How Cryptocurrencies Could Upend Banks' Monetary Role

By Jon Matonis
American Banker
Friday, March 15, 2013

http://www.americanbanker.com/bankthink/how-cryptocurrencies-could-upend-banks-monetary-role-1057597-1.html

Peter Šurda

I recently had a fascinating chat with the economist Peter Šurda to discuss how nonpolitical cryptocurrencies like bitcoin could alter the future of fractional reserve banking.

Peter is also a software developer experienced in the online payments industry and will present at the Bitcoin 2013: The Future of Payments conference in San Jose in May. His 2012 master's thesis at Vienna University of Economics and Business was entitled Economics of Bitcoin: Is Bitcoin an Alternative to Fiat Currencies and Gold? He's an abstract thinker, but the implications of his work are tantalizing: that digital money like Bitcoin opens up possibilities for banking without central planners or a lender of last resort, where interest rates and reserve requirements are driven purely by the market.

The debate between the full reserve bankers and the fractional reserve bankers is an old one and it has been explored in depth by the Austrian school of economics. More recently, the debate has been broadened to include the dynamics of introducing the bitcoin cryptocurrency, which is the functional equivalent of digital gold, since its supply is predictable and fixed. (There are currently 10.9 million bitcoins in circulation with a total fixed supply of 21 million expected to be mined before 2140, 99% of them by the year 2032.) The Austrian school economist Michael Suede and the technologist Eli Gothill have speculated that fractional reserve banking can indeed appear within a bitcoin monetary environment. This is where we join up with Peter.

JON MATONIS: I enjoyed your blog post, "Market Forces and Fractional Reserve Banking." Do you consider fractional reserve banking to be compatible with Austrian economics?

PETER ŠURDA: First of all, I would like to separate fractional reserve banking and credit expansion. On one hand, there are ways of increasing the money supply, in the broader sense, which do not require fractional reserve banking or changes in the monetary base such as a system based on the principle of mutual credit like LETS [local exchange trading systems], or a fiat currency that uses bitcoin as reserves (i.e. they are not claims in the sense that Ludwig von Mises uses them, but they act as full substitutes). From the opposite direction, fractional reserve banking does not necessarily lead to credit expansion.

I agree with the full reservists that credit expansion has the effects described by the Austrian Business Cycle Theory. However, I agree with the free bankers that fractional reserve banking is not necessarily a violation of property rights and other ways of increasing the money supply also are not necessarily a violation of property rights.

So I think that the economic and legal analysis are two separate issues and need to be addressed separately. I avoided the legal analysis in my thesis and concentrated on Austrian Business Cycle Theory and policy issues, but in an earlier draft I have several pages about legal aspects too, and I discussed the topic with [the legal theorist] Stephan Kinsella.

JON MATONIS: How does a nonpolitical cryptocurrency like bitcoin alter the landscape in the "full reserve" versus "fractional reserve" banking debate?

PETER ŠURDA: Austrians have made arguments in the past that lead to the conclusion that fractional reserve banking does not necessarily lead to credit expansion, even though they never explicitly formulated it this way and might not have realized the connection. The reason is that if credit instruments do not decrease transaction costs over the monetary base, they are unlikely to act as a part of the money supply. Bitcoin shows that this is not only a hypothetical but empirically possible to implement. With Bitcoin, it is much less likely that credit expansion will occur.

In other words, we need to separate two things. Why do people want to hold fractional reserve banking instruments, which may include the interest payments as one of the reasons, and why do people want to use fractional reserve banking instruments as a medium of exchange which, I argue, requires that the fractional reserve banking instruments decrease transaction costs. That they historically manifested themselves through a common instrument is an empirical quirk and not an economic rule. The ability to loan money is beneficial. Contrary to many Austrians, I agree that maturity transformation can be beneficial, and if the loan ends up being a liquid instrument, it also can be beneficial. But if it is so liquid that it becomes a part of the money supply, that's when it has a detrimental effect on the economy.

For full reservists, Bitcoin shows that the question of fractional reserve banking is less important than they thought. Fractional reservists, on the other hand, need to think about the nature of the mechanisms equilibrating the money supply. I tried to explain the issue to [the economists] George Selgin and David Glasner in comments on their websites, but I wasn't successful in getting my point through.

JON MATONIS: If bitcoin is digital gold, does that portend a future where a bitcoin standard (akin to the gold standard) can emerge or partial bitcoin backing for other currencies?

PETER ŠURDA: They probably can emerge, but the more important question is whether they would be preferred to bitcoin. Only something that provides a significant improvement would be preferred. I only know two potential candidates for that: Ripple and OpenTransactions.

JON MATONIS: In a bitcoin world, is fractional reserve banking only possible with offline substitutes (such as physical coins or cards, which can be traded hand-to-hand, containing the private key to a bitcoin address) or an intentional "fork" in the block chain ledger?

PETER ŠURDA: Hypothetically, the reserves can be offline and the substitute can be a clearing system like Ripple, so there are other possibilities too. But if I understand your point correctly, offline "substitutes" might have a higher chance of actually becoming full substitutes because they might have more obvious advantages.

JON MATONIS: As the recent block chain fork episode demonstrates, there is a need for offline bitcoin transactions to continue. Is this demand sufficient for a money substitute to evolve, such as offline substitutes with full or partial bitcoin backing?

PETER ŠURDA: This is primarily an empirical question, so we can't be completely sure about that. I think the probability for this is significantly lower than with the currencies that we've known historically. The end result is also path-dependent; for instance, it depends on how quickly bitcoin matures and/or adapts to changes compared to the potential substitute.

Fractional reserve banking does not come into existence magically. It must follow economic rules. With gold and similar commodities, fractional reserve banking comes into existence for these reasons: On the demand side, there is a demand for money substitutes, because they provide something that money proper does not; and on the supply side, money substitutes carry maintenance costs for the issuer (e.g. storage of gold) and these need to be offset somehow. The issuer can charge on holding (e.g. demurrage of bank notes), transacting (e.g. check clearing), or, obviously, externalize the costs through fractional reserves. From the point of view of an individual user, fractional reserve banking appears to be the least costly alternative. So obviously fractional reserve banking wins.

Putting it together: If there is a general demand for money substitutes, this leads to fractional reserve banking. Unless it's illegal. Then it might not. Solution: Have money which does not lead to the creation of money substitutes. Bitcoin shows that at least hypothetically, this is possible. I might even go a bit further and make this statement: If on a free market money substitutes do not develop even though there is no legal or technical obstacle for them, it means that the choice of money is Pareto-optimal since no change in the monetary system leads to an increase in utility.

JON MATONIS: Does a demand for positive return on bitcoin balances lead to an environment of competitive bank lending with risk-adjusted interest rates? And will this lead to an environment of fractional reserve banking with depositors offered higher interest rates in exchange for the additional risk premium of running a fractional portfolio?

PETER ŠURDA: Yes, I would say it does, but until there are industry niches that primarily use bitcoin, it is probably not much different from gambling.

This might lead to negotiable credit instruments with maturity-mismatching or maturity transformation, depending on which economic school you use for terminology. However, I don't think this feature alone is sufficient for these instruments to be accepted as full substitutes whereas George Selgin appears to think it is. Now, whether to call such a situation "fractional reserve banking" even though no credit expansion occurs is unclear. I lean towards yes, but there could be other interpretations.

JON MATONIS: How do you see bitcoin changing interest rate structures and lending practices?

PETER ŠURDA: Using Bitcoin for loans only makes sense for those businesses that use bitcoin as a unit of account, unless, of course, you're just speculating on the market but don't actually sell any goods or services. I think this will only occur at much higher levels of liquidity or until we can be quite sure that it deserves the label "money." Until these higher levels of liquidity are reached, the price of bitcoin will probably be quite volatile, which reduces the likelihood that people use it as a unit of account.

