Insights from Second Life for Metaverse Economies

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Introduction

What we’ve been noticing

Launched back in 2003, Second Life is an early example of a complex metaverse and digging into its history provides useful insights for those building the next generation of metaverses. Despite predating Bitcoin, it has a currency, the Linden Dollar, that is tradable back and forth for US dollars. It has a complex, user-run, economy with a $650 million annual GDP as of 2022, making for a larger economy than several countries. The company behind the game, Linden Lab, takes a fee from trades in their economy, providing a good test case for transaction-fee-based revenue models (though they do also have optional subscription fees as well).

Key Topics this Article will Cover:

• Introduction (above)

• Analysis of the Economy

  • A. Land Allocation

  • B. Monetary Policy

  • C. Taxes

  • D. Real Estate

• Economic Issues and their Impact

  • A. Free Content

  • B. Power Allocation

• Conclusion

Analysis of the Economy

A. Land Allocation

Land is an important metaverse component with many potential implementation pitfalls, some of which can be avoided by learning from Second Life. Early on, Linden Lab sold land to users at an extremely cheap fixed price. This led to frequent speculation by “land barons” who would buy up land (sometimes using automation tools) and resell it later for a profit. Efforts to limit cheap land sales to only new, landless players were frequently circumvented through the use of multiple accounts.

Linden Lab currently uses auctions for facilitating all land sales, which helps allocate to the highest bidder, rather than those who buy the fastest, however it can still exclude new players. Linden Lab also instituted a Land Use Fee, which charges players a monthly fee based on how much land they own. This ongoing cost somewhat dissuades speculators who do not intend to build on the land and pushes ownership more into the hands of those who will build. However, the fee is just based on land size, without accounting for differences in land value based on location.

This could be improved through a Land Value Tax method that ties the ongoing fee to an estimate of the valuation of individual land plots. Though some of the variations in pricing between plots are reduced through the implementation of free teleporting for all players. Previous versions had limited or paid teleporting, which created additional benefits to having land in a specific location.

The total quantity of land is (usually) not limited and scales up with players, which can satisfy the demand of new players as long as they don’t care about being close to a particular area. This focus on accessibility vs value accrual through limited supply and locational benefits through travel time differs from some more recent metaverse launches with limited land.

Another component to consider is that Second Life’s lack of zoning restrictions led to conflict between players using land in ways that clashed with their neighbours. In the worst cases, some players leveraged the appearance of their land to extort neighbouring property owners. 

B. Monetary Policy

Another important area of Second Life’s economy to examine is its monetary policy for Linden dollars. The currency’s role is as a medium of exchange, which is relevant for understanding currencies chosen in other metaverses and crucially distinct from metaverse tokens that focus on equity-like value accrual. This makes price stability important for Linden Dollars and other mediums of exchange currencies as excessive inflation can devalue savings and deflation can reduce spending (both of which can lead to players leaving).

Price uncertainty in the early years led to pricing problems for participants and the creation of a currency board in 2006 that would sell Linden dollars. This created a price ceiling where Linden Lab would sell an unlimited amount of currency at the ceiling price to keep the price from rising too high and the circulating supply of tokens would then depend on player demand.

A common reason for price volatility for medium-of-exchange tokens in metaverses is speculation (despite not having a method for value accrual to these tokens), which can require methods, like a price ceiling or other threats of sell pressure, to dissuade speculators from excessively pumping the token price. 

An important reason Linden Labs did not just peg their currency to another (like the US dollar) is that they wanted to retain the ability to stimulate activity through inflationary rewards. Early players would receive a recurring stipend of Linden Dollars and while this has currently been mostly reduced to rewards for subscription-paying premium members, there are still some old accounts that continue to get these rewards. These inflationary distributions must be carefully limited to ensure they are balanced out by sinks (mechanics like transaction fees that take L$ out of the economy). 

C. Taxes

The in-world economy is almost entirely player-run, with participants creating the buildings and virtual goods. Linden Lab taxes these transactions as part of its revenue model, showing that this can be a viable monetization method. Note that participants are earning Linden Dollars directly from other participants in exchange for an item or service they value, not from the game for activities that don’t provide value, as seen in some play-to-earn games. There was a particular case of rewarding non-skilled labour where players would pay others to “camp” (leave their avatar) on their land in order to increase their traffic score for search visibility, but the funding still came from players with demand stemming from misaligned incentives to game the traffic system. Game designers should consider what markets they may be created depending on how they structure various incentives and mechanics that impact businesses in their economy. 

D. Real Estate

Within the Second Life economy, real estate construction is the largest industry. This is a case that shows a tradeoff between complexity and proving employment opportunities in virtual economies. A metaverse project with an intuitive and easy building process would mean more construction by end users, rather than paying someone else to build it. Skill-based specialization leads to more robust economies than ones that are generally accessible but makes it harder for participants to pivot if their profession becomes less economically viable.

Economic Issues and their Impact

A. Free Content

Second Life has run into some economic issues that can provide a warning to other metaverse projects. The first is the situation of companies providing content for free (or even paying users) since they make money outside the Second Life economy and can treat it as an advertising cost. This does require some way for the item to convey a connection or other benefit to that company. This is crucial to limit items that have important utility to ensure a viable user-created economy for them.

The issue may be of less importance for cosmetics, as these items would be less substitutable and an advertisement could reduce demand for that asset relative to other products. Another large issue in Second Life is the presence of large economic inequality. Second life at times has had a Gini coefficient greater than 90%, meaning 90% of the money is held by the top 10% of players. Metaverse designers should consider the impact of financial and governance control in the distribution of tokens, land, and other resources.

B. Power Allocation

Those creating metaverses should understand the power they wield over their economy, especially if choosing to hand some of that power over to others, with something like a DAO structure. This power can be used to create market power for certain entities, for example, Linden Lab created a business advantage for “InfoNet,” a for-profit newspaper, by creating access points to it in places where businesses were not normally allowed.

While this change had a direct business impact, there can be indirect impacts as well. Linden Lab also caused a bank run at Ginko Financial after announcing the closure of casinos. Ginko had many ATMs in casinos and players emptied the bank’s reserves, while other capital was tied up in illiquid investments. Those in power should consider the secondary impact of changes and aim to mitigate harm to various types of participants. This involves examining the second-order impact of their actions, as well as potential proactive oversight or regulation around any financial institutions that arise in their respective metaverses.

With real money on the line, and the power to boost revenue or eliminate competition, it’s quite important for metaverse teams to consider who they want to give power to and how they will keep a single rich group from taking over and gaining monopoly power within their economy. 

Conclusion

Second Life has laid an excellent foundation of learnings for future metaverse creators. They should be wary of speculators who try to get land for cheap and may not use it if there are no ongoing costs for holding. Speculators can cause similar issues for currency stability, which shows the benefit of considering a price ceiling model or other strategies to prevent excessive price increases. Creators should also be aware of how companies can subsidize cheap production with external revenue can negatively affect their economies. Some regulations may be beneficial to prevent participants from taking advantage of others. Finally, those building metaverses should know to be careful wielding their power to control market competition with real money on the line and even more cautious when passing that power over to others.

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Got a question for our author regarding his article? Contact him at:

Kiefer Zhang | Associate Consultant
E: Kiefer.Z@EconomicsDesign.com | W: EconomicsDesign.com

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