Aviators, Moguls, Fashionistas and Barons: Economics and Ownership in Second Life

Second Life is a digital world that relies on a unique combination of grid computing and streaming technology [Rosedale03] to enable virtually all of its content to be created by its residents. To maximize the quality and quantity of user-created content, Second Life has embraced strong economic and legal connections to the real world. This approach is quite different than conventional massively multiplayer online games (MMOGs). Since Second Life launched in June of 2003, significant changes have been made to the business model and internal economic structure. These changes have shaped the many approaches residents have taken to creating content, building experiences and making real-world profits. This article will discuss the evolution of Second Life's business model and internal economy, its entrepreneurial activities, and the impact of those activities on Second Life's residents and community.

To the Beat of a Different Drummer

MMOGs generally follow similar paths regarding ties to the real world and business models. As spelled out in their End-User Licensing Agreements (EULA) and Terms of Service (ToS), most digital world operators own all of the content in their world, own any content generated by the player, and specifically deny residents the right to earn real-world incomes while using of the digital world. Sony [Koster2002] and Turbine [Castronova2004a] have followed through on their EULAs by banning the sale of digital items and currency on eBay. Most MMOGs are also subscription services, requiring ongoing monthly payments from all players in order to stay in the games.

Second Life takes a very different approach, recognizing residents' intellectual property rights to their creations, allowing them to generate real-world income [Linden03], and selling them as much digital real estate as they desire [Linden04]. As a user-created digital world, the ultimate success of Second Life is coupled to the innovation and creativity of its residents, not to ownership of their intellectual property. This is also a practical decision, as MMOGs establish economic links to the real world independent of the wishes of the developers or world operators. Land sales allow a more efficient and equitable allocation of resources and enable entrepreneurs to speculate in ways not previously available to them.

Heads in the Sand

MMOGs tend to be extremely time-intensive experiences, with players often spending 20 or more hours per week [Yee04] in world. Players with more money than time generate a demand for high-level characters, items and currency, while players with more time than money have an opportunity to supply all of these. Markets thus exist whether the EULA permits it or not. As Sony discovered, banning EverQuest sales on eBay simply moved the trade to other sites, such as PlayerAuctions and IGE. In fact, despite the nearly universal prohibition on legitimate digital item trading, the global market is conservatively estimated at $75 million [Castronova2004b] and experiencing very strong growth.

Game publishers continue to officially ignore the reality of item trading [Reynolds04], despite the untested, but intriguing, legal implications of failing to enforce their EULAs. Further muddying the water, some publishers have talked openly of monetizing digital item sales [Combs04], although it is interesting that the target is not subscription MMOGs but rather single and multiplayer games that have an online component.

Digital Property

The ownership of digital property is also an important question. Even leaving aside the debate about whether digital goods are property at all [Lastowka03], definitive answers do not exist about the enforceability of EULAs that retain ownership of everything created by players within MMOGs [Dibbell03a]. In fact, examination of hosting, colocation and bandwidth providers' EULAs show that it is simpler to allow customers to retain their intellectual property rights.

From an economic standpoint, property rights are critical to strong markets [Bernstein04], businesses [DeSoto00], and innovation [North94]. The already large digital item market would undergo dramatic growth if its participants were able to move out of the current gray and black markets. Additionally, strong and efficient markets also lead to rapid evolution of user-created content, as observed within Second Life.

Revolting Taxes

Second Life runs on an expanding grid of computers; however CPU, memory and bandwidth resources need to be limited and allocated to residents in a predictable and equitable manner. Initially, a complicated system of creation costs, taxes and stipends was chosen as the best method. Objects and land that a resident owned in world would generate a weekly tax burden. Residents would pay these taxes using Linden Dollars (L$, Second Life's internal currency) they had received from other users, by selling their creations, and from their stipend. Their stipend was a weekly payout that changed based on the resident's reputation. Residents paid a flat monthly subscription fee in US$.