However, there could be niche market segments that use bitcoin as a primary medium of exchange and [bitcoin] mining is the most obvious candidate. For these, the unit of account function would make sense even if the global market penetration is lower.

Assuming one of these thresholds is crossed and the money supply remains inelastic (i.e. no significant credit expansion), the interest rate of bitcoin should be a good reflection of the time preference of those market participants that use it as a unit of account. Bitcoin also makes it much easier for lending to occur in a decentralized manner, I think. Rather than a small number of "too big to fail" institutions, we should see smaller specialized teams that act as facilitators without owning the liabilities or being liable themselves.

JON MATONIS: Can a free market fractional reserve system (as opposed to a central banking fractional reserve system) coexist with full reserve banking? Or will one drive out the other?

PETER ŠURDA: I think that if money substitutes emerge, fractional reserve banking will out-compete 100% reserve banking in the market. I deal with this a bit in an earlier draft of the thesis. If they don't emerge, on the other hand, we'll have a money supply equivalent to the monetary base and debt will not cause changes in the money supply. It would be viewed as merely highly liquid credit. I don't think they can coexist for a long time assuming the same underlying money in the narrower sense, of course.

Bitcoin: Financial Deepening and Currency Internationalization

By JP Koning
Moneyness
Thursday, February 21, 2013

http://jpkoning.blogspot.com/2013/02/financial-deepening-and-currency.html

Much of the conversation about bitcoin adoption focuses on its use in goods and services transactions. Breaking bitcoin news, for instance, draws attention to the fact that the Internet Archive will be giving employees the option to be paid in bitcoin. This focus on brick & mortar transactions means that the role that bitcoin financial instruments—stocks, bonds, and derivatives—have to play in promoting bitcoin adoption often gets overshadowed.

I'm currently reading Barry Eichengreen's Exorbitant Privilege which goes into the mechanics of what it takes to create a truly international currency. Eichengreen points out that prior to World War I the dollar played a negligible role relative to the pound sterling in world markets, but by the mid 1920s it was the dominant unit for invoicing payments and denominating bonds. Eichengreen's theory is that the US dollar became the world's go-to currency because of the emergence of a very specific financial instrument—the banker's acceptance.

An acceptance is much like a bill of exchange, a financial instrument I explained in my last post. Say a merchant decides to pay for a shipment of goods with a personal IOU, or bill. If a bank first "accepts" the bill i.e. if it agrees to vouch for the IOU, then this gives the bill more credibility. It is now a banker's acceptance.

According to Eichengreen, around 1908 or 1909, a concerted effort to foster the growth of the US acceptance market began. Up till then, US banks had been prohibited from dealing in acceptances and branching abroad—both these limitations would be removed by new legislation. To promote liquidity and backstop the acceptance market, the Federal Reserve, established in 1914, was given authority to buy and sell acceptances via open market operations. Furthermore, these acceptances could legally "back", or collateralize, the Fed's note issue. This feature was particularly helpful. Although the Fed was also legally permitted to purchase government securities, government securities could not "back" the note issue. Acceptances, therefore, became the more flexible and preferred asset for Fed open market operations, at least until 1932 when the limitations on government collateral were removed. According to Eichengreen, the Fed was the largest investor in the acceptance market and sometimes held the majority of outstanding issues on its balance sheet.

By the mid-1920s foreign acceptances denominated in dollars exceeded those denominated in sterling by a factor of 2:1 and more central banks held US forex reserves than sterling. London was on the way out, and New York on the way in. By 1929, the amount of outstanding foreign public bonds denominated in dollars (excluding the Commonwealth) exceeded sterling bonds. The lesson here is that a key step in the sequence of internationalizing a currency is getting it to be used in financial markets. This involves the development of deep, liquid, and accessible markets in securities denominated in that currency.

What sort of financial deepening do we see in the bitcoin universe, and how might we compare it to the dollar's emergence in the 1910s and 20s?

There are a number of healthy signs of financial deepening. I count five competing bitcoin securities exchanges that provide a forum for trading bitcoin-denominated stocks and bonds. These include Cryptostocks, BTCT, MPEx, Havelock, and Picostocks. A sixth, LTC-Global, provides a market in litecoin securities, a competing altchain. Holders of bitcoin needn't cash out of the bitcoin universe in order to get a better return. Instead, they can buy a bond or a stock listed on any of these exchanges.

The largest publicly-traded company in the bitcoin universe is SatoshiDice, a bitcoin gambling website listed on MPEx. With 100 million shares outstanding and a price of 0.006 BTC, SatoshiDice's market cap is ~600,000 BTC which comes out to around $17 million. SatoshiDice IPOed last year at 0.0032 BTC. With bitcoin only trading at $12 back then (it is now worth $29), the entire company would have been worth $4 million. Given today's $17 million valuation, SatoshiDice shareholders have seen a nice return over a short amount of time—much of it provided by bitcoin appreciation.

While SatoshiDice certainly provides some depth to bitcoin financial markets it has the potential to shallow them out too. Because MPEx charges large fees to trade on its exchange, a few of the competing exchanges have created what are called SatoshiDice "passthroughs". Much like an ETF, a passthrough holds an underlying asset—in this case SatoshiDice shares on MPEx—and flows through all dividends earned to passthrough owners. As a result, investors can get exposure to SatoshiDice without having to pay MPEx's expensive fees. BTCT, for instance, lists two different SatoshiDice passthroughs (GSDPT and S.DICE-PT) which together account for more trading volume than all other stocks and bonds listed on BTCT.

SatoshiDice's sheer size is to some extent problematic since Bitcoin financial markets are not as deep as they might appear. Should something ever happen to SatoshiDice, a big part of the bitcoin financial universe's liquidity will be wiped out, and this would ripple out across the entire field of bitcoin securities. The same might have happened to banker's acceptances in their day, except for one difference—the Fed was willing to back the acceptance market up. In the bitcoin universe, there's no buyer of of last resort to provide liquidity support to SatoshiDice shareholders.

Another impediment to deeper bitcoin markets is the hazy legality of the bitcoin securities exchanges. The first major bitcoin securities exchange, GLBSE, was closed in October 2012 with no prior warning. According to this article, potential regulatory and tax liabilities convinced GLBSE's founder to shut it down on his own behest. If any of the existing bitcoin exchanges were to grow too noticeable, one could imagine the SEC (or its equivalent) knocking on their door and forcing the exchange-owner to pull the plug. This sort of regulatory uncertainty can only dampen the liquidity and depth of bitcoin financial markets.

US authorities, on the other hand, didn't need to heed the rules when they built the banker's acceptance market. They created the rules. If financial deepening in the Bitcoin universe is to proceed it will happen despite regulations and not because of them.

The last headwind to bitcoin financial deepening is bitcoin's volatility. Eichengreen writes that the seesawing of the pound sterling during the war period encouraged financial markets to search for a more stable unit in which to express debts. The pound had always been anchored to gold (or silver), but it was unpegged from its century's long gold tether when the war broke out. Although it was repegged in January 1916, this time to the dollar, this did not secure confidence in the sterling's value since the peg was dependent on American support. When this support was withdrawn at war's end, sterling fell by a third within a year. Through all of this, the dollar continued to be defined in terms of gold, a feature which no doubt attracted issuers.

Bitcoin, on the other hand, has more than doubled in just two months. Back in June 2011, it fell by 50% in just two days. Like pound sterling during the war, bitcoin's lack of stability will do little to promote deeper financial markets.

Although I've stressed the difficulties that bitcoin markets face in developing more depth, the sheer amount of financial innovation I'm seeing from those involved in the various bitcoin securities exchanges is impressive. I wish them the best. The more they build up bitcoin securities markets, the better an alternative bitcoin presents to competing currency units.

[Disclaimer: I am long SatoshiDice and several bitcoin mining stocks.]

