching her money grow. Eventually she had amassed 39,000 Lindens, worth $144.

Ginko–operated by an avatar called Nicholas Portocarrero, whose real identity is not clear–persuaded hundreds of people to deposit their Linden dollars. The reasons for what happened next are murky, but the results were clear enough: the “bank” vanished, and depositors say their money did, too. In July 2007, residents began clustering around machines to try to recover their money after Ginko began restricting withdrawal amounts. Then Ginko announced that deposits were now in “Ginko perpetual bonds” rather than Linden dollars. Those bonds soon plunged in value, and in October, they ceased to exist. The reported losses may have totaled $700,000, according to Ben Duranske, a lawyer based in Idaho who writes a blog on virtual legal issues.

Some Second Lifers have reported losing thousands of dollars in Ginko. Roberts is among the luckier ones: she says she lost only her $144 in savings. But the point isn’t just that somebody other than Roberts ended up with her money. What may be most significant is that nothing happened to whoever may have taken it. Her money disappeared into the 3-D ether.

That is not what we have come to expect from e-commerce. A combination of technical controls, laws, and regulation makes today’s online business fairly safe (or at least as safe as business in the rest of the world), with wrongdoers subject to punishment. “A lot of the legislation over the last 10 years relating to online commercial [transactions] has all been about governments trying to create a level playing field where trust between buyers and sellers is created,” says David Naylor, a partner in the U.K. law firm of Field Fisher Waterhouse, which in April became the first major law firm to establish a presence inside Second Life. As a result, people are now willing to make bank deposits online and enter their credit card numbers to make purchases. “An environment where it is easy and simple to defraud others, with them not having much of a comeback, if any, is not one which is going to lend itself well to significant business development,” he says. “It’s not the only factor, but it is a significant factor in the commercial attractiveness and viability of these environments. If you destroy the trust between a buyer and a seller–which is a fairly tenuous thing to establish in the online environment in the first place, where people lack face-to-face communication–you can quickly and massively impact people’s willingness to transact with each other.”

Although it created and issued the Second Life currency, Linden Lab denies responsibility for transactions, disputes, and losses involving Linden dollars. “People have got to deal with interactions [in virtual worlds] the same way they would deal with them on the Internet generally,” says Ginsu Yoon, Linden’s vice president for business affairs. “Understand what you are doing, understand what the consequences are, use available tools to make sure you are dealing with a trusted party.” The company has now taken steps to identify and suspend accounts where large Linden transfers and cash-outs are taking place–activity that could point to fraud. It’s also advising account holders to engage the services of third parties who provide identify verification. But whether such measures can make virtual economies functional in the absence of real-world prosecution or regulation remains to be seen.

Party Like It’s 1994
Second Life reports more than 10 million subscribers, including inactive or duplicate accounts; about 50,000 are online at any one time. But it is only one booming virtual world among many, including Entropia Universe and There; massively multiplayer online role-playing games like World of Warcraft; and more controlled and narrowly focused sites like the child-oriented Webkinz and Club Penguin, which is owned by Disney. Many corporations have their own virtual worlds–places where they assemble far-flung employees or students to collaborate on projects or attend classes. “Second Life gets a lot of press, but there are hundreds and hundreds of these platforms,” says Sandy ­Kearney, global director of 3-D Internet and virtual business at IBM. “If you look at all the platforms coming, it feels like 1994, when all of a sudden everybody was building a website.”

In just the past year, reports the trade organization Virtual Worlds Management, companies and venture capitalists have pumped a billion dollars into developing virtual worlds. Many mainstream businesses have presences–simulations, or “sims”–within them. Dell has a sales office in Second Life. Reebok has a store. The studio 20th Century Fox even held a movie premiere there, for X-Men 3: The Last Stand. IBM maintains business centers. In 2006, Sun Microsystems became the first Fortune 500 company to hold a press conference “in-world.” Even the World Bank presented a report in Second Life about business development (20 percent of Second Lifers log on from Latin America, Asia, or Africa). Corporations have taken up residence in other virtual worlds, too; for example, you’ll find Toyota’s Scion brand in There.