This system had numerous problems. In order for taxes to effectively balance load, they had to be insanely high. As a result, very few residents were able to create on a large scale, and it was extremely difficult to create experiences or games within Second Life. Rich residents were able to generate severely non-uniform load on the system, magnifying the inequities between the wealthy and the poor. Resident frustration culminated in the "Second Life Tax Revolt" [Grimmelmann03], where residents picketed, held Boston tea parties, and set fire to numerous structures.

A New Model

Although some of the frustration could be linked to the general dislike of taxes, the revolt forced an examination of the deeper problems. Residents had learned that creating experiences on a large scale, such as creating a city rather than just a building, made Second Life much more compelling. Similar to conventional MMOGs [Yee03] where multiple accounts allow dedicated users to enrich their experience by spending more money, Second Life residents and entrepreneurs demanded a mechanism to create on a larger scale, even if it meant paying more.

The system of creation costs and taxes was removed, as was the monthly subscription fee. Instead, the amount of land a resident owned acted to limit the scale of creation. If a resident wanted to build more, they simply purchased more land. Since land was a scarce resource, it was auctioned off continuously. Thus, land ownership consists of an up-front cost, the auction price, and an ongoing cost in the form of a maintenance fee. Residents can own as much land as they need and can change how much the own each month. Those who want to create complete experiences even have the option of purchasing estates that aren't directly connected to the mainland and that have more advanced access controls than normal land. Despite some initial concern over the dramatic nature of the changes, virtual real estate has proven to be quite successful [MSNBC04].

Land values vary in Second Life because arbitrary teleportation is not allowed and some global rules vary from location to location [Ondrejka04]. "Telehubs" provide a public transportation system, so land closer to a telehub will experience higher traffic than a more distant local. Areas within Second Life are also divided into "Mature" and "Non-Mature", with appropriate changes in Community Standards, so depending upon desired use, different types of land may be more or less valuable. Finally, aesthetic issues clearly matter, as beachfront property in Second Life has consistently sold for more than inland plots.

The stipend still exists. By providing residents with a steady income, the velocity of money within the economy remains high and consumers have little incentive to hoard what they have. The stipend has a minimum amount keyed to being a member in good standing and is supplemented by daily dwell awards. Dwell awards are L$ payments to the residents whose land receives the most visitors during the previous day. L$ drains also exist, in the form of land that is auctioned for L$, upload fees for adding textures, audio, and animations into the world, and listing fees for the in-world find functionality.

Economic Strength

While inflation could be a concern in this economic model, Second Life's rapid and sustained growth in 2004 has actually resulted in a mild reduction in median and average balances. More importantly, unlike other MMOGs, the L$ has actually appreciated against the US$. Second Life's internal economy has also grown significantly since changing models, with monthly internal economic activity passing US$1 million at current L$ to US$ exchange rates. Transactional volume has undergone dramatic increases as well.

Digital Entrepreneurs

Second Life had the pieces in place to generate sustained economic growth at the start of 2004. Residents owned their creations, were free to profit off of their activities within the world, and could speculate and experiment with large creations simply by purchasing land. The opportunity to earn real-world profits was enabled when third party sites connected Second Life's L$ to US$.

Currency Trading

IGE and Gaming Open Market have both supported L$ trading since late-2003. Both have seen strong growth in sales volume, and currently trade well over US$100,000 worth of L$ between them per month. Second Life has not experienced the "mudflation" generally seen in other online games due to duplication bugs, shortcuts in the treadmill, and commodification. This stability has made the L$ a worthwhile investment and allowed in-world businesses to generate significant real-world wealth. In fact, going shopping with your friends has become a major activity within Second Life.

Trendsetting

Clothing and avatar stores were the first businesses within Second Life. Because the built-in avatar creation and customization tools are the first skills learned upon entering the world, virtually all residents learn that they are able to create clothing and avatars. Obviously, the quality and desirability of clothing will vary, but many residents attempt to inspire the next Second Life fashion craze. The transition to the new land model allowed speculators and entrepreneurs to build stores that supported large and varied displays, so designers with complementary skill sets began working together to improve the shopping experience. The ability to buy more land has allowed creators to explore franchising, multiple locations, advertising, and branding. Second Life's approach to intellectual property also means that budding fashionistas actually own their creations, whether in the digital or real worlds. One real world firm is even taking advantage of this to "cool hunt" within Second Life [STD04], exporting content from the digital to the real.