Reprinted with permission. 

Market Forces and Fractional Reserve Banking

By Peter Šurda
Economics of Bitcoin
Monday, January 21, 2013

http://www.economicsofbitcoin.com/2013/01/market-forces-and-fractional-reserve.html

Ralph Musgrave made a blog post "Lawrence White Tries to Argue for Fractional Reserve Banking" where he criticises some of the arguments made by Lawrence White in testimony on his fractional-reserve banking. I tend to agree with many of the things Ralph wrote, but here I'll concentrate on one aspect where I disagree.

Ralph writes:

"In fact there is no reason to suppose that “payment services” provided by a fractional reserve bank are any cheaper or “more economic” than those provided by a full reserve bank. That is, the ACTUAL COSTS (clearing cheques, issuing bank statements, etc) are the same in both cases. However, fractional reserve offers depositors interest on their deposits. And if you deduct that interest from the costs of payment services, then of course the cost of those services could be said to be reduced. But the reality is that this is just cross-subsidisation of one bank activity by another." [emphasis original]

Ralph missed several things here.

Storage costs

The first one (which I cannot find explicitly in White's testimony), is that holding less than 100% reserves decreases storage costs. Even if the "excess" reserves were used in a different manner than loaned out, FRB would still have lower operating costs. Storage costs are a subset of what I call "maintenance costs of money substitutes". One might argue that if a withdrawal request arises in excess of reserves, the transaction costs of facilitating redemption (e.g. sale of assets) would be higher in an FRB. But the operational issues of redemption are not a feature specific to FRB. Even in a full reserve system, as long as branch operations are allowed, it is still possible that someone wants to withdraw more than the available reserves in that specific branch. The withdrawal would still have to be postponed and either the reserves transported from another branch, or some assets sold (the latter might be still chosen even in a full reserve banking if it has lower transaction costs, which is entirely possible).

Bank notes

The second thing is mentioned by White: "The other bank payment instrument, redeemable banknotes circulating in round denominations, simply cannot exist without fractional reserves. Banknotes are feasible for a fractional-reserve bank because the bank doesn’t need to assess storage fees to cover its costs. It can let the notes can circulate anonymously and at face value, unencumbered by fees, and cover its costs by interest income. An issuer of circulating 100% reserve notes would need to assess storage fees on someone, but would be unable to assess them on unknown note-holders. There are no known historical examples of circulating 100% reserve notes unencumbered by storage fees."

 Now, I have a minor addition here, it is hypothetically possible to create a bearer instrument with demurrage (e.g. stamps) even on a 100% reserve banking. Whether there is a practical merit in that I will leave open, but I'll ignore it for the time being, in order to explain the argument of White. So, let me reformulate White's argument: In a metallic monetary system, as long as people prefer bank notes to coins, FRB will emerge. This is a straightforward logical necessity. Irrespective of what people think about legitimacy of FRB, in this particular case it is an unavoidable consequence of consumer demand. Why might people prefer bank notes to coins? I'll address that right away.

Why are substitutes substitutes?

Here it gets a bit tricky, because anti-FRB-ists, when criticising FRB, tend to "objectivise the boundaries of goods". They argue that an instrument issued by the bank is treated by the users of that good as a substitute because they think it's the same good (i.e. it is a claim, an ownership title). But this is a non-sequitur. The best refutation of this assumption are so called "complementary currencies", in particular those of type "mutual credit". Mutual credit are a form of circulating medium of exchange which is derived from a "normal" money (e.g. the USD or EUR), but they are not based on deposit banking. Some of the more popular examples are WIR and TEM.

In other words, a subsitute medium of exchange (money substitute) does not need to be a claim. Mutual credit is not even convertible into the base money. This leaves the question open: why are then some goods accepted as a substitute medium of exchange? The Austrians know this, but magically, when talking about FRB, they forget about it. They are accepted as substitutes because they decrease transaction costs. Practically all of the anti-FRB Austrians realise this, but only when not talking about FRB: Rothbard, Hoppe, Salerno, de Soto.

So what are money substitutes? Money substitutes are copies of the monetary base. They are persistently causally related to the original (e.g. by a peg, by using the same name, etc.), and they act as substitutes from economic point of view. And, at the latest since Kinsella's Against Intellectual Property, the Austrians increasingly come to the realisation that copying is not per se a violation of property rights. Analogously, creating an instrument which is subsequently then accepted as a substitute by the market is not, per se, a violation of property rights either.

Cross-subsidising

Now that we have clarified what are money substitutes, we can look at cross-subsidising. The instruments issued by the banks are copies. They have two important features that distinguish them from the originals:

1. They have lower transaction costs
2. They allow credit expansion

Here the error of anti-FRBists becomes apparent. They do not realise that the instruments are goods separate from the original. They draw the boundaries of goods based on their own desires, not based on how these goods are treated by the market. The result of banking is a new good, that unifies lower transaction costs with credit expansion. Even if they don't like it, this is the economic fundamental of the banks' activities.

Since this new good, this copy, satisfies both the demand for lower transaction costs and credit expansion, these two activities economically manifest themselves as one. The merging of these two activities by the bank is simply a response to this unified demand. As long as this new good, copy, satisfies both demands, the activities of the bank are economically inseparable. Therefore, there is no cross-subsidising, similarly as the manufacturing of tires is not cross-subsidising the manufacturing of chassis as long as people demand the whole car, even if some people have a fetish for the tires and want to ban car assembly.

How to fix this?

Unlike the free banking branch of the Austrian school, I actually agree with the gold standard branch that credit expansion [EDIT: and I mean any credit expansion] leads to distortions, such as the business cycle. So I'm at odds with both of them, as I argue that FRB is economically detrimental, yet not a violation of property rights, but a consequence of market forces. I could just end here, leaving everyone baffled and annoyed. But this blog is called "Economics of Bitcoin". And here it comes in.

To explain why, I'll first start with a quote by none other than professor White, in Competitive Payments Systems and the Unit of Account:

"Coinage reduces transaction costs compared to simple exchange, because of authentication and weighing. Bank liabilities also reduce transaction costs. But these are empirical factors, and not something inherent in all possible monetary systems."

Now, putting it all together, if the transaction costs of monetary base are sufficiently low, money substitutes do not emerge, and thus there is no credit expansion. Bitcoin shows that such a system is empirically possible. It "fixes" credit expansion without "fixing" FRB. Is that a hack? No. Money substitutes are a hack, and credit expansion is a result of that. Bitcoin shows that a proper solution is possible.

Reprinted with permission.

The Bitcoin Richest: Accumulating Large Balances

By Jon Matonis
Forbes
Friday, June 22, 2012

http://www.forbes.com/sites/jonmatonis/2012/06/22/the-bitcoin-richest-accumulating-large-balances/

Everyone is familiar with Forbes 400 as the definitive list to wealth in America. But few people know about the world's up-and-coming bitcoin richest and what motivates them to accumulate and maintain large balances.

The Bitcoin Richest ranks the top worldwide holders of bitcoin wealth on the blockchain. The caveats are that we cannot identify the affluent person or business (but you know who you are) and the same entity may hold the private keys to multiple bitcoin addresses. At the current exchange rate of $6.50 per BTC, the top address on the list holds control to an astonishing $2.85 million in total value (as of 6/20/12). Top ten balances are clickable to show dates with transaction history and my analysis follows:

BTC Balance                Bitcoin Address (Hash 160-bit format)

438824.90216295 8bf24a18a58ab500d30c73bf21dbf4703d31ad2c
105555.0000000 582431b9e63d2394c8b224d1bc45d07ae95d2379
79956.00100000   a0b0d60e5991578ed37cbda2b17d8b2ce23ab295
59258.88000000   89a37004da17f792487bcc26f853c7722c56fd91
53000.00000000   3d9e561f21d312f9b8b46e74169263e2452d5591
50129.66980000   2004f419e735115cb2a42cbc76f5b0a20c9698f8
50000.00000000   863ec44fbf7c9ed0819b52f275006b22ba781794
50000.00000000   f1c87a5e8ff7d14e74b858089bf771c94b1b6db4
47457.46000000   6fbe1851f5d1de5477d147e93b3da5c0c98f4e8e
45000.00000000   f68212be6db427d4b30f01113920db0e9e457c8d

Source: Bitcoin richest addresses created on June 19, 2012 by znort987 via blockparser.