With all this blue-chip interest, and continuing increases in processing horsepower and Internet bandwidth, virtual worlds may provide a peek at the future of the Web: instead of jumping from page to page, we could one day navigate 3-D environments to communicate, shop, and do research. Some observers even think that virtual worlds may merge with 3-D representations of the real world, such as Google Earth and Microsoft Live Search Maps (see “Second Earth,” July/August 2007). Many virtual worlds have their own currencies: in addition to Linden dollars, there are Project Entropia dollars, or PEDs (10 to the dollar), in the competing Entropia Universe; Therebucks (1,800 to the dollar) in the teen-focused There; and Webkinz KinzCash that kids use to buy treats for digital Chihuahuas and raccoons.

But big companies like Sun, Reebok, and IBM don’t really do business in virtual worlds; they “tunnel” into them. To close a deal, you need to step out of the “sim” and into the traditional Sun or Reebok or IBM website. These companies deal only in real currency, using established protocols for encryption and authentication. By contrast, people like Stephanie ­Roberts are actively conducting transactions in virtual worlds, using virtual money to buy virtual clothing, land, animals, surfboards, and art for their avatars. They deposit money in virtual banks and even invest in virtual stocks. And that’s where the problems are arising. The blogosphere is full of complaints about Ginko losses and about deals for land and goods that went wrong. And some fear that these issues will thwart the growth of e-commerce in virtual worlds.

Virtual Upstart: Stephanie Roberts’s avatar, Zania Turner (right), earned money hosting Slingo, a blend of bingo and slots. Roberts (left) now dreams of selling virtual Zamboni machines.

Credit: Photograph by Hayley Murphy (left); Courtesy of Stephanie Roberts (right)

To IBM’s Kearney, the situation recalls the formative days of e‑commerce, which were plagued by uncertainty and lack of trust. “If you look at early [Web] days, it was the same,” she says. “You had all the similar issues: ‘I’m not buying anything on the Internet because someone can steal my credit card number.’ ” Linden Lab’s Yoon agrees. “When you first started to see the Internet as more than just education and government, you started seeing all these crap websites thrown up all over the place. It’s sort of like the disorganized user-created content within Second Life,” he says. “We saw that whole cycle in the development of the Internet–the cycle of doubt and fear, and realization that there is economic value, and communication and community value. We are seeing exactly the same thing happening again.”

So far, not many complaints about virtual finance and commerce have surfaced in courtrooms. One–maybe the only one–revolved around a Pennsylvania lawyer named Marc Bragg, whose avatar went by the name Marc Woebegone. In 2005, Bragg signed up with Second Life and started whiling away his off hours amassing and reselling virtual land and selling virtual fireworks to other residents. He was doing quite well until May 2006, when Linden Lab accused him of manipulating an auction to acquire virtual land at a below-market price. The company shut down his account and confiscated all his virtual holdings; in so doing, it seized Linden dollars and property worth about $8,000. As the company saw it, Bragg broke the terms of service on his account, and his account was consequently canceled. Bragg felt he’d been robbed of real assets, not just a Second Life account, and so he took Linden Lab to court. He got his account and some of his belongings back in a recent settlement whose full terms were not disclosed.

The Bragg case–which hinged partly on Second Life’s representations of virtual land as something that can be “owned”–showed that real-world authorities may not automatically dismiss virtual currency as Monopoly money, or in-world contracts as a game. But Ben Duranske says that other complaints, such as those of Ginko customers who say they lost money, have not yet elicited any governmental action. Duranske founded the Second Life Bar Association, an in-world community of real-world legal professionals and scholars, to explore questions of technology and the law. “If I did what the people of Ginko did–only using stamps and envelopes–it would be illegal, and easy to prove to a jury,” he says.

Virtual Solutions
In the summer of 2007, Linden Lab announced that to help make transactions more secure, it was creating a voluntary ID system, so that in-world consumers could verify attributes–such as the age–of the people behind the avatars they were dealing with. Another reason was to keep minors out of certain areas of Second Life; people under 18 are not allowed to sign up for accounts, and Linden has been trying to stamp out virtual sex between “adult” avatars and “child” avatars. The company also introduced algorithms that identify suspicious activity and warned users to be more prudent in their online dealings. “We caution our residents to be wary of anyone offering extremely high interest rates at no risk, either in the real world or in Second Life,” the company’s CFO, John Zdanowski, wrote in the Second Life blog (under the avatar name Zee Linden). “If it sounds too good to be true, it probably is.”

Now users themselves are setting up some quasi-regulatory structures. Some have started the Second Life Exchange Commission, which sets standards for financial disclosure; others have created the Virtual World Business Bureau, which rates businesses, warns residents against scams, and acts as a clearing­house for complaints. Just as a real-world company will seek affirmation of its credibility from Pricewaterhouse­Coopers, “the virtual environment absolutely has to be able to say you are a legitimate company doing legitimate business,” IBM’s Kearney says. “If you look at the 3-D Internet as the unformed future of the Internet, it will be very important to solve these problems.”