Clothing and accessories often act as a gateway to other retail opportunities. Storeowners can distinguish themselves from their competition by offering vehicles or weapons, or by selling clothing that matches other creations. Alternately, small outlets are often added to existing clubs and other popular location. Sellers quickly learn that the realities of a digital world, such as no marginal cost of reproduction and no need to keep inventory on hand, allow them to be flexible and experimental in their sales approaches.

Shoppers are able to choose stores based on text searches, the popularity of the store, and the recommendations of other residents. This results in a virtually infinite supply of new clothing ideas and options, sold in environments ranging from shopping malls to remote boutiques floating in the sky. For many of the storeowners, the shopping experience is as important as the actual clothing they sell, so meeting and greeting the clientele is a big part of their business.

All Dressed Up

Of course, once the perfect clothes and accessories have been purchased, seeing and being seen becomes the next important activity. Clubs and events are very popular in Second Life and make up another common business venture. As with stores, bigger is often better and many residents have chosen to make large land purchases in order to fully explore their visions.

Clubs, ranging from Wild West saloons to science fiction cantinas to clubs that would make Las Vegas blush, provide destinations and meeting grounds. Clubs consistently receive the most traffic within Second Life, and are often used to launch or sell other products. Clubs earn L$ for their owners and operators both through dwell awards and through goods and services sold within them. Clubs often act as locations for various events, although events also occur at private homes and public stages.

Resident-run events within Second Life are a common way to meet large numbers of other residents. They also can have economic motivations, as many give out prize money or are used to generate higher dwell awards. Events of all types exist. Costume parties, trivia contests, themed chat, open houses and game shows are quite common. Educational events, where residents teach new users about the best ways to accomplish various tasks within Second Life, are also extremely popular. Residents who entered Second Life without any formal programming training now teach hundreds of people how best to create airplanes, weapons, and other scripted objects.

Inventing the New

The ability to truly create within Second Life, and the rapid commoditization of content within MMOGs in general, provides a real opportunity to profit for those who come up with new ideas. The scripting language and creation tools can be used to provide features and behaviors not yet built into the system, to implement ideas better than everyone else, and to simply explore design space.

Second Life doesn't yet implement multiple avatar animations but several enterprising residents independently solved the problem [Au04c] by using the scripting language and user-created animations to allow avatars to hug each other. In each case, multiple groups of residents worked together and combined various skills and expertise. Their products have sold quite well and have served as the inspiration for the next round of animation scripts.

The popularity of shops, clubs, and events has also created a high demand for architects and those with a strong industrial design sense. While many residents can create a home or a store, fewer are able to design one that shows items well, allows avatars to move through it smoothly, and consumes minimal system resources so that more people can visit and enjoy it.

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Come Fly With Me

In Second Life, everyone can fly. Despite (or perhaps because of) this, wings and flying vehicles have generally been on the cutting edge of user development from early in Second Life's Alpha. Although vehicles of all types have been created, flying vehicles have always been dominant, from the early jetpacks and wings, through the hot-air balloon races, to the current high performance aerobatic and dog fighting aircraft. Residents with a passion for flying have taken great advantage of the new economic system as it allows them to build airports and aerodromes.

Recently, a skydiving craze has swept though Second Life [Au04b]. The owners of "Abbotts Aerodrome" have created one of the most complete experiences within Second Life, allowing other residents to take skydiving classes, join groups for multi-person jumps, compete in contests, purchase upgraded equipment, look at screen shots of jumps, and even buy a jump plane to take up their own groups. The skydiving equipment utilized the skills of scripters, modelers, texture artists and animators, as well as in-world jumpmasters, teachers, and community organizers. Even more importantly, skydiving is just part of the experience of visiting the Aerodrome. New vehicles appear almost daily and the owners are usually around to talk about flying, scripting, or how to make something new.