Analysis

What can we learn from this list? First, it demonstrates that a broad group of people are comfortable enough with the bitcoin crypto to exit the traditional banking system and leave significant value on the blockchain for extended periods. I can only guess that they must have a rigorous onsite and offsite backup process for retrieving the private key or perhaps they rely on Brainwallet for the utmost in mobility.

Also with the exception of the top three addresses, the wealth is evenly distributed as 8,000 BTC is the cut-off to make the top 100 list. Incidentally, this has remained consistent with a similar list computed in December 2011 in which the cut-off to make the list was 6,925 BTC.

But why leave your wealth in a distributed proof-of-work system instead of a traditional bank? In a broad sense, bitcoin wealth offers protection from unpredictable political risk such as sovereign confiscation, excessive taxation, and capital controls at the border. In addition to preservation of value when compared to national fiat currencies, bitcoin wealth eliminates bank solvency risk and the risk of exogenous shocks to the uber-leveraged financial pyramid. Remember, a pyramid was not a monument but a tomb.

One of the challenges confronting bitcoin consultants in certain industries is how to transfer bitcoin value in amounts of $10 million or more for purposes of trade settlement and for the mitigation of jurisdictional bank risk. With the total bitcoin market capitalization at approximately $60 million and the largest single address holding merely $2.85 million, you can begin to see the obstacles. The bitcoin market is still too nascent and small for robust use in global trade settlement. Liquidity and depth would have to increase significantly to accommodate requests without severe price disruption.

Thanks to the excellent work of Blockchain.info, we can get an idea of current trade and settlement usage by looking at the 100 largest bitcoin transactions culled from the most recent 50,000 transactions. Bitcoin Days Destroyed also provides an indication of transaction volume that attempts to strip out transfers to oneself and account reorganizations.

For further reading:
"The death of banks – and the future of money", Detlev Schlichter, June 20, 2012
"Underground Remittances - From Hawala to Bitcoin", Mondato, June 20, 2012

Be Your Own Bank: Bitcoin Wallet for Apple

By Jon Matonis
Forbes
Thursday, April 26, 2012

http://www.forbes.com/sites/jonmatonis/2012/04/26/be-your-own-bank-bitcoin-wallet-for-apple/

Have you ever wanted to be your own bank? There's an app for that. With the new Blockchain bitcoin wallet for Apple’s iPhone, iPad, and iPod touch, anyone can emulate the functionality of a bank. Simply download the free app from the App Store and you have a fully-functioning send and receive online wallet that allows value transfer without the need for a bank or other financial intermediary. This is the proper path to a cashless society!

Blockchain.info is an offering from UK-based Qkos Services Ltd. that provides online wallet management services and real-time data analytics from the bitcoin block chain. Run by Ben Reeves, the small company has released several reliable services and products for the thriving bitcoin community including charts, statistical data, the web-based My Wallet, an Android wallet app, and most recently an impressive bitcoin wallet app for Apple’s iOS.

The reviews coming in so far are excellent. "Welcome to the future. This is going to change the game," writes one app user. Blockchain has combined powerful payment functionality with ease-of-use and an aesthetically pleasing interface. "The pace of innovation in the Bitcoin-related space is accelerating — something that could be revolutionary even, considering it all comes from participation by individuals as there is no corporation or industry group overseeing Bitcoin endeavors," observes the BitcoinMoney blog.


Apple has long had their eyes on the lucrative mobile payments space strategizing on an entry point. This non-dongle iPhone app is especially important now that the 'dongle wars' have heated up between Apple mobile payment competitors Square and PayPal. Ironically with mountains of existing iTunes customer accounts, Apple could find itself in the best position to capitalize on a robust cash-like ecosystem that completely bypasses the banks via apps. If they chose to do so, Apple could quickly become the premier bitcoin exchanger for retail.

Company founder Ben Reeves explains, "The beauty of bitcoin is that it's fully decentralized -- no government or corporation can block payments or revoke accounts. My hope is that this app allows bitcoin to reach a more mainstream audience." The company also plans to release an SDK (Software Development Kit) which will allow developers of iPhone apps to accept bitcoin payments in their own apps. Interviewed for this article, Reeves said that Apple wallet downloads have been averaging about 250 per day which should allow it to quickly surpass the number of downloads for the Android version.

So, what's new for Apple users worldwide? Firstly, financial privacy is paramount and it's protected by requiring only a password as identifying information and by shielding your Internet location from the network. International payments are now free without using credit cards and without the risk of chargebacks. Transactions are received in milliseconds and they become irreversible within a hour. There is capacity for up to 400 bitcoin addresses so you can open new bank accounts and instantly receive deposits at the touch of a button. Addresses are clickable to display a QR code and you can also scan QR codes to make payments. Keys are stored securely on your phone and encrypted on Blockchain's servers so if you lose your phone, no sweat -- you're protected.

Empowering your own monetary future has never been so accessible. I might even wait in line to purchase the new iPhone 5. Why approve the Blockchain app at this time when it was mysteriously rejected before? Maybe Apple no longer wanted it as an illicit app on the Cydia website. "Or perhaps Apple saw the Android version of the app and prefers to maintain its strong iPhone market share," posits BitcoinMoney. Whatever the reason, Blockchain now joins 16 other bitcoin-related apps currently available from the App Store.

Virtual Currencies and Roach Motels

By Jon Matonis
Forbes
Tuesday, March 6, 2012

http://www.forbes.com/sites/jonmatonis/2012/03/06/virtual-currencies-and-roach-motels/

According to Google's Eric Schmidt at the recent Mobile World Congress in Barcelona, the company once considered issuing its own digital currency for use and circulation across its expanding global platform. After reviewing various proposals for the proposed Google Bucks, the company decided not to proceed, citing 'legal concerns' which most likely implies the strict licensure and compliance regulations for quasi-financial institutions.

They probably realized that Google Bucks could end up like Facebook Credits and become a virtual currency roach motel where your money checks in, but it doesn't check out. Facebook does not provide two-way convertibility and person-to-person payments due to the potential for fraud and the emergence of a secondary market beyond Facebook's control. For the moment, that is good news for Facebook shareholders but it could quickly lose appeal for users and game developers that are locked into the self-serving paradigm. Although with money transmitter licenses in at least 15 states now, Facebook Credits is further along than previously thought in competing more directly with banks.

Google probably also realized that they could not improve upon the elegance and resiliency of bitcoin, a three-year-old decentralized P2P digital currency with an independent floating exchange rate of about $5.00 per bitcoin. In March 2011, Mike Hearn, a Google engineer, released an open source java client for bitcoin called BitcoinJ so obviously the protocol did not go unnoticed at Team Google. A true, and ideal, virtual currency will have the attributes of two-way convertibility, an independent floating exchange rate, and a nonpolitical unit of account. Consequently, it is those core features that stoke direct competition against national currencies and bitcoin possesses all three.

Renowned gamer and welfare economist Edward Castronova rejects bitcoin as the ideal virtual world gaming currency because, according to him, good game currencies should be based on controlled 'productive work', promote mild inflation, and rely upon a strong central authority for enforcement and repudiation. The freedom-loving, Libertarian gaming world of World of Warcraft and Eve Online was aghast. How could a PhD in economics think that a Keynesian currency system that has failed so badly in the real world be the desired path for currencies like WoW Gold and EVE Online ISK in the virtual world? Is the range-bound Linden Dollar of Second Life the future model of virtual currency and virtual monetary policy? Not only was Castronova rejecting bitcoin as a gaming currency, he was condemning the unregulated virtual world to a gray, inflationary future of State-sanctioned centrally-managed currency roach motels.