Dan Miller, one of Capitol Hill’s few experts on the subject of virtual economies (he’s a staff economist with the Congressional Joint Economic Committee, working with the ranking member, Republican representative Jim Saxton of New Jersey), notes that different virtual worlds take different approaches to keeping transactions secure and transparent. Within Entropia Universe, every PED has a unique ID code and is tracked from its creation, through every transaction involving it, to the point at which the user cashes out by exchanging PEDs for real dollars. Linden dollars do not bear such codes, though the company says all transactions are monitored. Differences in transaction-­tracking technologies could make it harder or easier for legal authorities to reconstruct alleged incidents of theft or fraud. But it also gives consumers a choice, Miller says: “If one virtual world likes the heavy-handed Big Brother controls to make everybody feel safe, that will appeal to certain people. If someone else is more of a caveat emptor person, they might go more toward another world.” He warns that any government intervention to regulate commerce could be a slippery slope. “If the government starts regulating aspects for criminal purposes, they might start regulating the economic aspects,” he says–by taxing virtual goods and services, for example.

David Naylor of Field Fisher Waterhouse, on the other hand, argues that if virtual worlds are going to attract more participants–and create a lucrative new front for e-commerce–they need real-world intervention. “The issue is that I don’t think the authorities, in any jurisdiction, have really got their heads around Second Life,” he says. “One reason is that it’s brand-new tech­nology. Or if they are familiar with it, they take the view that in terms of the potential damage, or potential losses, they’ve got bigger fish to fry.” Cleaning up the situation “is going to take real-world regulators taking an interest,” he says. “Watchdogs can’t do it on their own. They can alert people to malpractice but can’t provide compensation.”

Wild West
Cornell’s Robert Bloomfield is an experimental economist who conducts lab research–allowing 20 students to make simulated stock trades using real money, for example, and seeing how regulatory changes affect their behavior. He envisions a day when he can do larger studies by setting up parallel virtual worlds. “I could create two virtual worlds, one with one legal structure, one with another, and compare them,” he says. “I might lower the capital-gains tax rate in one and see how business responds. There are things I can’t do with 20 people in a classroom but I can do with 2,000 or 20,000 people in a virtual world.”

For now, though, he’s studying what’s actually happening among the 318,742 people who are spending money in Second Life. “It’s pretty much the Wild West, and that makes it a fascinating place for study in its own right,” Bloomfield says. “We just have to sort out what the best practices are, and the best practices involve a lot of transparency.” Yoon, meanwhile, says he wouldn’t be surprised if law enforcement was gearing up to prosecute some form of misdeed within virtual worlds, whether a financial scam or virtual pedophilia. “I have no doubt that that is going to be something that people are interested in looking into,” he says. “It’s not any different than Internet chat rooms as a collaboration medium. There are guys whose police beat it is to hang around in an Internet chat room, and to chase spam, and prevent those scams. I don’t see why they wouldn’t do this in virtual worlds.”

To be sure, there are plenty of fleeced avatars who want their money back–and who are already backing away from the experiment that Bloomfield finds so promising. One of them is Rick Jones, a 47-year-old retired navy electronics technician who lives with a roommate in Oceanside, CA. In Second Life, he named his avatar Kiyotei Xi and bought and sold some land. “I had animals and fish and stuff that I would put around the land, for entertainment,” he says. He makes art that he sells at another avatar’s gallery, and he surfs in an area called Chi. But his experience has been marred, he says, by losing $460 in Ginko. He says he’d join a class action suit, though he wouldn’t sue on his own. And has he lost his trust in in-world transactions? “Oh, heck yeah.”

Stephanie Roberts has also lost some of her trust–but not enough to overwhelm her love for the possibilities she finds within Second Life. And certainly not enough for her to overlook the fact that there’s nowhere in the virtual world to buy a digital Zamboni. Roberts is looking for someone to teach her how to design one, so she can start selling them to other residents–and do her own small part to expand the virtual economy. “Nobody else has built one yet,” she says. “I could earn quite a bit off the sale of this thing!”

For further reading:
"Second Life Closes Banks", David Talbot, Technology Review, January 10, 2008
"Money Trouble in Second Life", Erica Naone, Technology Review, August 8, 2007