Capitalism at Play

With a healthy and stable market for L$, many Second Life residents are actively trying to generate real-world profits. Some are using those profits to augment or replace their real-world jobs. Unfortunately, markets also offer opportunities that range from unpopular to illegal. Like all other online services, Second Life has to deal with credit card fraud, identity theft, and, of course, the PayPal chargeback. This last happens when the thief purchases digital goods using PayPal and then, exploiting a quirk in their chargeback policy, reverses the payment. This leaves the thief with both the digital goods and his original money, while the victim has neither. Even worse, the victim generally has no recourse [Dibbell03c]. This particular exploit has been documented [Cringely04] and it is likely that eBay and PayPal, in conjunction with digital world operators, will find an appropriate solution.

Land Barons

Land in Second Life is a scarce resource and is released to residents via auction. Some residents quickly determined that they could purchase land, subdivide it, and resell it in world for a profit. Land barons have proven to be unpopular with the other residents and discussion threads about the problem have shown up regularly in game forums.

The problem is both one of perception and of fact. The reality is that the speculators are so efficient and motivated to win auctions that other residents have been largely squeezed out of the auction system. For example, over a recent 30-day period, only 5% of those residents who purchased land had purchased it from the auction system. The other 95% buy land from the land speculators.

This gives rise to the perceptual problem. Although many speculators spend time and effort subdividing the land, performing small terraforming tasks, and generally preparing to sell the subdivided parcels, most residents don't feel that any value is added in this process and that the new land is exorbitantly expensive. In reality, the price increase is only about 10% above the auction price. More importantly, the smaller parcels are cheap enough to be purchased by a much larger percentage of the residents. Second Life recently added a "First Land" feature that greatly simplified land purchases for new users. As a result, speculators are changing their approaches to land resale.

Going forward, it seems certain that virtual real estate agents within Second Life will have to compete with each other for business. As in the real world, agents who add value by correctly staging property, doing research about the property's location, and who actively manage their client lists, will be able to charge a premium for their services. As the world continues to grow, the ability to connect buyer and seller will be increasingly valuable.

Bringing on the Lag

Second Life's open-ended building and scripting tools provide residents with ample opportunities to stress both the client rendering and server simulation. These stresses are broadly classified as "lag," where the client's frame rate drops or updates from the server are delayed or blocked. As in other MMOGs, properly timed lag can be used to gain an advantage over other players or to interfere with their businesses. Second Life does allow residents more opportunities to generate lag than any other MMOG, but it isn't possible to eliminate this without greatly damaging the flexibility and culture of experimentation so critical to growth. Instead, creations within Second Life always indicate both their creator and current owner, generally allowing residents to quickly determine the source of problems. In addition, malicious use of the system is a serious violation of the Community Standards. Much like the real world, an arms race exists between business owners and criminals, and much of the continuing development effort in Second Life is focused on ensuring that businesses are free to operate.

Timeshifting

The average person has a very full schedule. For the average American, television, work and sleep, are enough to take most of the hours in the week. While people have begun to exchange television viewing for game playing [Loftus04], the high time cost of MMOG play is still a significant problem for many. The very real possibility of generating an income within Second Life can change that.

As Julian Dibbell can attest, it is possible to make a living selling digital goods [Dibbell03b]. Several of Second Life's more successful creators are using their profits to pay for tuition or as income while unemployed [Au04a]. For many of these digital entrepreneurs, the ability to make money doing something that they enjoy is a new experience. Residents often join Second Life with no idea that they possessed the creative skills or business acumen needed to make and sell digital items, but the ease of experimentation and readily available in-world educational resources lead them to explore the possibilities.

Some have even setup databases in the real world, tracking inventory, sales, and customer data from their multiple stores within Second Life. Using this data, they adjust product lines, prices, and advertising, acquiring skills and knowledge that would be acquired at far greater financial risk in the real world. For example, residents have discovered that Sunday is the largest shopping day in Second Life and that attractive but simple displays generate more sales. Undoubtedly, some will eventually transfer their newfound business acumen back into the real world.