Castronova misses the point here and misses it badly. Bitcoin is the perfect virtual game currency precisely because it is not controlled by any State authority or virtual world company. It also facilitates the many other currency features that are so important to users, but not to governments, such as unrestricted person-to-person payments, user-defined anonymity and untraceability, near-immediate bearer settlement, transaction irreversibility, reliable store of value, multi-grid capable, and decentralized processing. You can think of bitcoin as the distributed digital representation of a real world physical casino chip also making it extremely suitable for online casinos and social betting. We are fast approaching a time when currencies will be serious differentiators and competitive wedges for companies simply because customers demand a particular payment type. The virtual gaming environments will be forced to adapt in order to survive.

Gamers and virtual world avatars don't want the corporations controlling their money anymore than they want central banks debasing the value of their real world money. Certainly, the regulations will be there for the digital currency exchanges that provide the conversion into and out of bitcoin; however, once the bitcoin is in the gaming and virtual world environment, it can function as gold coins and paper cash to stimulate and drive economic activity. No other virtual currency will even come close to that kind of vibrant liquidity and building walls to ring fence a virtual environment will turn out to be a counter-productive strategy. The bearer nature of these digital instruments like the cryptocurrency bitcoin will keep transaction costs low by eliminating third-party processors and counter-party risk. Electronic commerce will flourish.

Contrary to utopian social planning, free-market virtual economies will emerge spontaneously rather than through design and the ultimate victorious currency will be a market-based competitor that can move seamlessly across multiple grids. The virtual world is the perfect crucible for launching unrestricted currency competition and that competition will enable further opportunities for transporting virtual world earnings to real world value. This bridging of the two worlds could be the sought-after "killer app" for open-loop digital cash. Now, there will be three different mega-places for income and wealth generation -- the traditional taxable economy, the informal shadow economy, and the virtual world economy. However, with the virtual world bitcoin wealth being selectively anonymous and practically untaxable, it may just decide to stay there.

Note: The Virtual Policy Network has a podcast to accompany this article.

A Virtual Fortune: Property Rights in Virtual Economies

Press Release
The Public Interest Advocacy Centre
Wednesday, January 11, 2012

http://www.piac.ca/consumers/consumers_should_be_wary_of_risks_in_virtual_worlds/

The Public Interest Advocacy Centre (PIAC) today released a report entitled “A Virtual Fortune: Consumer Protection for Banking and Consumer Fraud in Virtual Worlds”. The report studies virtual worlds, which are sometimes described as “massively multiplayer online role-playing games” (MMORPGs) that provide an immersive virtual experience for many players that many players consider to be “real”. Many virtual worlds have developed virtual economies based on a virtual currency that may be exchanged for real-world currency. Players will play the role of consumer and entrepreneur within virtual worlds.

As virtual economies grow, there have been instances of fraud in these virtual worlds. PIAC’s report studies examples of economic fraud conducted in virtual worlds such as Second Life, Entropia Universe, EVE Online, and World of Warcraft. For example, there have been cases of bank runs, securities fraud, and theft of virtual property. These situations have resulted in a financial loss to consumers in virtual worlds. Notably, virtual world operators in most cases stated that these fraudulent schemes are “part of the game” while denying responsibility and liability and refusing to compensate players who have lost money to fraud in virtual worlds. Efforts to set up in-world justice systems have not been successful.

“Where a consumer falls victim to fraudulent activity within a virtual world, they are not likely to be successful in seeking redress or compensation for their losses,” said Janet Lo, Legal Counsel at the Public Interest Advocacy Centre and author of the report. “Virtual world consumers must be aware of potential risks to their in-world assets and property, such as in-world fraudulent schemes or unilateral actions by virtual world operators dealing with user accounts.”

Given that individuals view their virtual world avatar as an extension of themselves, the report explored whether real-world rights should extend to the avatar and whether traditional notions of property rights and consumer protection should apply to virtual avatars participating in virtual economies. The report noted the use of End-User License Agreements (EULA) or Terms of Service by virtual world operators to limit their liability and stipulate certain mandatory forms of dispute resolution. The enforceability of these terms in real world courts have been questioned but real world case law has not yet clarified the legal status and rights of virtual world users.

The report notes that real-world regulators around the world continue to examine virtual world economies and contemplate whether real-world regulation should be applied to financial transactions conducted in-world. For example, securities and payment regulations could be applied with a view to providing greater consumer protection to virtual world users.

“As virtual world experiences blend into social networking websites and other areas of commerce, regulators will need to consider how consumer protection will operate and whether the application of real-world regulations will be sufficient to protect consumers,” said Lo.

Why Facebook Never Built P2P Credits Payments

I have always maintained that a 'true' virtual currency will have at least three attributes: two-way convertibility, floating exchange rate, and privacy (or anonymity). Any currency without those attributes is merely an extension of the existing payment structure or a surrogate currency like a glorified coupon. There are some strong legal reasons for companies electing not to support those attributes, including regulation as a US-based licensed money service business and strict AML (anti-money laundering) guidelines. In writing for TechCrunch, Josh Constine explains why Facebook doesn't allow its Facebook Credits virtual currency to be used for person-to-person payments:

"But why hasn’t Facebook built its own way for friends to send money to each other using its virtual currency Credits? Because of significant fraud risks and its focus on making Credits work better for virtual goods purchases where it earns 30%."

"The primary reason Credits can only be spent in games and apps, not sent to other users, is fraud. There are several ways for users to earn Credits instead of paying for them, such as completing on-site offers, or making off-site purchases that are incentivized with Credits rewards through companies like ifeelgoods. If users could transfer Credits to someone else, the occupation of 'Credits Miner' would emerge. These people would earn Credits any way they could and sell them to others for more than they cost to earn but less than Facebook sells them for. This would essentially create a secondary market for Credits and undermine Facebook’s ability to make money on them."

Mining for 'credits' is not necessarily a bad thing and it can tend to increase the overall demand for the nonpolitical currency unit. The so-called fraud (or unfair profit) can always be addressed by floating, rather than fixing, the exchange rate for Credits in the way that Linden Labs has done for the economy of Second Life. Constine correctly hints that the close partnership between PayPal and Facebook is what prevents Facebook from entering the payments business directly:

"To be competitive, Facebook would only be able to take a few percent on transactions, and still it wouldn’t have the base of merchants PayPal cultivated through eBay. Instead, Facebook is focusing on Credits as its platform’s mandatory virtual goods payment processor for developers, where it earns its juicy 30% cut. That business is growing thanks to gaming giants like Zynga, so there’s no need to move into a risky sector such as P2P payments that’s outside its core competencies and dominated by incumbents."

While I believe that to be true for the moment, if Facebook were to address the fraud issue and the legal and regulatory issues of two-way convertibility, it would have an enormous opportunity that PayPal would not -- the ability to create currency at will and earn seigniorage.

For further reading:
"Virtual Currencies, Real Potential", Keith Button, Bank Technology News, November 1, 2011

Virtual Currency: Beyond Fun and Games

Karen Epper Hoffman writes in the September 2011 issue of Digital Transactions, "Beyond Fun and Games":

"A fixture in online gaming, virtual currencies are moving into other digital markets and may break into the physical world. But will acceptance costs and regulatory concerns stymie their growth?"

"'Online gaming has been a key driver for virtual currency,' says Beth Robertson, payments research director for Javelin Strategy & Research, Pleasanton, Calif. 'But that's beginning to change because of the move to broaden the use of virtual currency... potentially even to physical goods.'"

After briefly mentioning the decentralized bitcoin and a previous centralized online currency provider, Karen Epper Hoffman provides some insight on potential challenges for the regulators:

"Government oversight could put boundaries around usage in individual countries. But since virtual currency, like the digital goods it pays for and the platforms on which it operates, is global in nature, it's hard to say if that alone would quell any risk."

"In developing a system where users exchanged different currencies for a virtual one, it had created an unregulated foreign-exchange marketplace."

For further reading:
"Facebook currency takes to the web", Paul Dantanus, October 25, 2011
"Getting the Goods on Virtual Items: A Fresh Look at Transactions in Multi-User Online Environments", Justin A. Kwong, William Mitchell Law Review, Fall 2011
"Virtual Currency and Social Network Payments – The New Gold Rush: How Emerging Virtual Transactions Will Alter the Payments Landscape Forever", Javelin Strategy, June 2011

Facebook: Pay Our Way or Get Out

By Chadwick Matlin
Fortune
Friday, January 28, 2011

http://tech.fortune.cnn.com/2011/01/28/facebook-pay-our-way-or-get-out/

As Facebook starts to host all sorts of commerce -- and is now mandating the use of its currency -- perhaps it's time to stop thinking of it as a company and start thinking of it as a country.

"The strength of a nation's currency is based on the strength of a nation's economy." Richard Nixon, circa 1971, announcing that foreign governments could no longer convert U.S. dollars into gold.

"If you're a very large company, and supporting you is going to cost us tens of millions of dollars, then we want to at least have an understanding of how you're going to use what we're doing, and that you're not going to just import the data but also contribute back to the ecosystem and make peoples' Facebook experience better." —Mark Zuckerberg, circa 2010, explaining its agreements with social game companies that bring in 30% revenue cuts to Facebook.

Earlier this week, Facebook announced that by July 1 developers that have apps on the site must make their users pay for virtual goods using Facebook's official currency, Facebook Credits. Along with Credits come fees: 30% of every credit spent goes to Facebook.

Smaller developers, of course, aren't pleased. They would rather avoid paying Facebook altogether. Facebook, meanwhile, would rather avoid being a site that confuses its users with dozens of currencies.

At first glance, the move suggests Facebook has become a monetary autocracy, forcing the companies critical to its success to use its currency, and to pay a fee for doing so. But on second thought, isn't that more or less how taxes work? As Facebook grows and starts to host all sorts of commerce, perhaps it's time to stop thinking of the social network as a company. Maybe it's best to think of it as a country.

Imagine, for a moment, that you're the central banker of a country with nearly 600 million residents. Your economy is growing quickly, and the bigger it gets, the more foreign investors are knocking at your door, trying to hawk their wares and build within your borders. Nobody knows how much your economy is actually worth -- some place the GDP at $50 billion, making it the 73^rd largest economy in the world, though everyone agrees that your country will be a global force for years to come.

But there's one sector of your economy that won't fall in line. By the end of the year, it'll be worth over a billion dollars and it has proved to be sustainable even during an economic downturn. But a lot of the companies that make up the industry don't want to use the national currency. They'd rather use their own currencies and avoid a hefty 30% tax on all transactions.

But, as a wise central banker, you know that for a country to grow its economy, it needs a singular currency so the proletariat doesn't get confused. You've been able to convince the largest companies to use the national currency, but rogue stragglers remain. What do you do?

Tell them they can either use the currency or get the hell out.

Read the rest of the article.

Facebook's Virtual Currency Ambitions

By Niraj Chokshi
The Atlantic
Tuesday, April 27, 2010

http://www.theatlantic.com/science/archive/2010/04/facebooks-virtual-currency-ambitions/39572/

Facebook's expansion plans have moved into the realm once reserved for central banks and kings: creating its own currency.

Details on Facebook Credits emerged at last week's f8 Facebook developer conference, although the news was obscured by the network's plans to extend its reach and an ensuing privacy debate. Credits can be used to purchase virtual goods, such as items in games, and at least one company seems to have already benefited. Facebook's mobile payment processor of choice, Palo Alto-based Zong, today announced $15 million in new venture funding.

The marketplace for virtual goods is on a tear. Domestically, it is expected to reach $1.6 billion this year and possibly $3.6 billion in three years, according to an analyst cited by Bloomberg. The founder of the 28-year-old video gaming giant Electronic Arts is much more optimistic: He expects the market to hit $100 billion within the decade.

Whatever the numbers, Facebook is positioned to reap huge rewards from the expanding market. Credits will be the only currency allowed on Facebook and the company will take a massive 30 percent cut of all transactions. Its users currently engage in roughly 800 million game sessions a month, Facebook Credits manager Deb Liu said last week.

Read the rest of the article.

For further reading:
"Is This the Dawn of the Facebook Credit Economy?", Ian Schafer, Advertising Age, May 20, 2010
"Stored Value Systems vs. Currencies – Which One is Better for Your Community?", Cha-Ching!, May 17, 2010
"Facebook Faces Payment Feud Down on the Farm(ville)", Karen Webster, May 13, 2010
"Zynga: 'Facebook’s Not Always Going To Be The Answer'", Nicholas Carlson, May 10, 2010
"Offerpal Media launches a virtual money war with Facebook", Dean Takahashi, May 4, 2010
"Virtual Goods: A license to print money", James Grant Hay, May 2010
"Will Facebook Credit become your default payment method?", Yann Ranchere, April 25, 2010
"Zuckerberg: 'There’s Just Going to be One Currency that People Use' on Facebook Apps", Eric Eldon, April 23, 2010
"Which businesses has Facebook just killed?", Andrew Davies, April 22, 2010

Currency Design For Social Networks

I recently completed this presentation on virtual currency issuance and management. As never before, the virtual world and gaming environments are providing incredible opportunities for the nonpolitical digital currency ecosystem. While private currency issuers tepidly begin to circulate beyond the in-world environments, it creates a set of economic and legal considerations that may give rise to a form of "virtual" central banking. Undoubtedly, this will have implications for corporate revenue and profitability models, not to mention being a distinct challenge to the government-issued political currencies.

Currency Design For Social Networks
by Jon Matonis

View more presentations from Jon Matonis.

Virtual Economies, Virtual Goods and Service Delivery in Virtual Worlds

The Journal of Virtual Worlds Research recently profiled virtual economies, virtual goods, and service delivery in virtual worlds. Of particular interest to readers of The Monetary Future are the discussions surrounding unregulated virtual currencies and the evolving two-way exchange into real-world currencies.

From the summary:

In this special edition (Volume 2, Number 4, February 2010) on virtual-world goods and trade, we are pleased to present articles from a global cohort of contributors covering a wide range of issues. Some of our writers, such Edward Castronova, Julian Dibbell or KZero’s Nic Mitham will be well known to you as distinguished leaders in the field, but it is equally our pleasure to introduce exciting new voices. Here you will find pieces written by academics, practitioners, journalists, a documentary filmmaker and perhaps the youngest contributor to JVWR yet, Eli Kosminksy, who attends high school in upstate New York. We would also point out that this issue extends its format to include Anthony Gilmore’s pictorial story, Julian Dibbell’s audio interview, and Lori Landay’s machinima. In real life, most contributors live in the US, the UK and Europe, and we, the editors, are based in Australia and France.

The editorial team for this issue includes Mandy Salomon of Smart Services CRC, Australia and Serge Soudoplatoff of ESCP-EAP/Hetic, France.