Conclusion

Second Life's transition from a simple subscription model to one based on land and intellectual property ownership has profoundly changed creation within the world. Residents are able to create on a larger scale, to explore new ways to earn real-world profits, and to leverage their early successes into more land and opportunities. Trade with the real world, in the form of currency exchanges on 3rd party sites, has increased steadily and the L$ has appreciated in value against the US$. On the other hand, economic temptations have also increased as more residents supplement their income via Second Life, and both unpopular and fraudulent behaviors have been observed. Most importantly, the primary goal of the change, increased quantity and quality of user-created content, has been conclusively observed.

Second Life is proving that users truly can create a world, as well as compelling experiences within that world. Leveraging user-creation is far more than simply providing users with the correct tools. A complex set of economic and legal choices exist and any project that expects quality output needs to carefully consider the interaction of all of them. Economic factors provide a powerful selection pressure for high quality content while property rights provide creators with the incentives to work on large projects over significant periods of time. Filtering and search functionality required to separate the wheat from the chaff becomes increasingly important as the content creation scales up with the world population.

As the world of Second Life grows and new functionality improves the experience for all residents, its markets and connections to the real world will also grow and strengthen. This is a different path than conventional MMOGs, but an absolutely necessary one for building a truly user-created place.

Further Reading

For more information on law, economics, and digital worlds, the references provide a wealth of information. In addition, the following websites and mailing lists are excellent sources of data and debate:

References

[Au04a] Au, Wagner James, "Post War Reconstruction, Part 1" available online, April 26, 2004.
[Au04b] Au, Wagner James, "Taking a Dive" available online, July 19, 2004.
[Au04c] Au, Wagner James, "Permission to Hug" available online, August 19, 2004.
[Bernstein04] Bernstein, William, The Birth of Plenty, McGraw-Hill, 2004.
[Casronova04a] Castronova, Edward, "Veteran Virtual World Bans Ebay," available online, July 27, 2004.
[Casronova04b] Castronova, Edward, "Data," available online, 2004.
[Combs04] Combs, Nate, "…The Dam Breaks" available online, May 14, 2004.
[Cringely04] Cringely, Robert, "PayAcquantance - When It Comes to Selling Virtual Property, PayPal Isn't Always Your Pal," available online, May 6, 2004.
[DeSoto00] De Soto, Hernando, The Mystery of Capital, Basic Books, 2000.
[Dibbell03a] Dibbell, Julian, "Serfing the Web" available online, January, 2003.
[Dibbell03b] Dibbell, Julian, "Play Money" available online, March 11, 2003.
[Dibbell03c] Dibbell, Julian, "On the Nature of the Intangible: A Dialog" available online, October 17, 2003.
[Grimmelmann03] Grimmelmann, James, "The State of Play: Free As In Gaming?," available online, December 4, 2003.
[Koster02] Koster, Raph, "Online Worlds Timeline," available online, February 20, 2002.
[Lastowka03] Lastowka, F. Gregory, Hunter, Dan, "The Laws of Virtual Worlds," available online, May 29, 2003.
[Linden03] "Your Second Life Begins Today," available online, June 23, 2003.
[Linden04] "Now Selling: Real Estate on the Digital Frontier," available online, March 30, 2004.
[Loftus04] Loftus, Tom, "TV execs try to lure gamers back - Golf players watch golf, but will video game players watch games?," available online, April 30, 2004.
[North94] North, Douglas, "Economic Performance Through Time," available online, June 1994.
[Ondrejka04] Ondrejka, Cory, "A Piece of Place: Modeling the Digital on the Real in Second Life," available online, June 7, 2004.
[Reynolds04] Reynolds, Ren, "EAs Eyes Wide Shut" available online, August 13, 2004.
[Rosedale03] Rosedale, Philip, Ondrejka, Cory, "Enabling Player-Created Online Worlds
with Grid Computing and Streaming," available online, September, 2003.
[STD04] "Future Fashion 04," available online, July 28, 2004.
[Yee03b] Yes, Nick, "Number of Accounts," available online, February 11, 2003.
[Yee04] Yes, Nick, "Hours of Play Per Week," available online, February 21, 2004.

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