The selected research articles related to virtual currencies and the real-money trade are:

"On Money and Magic", Edward Castronova

"Understanding 'Gold Farming' and Real-Money Trading as the Intersection of Real and Virtual Economies", Richard Heeks

"Currencies and Capitalisms on the Internet", Minna Ruckenstein

For further reading:
"Second Life's virtual money can become real-life cash", Michael S. Rosenwald, Washington Post, March 8, 2010
"In-world payments come to OpenSim grids", Maria Korolov, Hypergrid Business, March 2, 2010
"Lights Going Out in the Anti-RMT Bunker", Edward Castronova, Terra Nova, February 16, 2010
"Virtual Goods, Accounting, and the Power of the 'Rental' Model", Bill Gurley, February 8, 2010
"VirWoX Picks Neovia for L$ Exchange", Maria Korolov, Hypergrid Business, September 23, 2009

'Money' Interview on Australian Broadcasting Corporation

The Australian Broadcasting Corporation (ABC) has just released a two-part series on the topic of money and its future direction. Future Tense, hosted by Anthony Funnell, is a weekly half-hour program/podcast that takes a critical look at new technologies, new approaches and new ways of thinking.

In Part One (February 25, 2010) of 'Money', Anthony Funnell examines the changes underway in the finance and banking sector. In Part Two (March 4, 2010) of this series, he looks at the changing nature of currency. Is traditional state-issued tender now losing its monopoly? And how widespread is the use of alternative currencies - be they digital or virtual, or both?

The guest panel for part two includes: Douglas Rushkoff, author of the book Life Incorporated; Edward Castronova, Associate Professor of Telecommunications at Indiana University; Stan Stalnaker, Founder & Creative Director of Hub Culture; and Art Brock, Co-founder of the Meta-Currency Project.

Here is an interesting exchange excerpted from part two which revolves around the notion of alternative currencies threatening the authorities' control of economic policy:

Antony Funnell: One thing we haven't really focused on so far has been the response of government to the development of alternative currencies.

While things like frequent flyer points might be deemed OK, would central government really be prepared to let alternative currencies develop to the point where they threaten their control of economic policy?

In China at least there's already been a backlash, with the government in Beijing last year introducing new regulations to restrict the use of virtual money.

The crackdown was prompted after large numbers of people began using a form of online game currency called QQ coins to buy real world products and services.

Edward Castronova from Indiana University, says the Chinese example should give us pause for thought. Because, he says, along with the benefits, there are potential dangers in the development of virtual and alternative currencies.

Edward Castronova: Let's say a virtual currency sort of got out of control. Now everybody's using the virtual currency to do their day-to-day transactions. I don't think we are anywhere near that now, but let's say, it's something that could happen and in that case the people who are managing QQ coins are very influential in the real world economy. And who are they? People who developed a game. They're not elected officials, they're not appointed by any government, they're not trained necessarily in anything. And so that would be a case where the people who run a virtual environment has significant influence on what happened, out here in the real world.

And in the longer run, I think it's something to think about with that you imagine future generations of people who, they grow up and they spend some time in virtual worlds, and they spend some time in the real world, and are sort of back and forth, and they sort of develop this idea of what an economy should be and how things should work, partly by being in the real world and partly by being in the virtual world where the way people have set up the rules, can be totally different. And that might affect their expectations.

So for example, in a virtual world everybody starts out with nothing, equal playing-fields, and everybody starts out poor. Now what if that became kind of a standard cultural expectation? As you went through your life you sort of expected the real world to be like that also. The true worlds and the way they're designed could start to have an effect on what we expect the real world to look like.

Facebook Gets Out of the Way in Payments Battle

By Jon Matonis

Either lead, follow, or get out of the way. Facebook chose the third route.

I don't really understand the benefits of this latest move by Facebook to accept PayPal, but then again I wasn't present at the meetings, so it could be that I am missing part of a 'grander' strategy. It's a great deal for PayPal to acquire new subscribers. On the one hand, it paves a road for Facebook to demand Facebook Credits and 'push out' the virtual currency platform companies. But, on the other hand, it opens the door for a universal virtual currency that has the ability to move both in-and-out of the Facebook gaming environment.

Paypal is simply a VISA/Mastercard/bank account intermediary and Facebook is certainly free to develop and to extend those credit card association relationships on their own, especially with Peter Thiel on the board of Facebook. This is a layer on a layer on another layer to purchase Facebook Credits. Facebook needs revenue and their most promising path to revenue had seemed to be via exploiting the payment platform space!

With its incredible trust factor and customer brand loyalty, an international Facebook currency would be a tremendous force in the market. Any attempt now by Facebook to extend payment transactions into the non-Facebook universe would effectively nullify the non-exclusive partnership with PayPal. Instead, they chose to enrich the PayPal proprietary database with potentially millions of new subscribers. Maybe this latest move will give new juice to the freely-convertible, universal currency notion now that Facebook is out of the way.

For further reading:
"Facebook Said to Offer More Payment Options for Items in Games", Ari Levy, Brian Womack and Joseph Galante, Bloomberg, February 19, 2010
"Facebook Announces Partnership with PayPal for Ad and Credits Payments", Eric Eldon, February 18, 2010
"PayPal Integration Shows Facebook Wants to Play in Currency, Partner for Payments", Justin Smith, February 18, 2010
"Facebook’s Increasing Focus on Credits Prompts Developer Speculation", Eric Eldon, February 18, 2010
"Facebook's PayPal Killer Now Accepts PayPal", Nick Saint, February 18, 2010
"PayPal Becomes A Facebook Credits Payment Provider", Nick O'Neill, February 18, 2010
"Facebook, PayPal partner on advertising, virtual goods payments", Kim-Mai Cutler, February 18, 2010
"Facebook's New Payments System Is Increasing Virtual Goods Sales By An Impressive 25%", Rory Maher, February 9, 2010
"Facebook Cut Of Transactions Could Be High As 50%", Virtual Goods News, January 13, 2010
"'Virtual currencies' power social networks, online games", John Sutter, CNN, May 19, 2009
"Why Facebook Wants A Virtual Currency", Michael Hickins, InformationWeek's Digital Life, May 18, 2009

Virtual Goods and Real Money Trade from the European Perspective

By Petteri Günther
Virtual Economy Research Network
Friday, February 5, 2010

http://virtual-economy.org/blog/virtual_goods_and_regulatory_i

Article by Petteri Günther on EU regulatory issues in connection with real-money trade on digital items in virtual worlds. Reprinted with permission.

Introduction

Virtual worlds, for example various massively multiplayer online role playing games (MMORPGs) are becoming increasingly real to many people around the world. This emerging field of digital economy within virtual worlds has made us to face the interdependence of those and “real” offline worlds. This occurs e.g. in form of real-money trade (RMT) on digital items, while the question on property rights over digital items remains basically unresolved in Europe, although the US and the rest of the world are pretty much in the same situation.

In this blog post I concentrate particularly on issues that have risen from economic activity in connection with virtual worlds as well as online gaming frauds, in which other players often target other MMORPG end-users. The purpose is to provoke discussion on whether these developments should cause legislators to become more interested in what happens in cyberspace as RMT in virtual worlds is a wide-spread phenomenon and generates considerable economic values on a global scale. Many virtual world service providers are rather unwilling to recognize players’ rights to in-game assets, as they probably worry about liability issues, e.g. when it comes to online-world frauds that, nevertheless, are reality. Also European courts have addressed this matter quite recently.

Virtual Worlds and the EU regulatory Framework

The European Network and Information Security Agency (ENISA), which is an EU agency created to advance the functioning of the internal market, has estimated that the worldwide annual RMT of virtual goods amount to nearly 1,5 Billion Euro. [1] ENISA has reported in its 2008 report, Virtual Worlds - Real Money [2], that “the failure to recognize the importance of protecting real-money value locked up in this grey-zone of the economy has lead to a 'year of online-world fraud'.” A survey, which is included in the ENISA report, indicated that 30% of users have lost some form of virtual property through online gaming frauds targeting virtual world end-users. [3]

McInnes et al. divide regulation of virtual worlds regulation of the world itself and transactions of digital items. [4] A digital item can be defined as ”an image created by a service provider and tracked through a database that can be transformed and exchanged among users. Its value is decided through rarity, utility, and resulting demand.” [5] From a legal point of view the virtual world service providers purport to "legally link" the online and the real-life world by means of contract law through their end-user license agreements (“EULA”) and thus create private rules to compensate the somewhat absent regulation, and thus enable the potential development of "self-regulatory structures on the net." [6] In practice, this could mean industry self-regulation with respect to virtual worlds.

For the purposes of analogy to a property-style regime, we can take the International Corporation for Assigned Names and Numbers (”ICANN”) [7] as an example. It is an organization that acts as a global coordinator for internet addresses, domain names. With the aid of adopting this system, there are clearly defined property forms associated with domain names, which can also be termed as virtual property in the sense that they also are intangible assets but mimic certain characteristics of real-world assets, like exclusive ownership, persistence of rights and transfer of rights by agreement. Some online resources, such as digital items and powerful characters in massively-multiplayer online games, as well as domain names – just to point out a few, are almost identical to some physical goods in that sense that only one person at a time can control that particular resource.

There is a recent case [8] from the Netherlands where the defendants had used physical violence and thus forced the victim to hand over virtual goods in a MMO game RuneScape. The virtual goods, a mask and an amulet, were transferred from the victim’s account to the other defendant’s account in RuneScape. The court confirmed in its verdict that the said virtual goods qualify as goods under Dutch law. This was a prerequisite for the actions by the defendants, forced transfer of the virtual goods by using physical violence on the victim, to qualify as robbery (diefstal met geweld) under Article 312 of the Dutch Criminal Code.

In Finland a player had sold his World of Warcraft account to another player and, after two years used a master password to regain control of the account. The perpetrator was accused of criminal damage [9] and unauthorised use [10]. The parties settled the case later and the charges were thus dropped, so there was no final verdict on the merits of the case.

Conclusions

The concept of virtual worlds and virtual property is novel: there are precedents, neither in law nor in practice, to provide guidance. The real-money trade of virtual property is an example which shows that the real and virtual worlds are interdependent. And, while that interdependence is recognized, at the same time property rights over digital items have not yet been determined in Europe. Hence, currently it is possible to assume that there is inefficiency in allocation of rights in virtual property.

How should law treat intangible code that has been coded to resemble tangible? There are many ways to approach this question and different views are presented depending on whom you ask this question. According to Lastowka and Hunter a property system is central to the functioning of most contemporary virtual worlds. [11] But on one hand virtual world service providers assume contractual freedom by default to confirm their control over the MMORPGs and make certain their protection later on. Terms for entry to virtual worlds is regulated by EULAs, which specify the Terms of Service to declare the company’s claims regarding ownership and intellectual property rights over both game content – such as characters or items – and activity by players – the end-users. On the other hand economically efficient use of online resources would, based on Lastowka’s and Hunter’s assertions above, call for exclusive ownership, persistence of rights, transfer of rights by agreement, as well as a currency system to facilitate transactions on virtual property. [12]

Nevertheless, the volume and monetary value of RMT makes it a public policy issue of a broad impact. One solution to this situation in European context would be to apply the European mixed mode of regulation comprising industry self-regulation, such as codes of conduct for virtual worlds and establishing harmonizing regulatory instruments at the Union level to protect the rights of those within the virtual worlds as well as to support the development of virtual worlds.

A good approach, as envisioned in the Virtual Worlds - Real Money report, would be to address certain policy issues e.g. by setting up a forum for virtual world service providers to establish best practices [13]. But, if industry self-regulation finally proves inefficient to provide sufficient level of protection for users, many of whom have recently lost some form of virtual property through fraud, and where the service provider has been reluctant to address the matter and referred to their ToS banning RMT on digital items, the need for regulatory actions should be considered to clarify the issues in order to protect users.

Petteri Günther, LL.M, LL.M. (Law and IT), graduated from the University of Helsinki in 2006 and from the Stockholm University in 2007. In his master thesis (LL.M. in Law and IT) at the Stockholm University, upon which this article is based, he delved into real-money trade of virtual goods from the European perspective. The author is currently working as an associate lawyer at Lexia Ltd, a Finnish, Helsinki-based law firm, and focuses on IT and intellectual property law.

References

1 ENISA, Press Release (20.11.2008), Virtual Worlds - Real Money, http://www.enisa.europa.eu/media/press-releases/2008-prs/virtual-worlds-real-money (accessed 15.1.2010).

2 The report, Virtual Worlds - Real Money, available at http://www.enisa.europa.eu/act/it/oar/massively-multiplayer-online-games-and-social-and-corporate-virtual-worlds/security-and-privacy-in-virtual-worlds-and-gaming (accessed 15.1.2010).

3 ENISA, Press Release (20.11.2008), Virtual Worlds - Real Money, http://www.enisa.europa.eu/media/press-releases/2008-prs/virtual-worlds-real-money (accessed 15.1.2010).

4 MacInnes, Ian, Park, Y.J. and Whang, Leo Sang-Min (2004). Virtual World Governance: Digital Item Trade and its Consequences in Korea. Presented at Telecommunications Policy Research Conference, Arlington, VA. Available online at: http://web.si.umich.edu/tprc/archive-search-abstract.cfm?PaperID=382, p. 2. (accessed 15.1.2010).

5 MacInnes, Ian, Park, Y.J. and Whang, Leo Sang-Min (2004). Virtual World Governance: Digital Item Trade and its Consequences in Korea. Presented at Telecommunications Policy Research Conference, Arlington, VA. Available online at: http://web.si.umich.edu/tprc/archive-search-abstract.cfm?PaperID=382, at 5.

6 See: David R. Johnson & David Post, Law and Borders – The Rise of Law in Cyberspace, 48 Stan. L. Rev. 1367, at 1370-76 (1996) (where the authors discuss the difficulties in real world jurisdictions).

7 Internet Corporation for Assigned Names and Numbers (ICANN): http://www.icann.org/ (accessed 15.1.2010).

8 RuneScape, LJN: BG0939, Rechtbank Leeuwarden , 17/676123-07 VEV: http://zoeken.rechtspraak.nl/resultpage.aspx?snelzoeken=true&searchtype=ljn&ljn=BG0939&u_ljn=BG0939 (accessed 14.1.2010).

9 Criminal Code (Act 39/1889) Chapter 35 - Section 1 - Criminal damage (vahingonteko).

10 Criminal Code (Act 39/1889) Chapter 28 - Section 7 - Unauthorised use (luvaton käyttö).

11 Lastowka, F. Gregory and Hunter, Dan (2004). The Laws of the Virtual Worlds. 92 California Law Review 1, at 37.

12 Lastowka, F. Gregory and Hunter, Dan (2004). The Laws of the Virtual Worlds. 92 California Law Review 1, at 37.

13 Cf. Safer Social Networking Principles for the EU: the Commission convened various stake holders with respect to Europe's major social networks, and as a result, guidelines for the use of social networking sites by children developed voluntarily by the European industry. http://ec.europa.eu/information_society/activities/social_networking/eu_action/selfreg/index_en.htm (accessed 17.1.2010).

For further reading:
"The rise of goldfarming", Greedy Goblin, February 5, 2010
"Developers Should Open Virtual Goods Markets", Pixels and Policy, January 24, 2010
"How Can Developers Combat Secondary Loot Markets?", Pixels and Policy, January 20, 2010
"Keeping the gold farmers at bay: An interview with Fallen Earth's Colin Dwan", Shawn Schuster, Massively, January 4, 2010
"Real Money, Real Problems", Scott Jennings, MMORPG.com, November 18, 2009
"Digital Goods getting aisle attention", CIOL, October 30, 2009
"The fight against RMT in EVE Online", James Egan, Massively, August 11, 2009
"Debate Over the Justification and Legality of RMT", Gamerates, July 21, 2008