The phony economics of Second Life

 Original article here , posted on Tue 20 Feb 2007

ANALYSIS Two weeks ago, business leaders at Davos gave their blessing to Linden Lab's Second Life. They hailed the spectacular growth of its virtual economy while politicians spoke of democracy itself moving into its online world.

But little of this coverage questioned its true popularity, or how sustainable its "virtual economy" might be.

Second Life went live in 2003, burning through $8m of venture capital investment over the next three years. And it remained invisible until recently - with a few mentions on enthusiast weblogs. But in March 2006, Linden Lab used some of an $11m additional investment from VC firms, and from Amazon's Jeff Bezos, eBay's Pierre Omidyar, and the Open Source Foundation's Mitch Kapor, to hire a professional agency, Flashpoint PR.

It was now business journalists who began to spread the word.

The Wharton School, Business 2.0, the Harvard Business Review - all wrote approvingly of Second Life's virtual economy. Newsnight's business correspondent, Paul Mason, entered it and interviewed an "in world" entrepeneur. The Guardian's former business editor Victor Keegan declared it, "the beginning of a whole new world." But, the most enthusiastic business reporter following Second Life has been Business Week's Robert D Hof. He has reported that it could challenge Windows as a way to create business software.

The coverage was less than complete, however. For example, there was scant mention of Linden Lab's scaling issues. Second Life's servers - which are hosted exclusively by Linden Lab - can only support between 50 and 100 avatars in one place at one time. Newsnight's party crashed after only 30 "guests" arrived. Melbourne's The Age reported Ben Folds launching an album before an "in world" audience of 25.

Virtual maths

Second Life needs large numbers of both producers and consumers if it is to represent the "new, new economy". However, its own estimation of user numbers is questionable.

Last October, Linden Lab claimed it had a million residents. By December, it was reporting two million. Second Life's front page now proclaims 3.1 million residents.

A "resident" of Second Life, as defined by Linden Lab, is a login of its software. Remove the clients belonging to the same email address or payment details and the number of residents falls by over half a million. Remove the number of clients resolving to the same IP address, and it falls still further.

Only 15 per cent of those who became residents in October of last year ever logged in again after their first 30 days - a churn rate that might surprise and dismay executives from other industries. Remove all those who never returned to Second Life after their first month and the figure falls from a then two million residents to around a quarter of a million. Typically, there are only around 15,000 clients logged in to Second Life at any one time.

In other words, this economy has a population about the size of Ilkeston, Derbyshire, or Troutdale, Oregon. And each business has the prospect of a market of no more than 100 people in one place - a number easily accommodated by a church hall.

Second Life also claims it has not just a passive population, but an active community of entrepeneurs.

To become an entrepreneur in Second Life - to fulfil the business press's predictions for the virtual economy - a user needs a premium account. These start at $9.95 a month. They grant the user a plot of virtual land and the permanent presence necessary to start an "in world" business.

Unsurprisingly, with the level of traction so low, Linden Lab says it expects to gain most of its revenue, around 70 per cent, from virtual land sales and maintenance fees.

Some real estate developers like the Graefs, Second Life's first virtual "millionaires", have brought large amounts of virtual land to parcel up and sell on. And many of the existing businesses in Second Life sell things like scripts and 3D textures that are essential to newcomers looking to start a business there. All rely on a supply of new users entering Second Life, not as tourists but as budding entrepreneurs. And these new entrants are expected to ignore the role of scarcity as the source of value. They have to defy Mark Twain's advice and buy "land" while Linden Lab is still making it.

The latest figures show that there are less than 50,000 of these premium accounts. So, only a fifth of Second Life's returning users have a premium account that lets them fully participate in its economy. With around 15,000 concurrent logins, it is possible to speculate that there may be as few as 3,000 paying customers online at any one time (although this figure would rise if they logged on more frequently and for longer than those with free accounts).

Linden Lab itself estimates the number of "in world business owners" by counting those with a positive monthly cashflow. There were over 21,000 of these last month. For more than 11,000 of them, however, their positive cashflow came to less than US$10. And this is before Linden Lab's charges were applied to their account.

So, from the three million residents who, we are told, are living the dream of a virtual economy, we arrive at a figure of around 3,000 economically active users at any one time - most of whom are turning over only a token sum.

This is a far cry from the predictions of the business journalists.

"Residents spend...a total of nearly 23,000 hours a day creating things," raved Business Week's Hof. "It would take a paid 4,100-person software team to do all that, says Linden Lab... Think of it: the company charges customers anywhere from $6 to thousands of dollars a month for the privilege of doing most of the work... In other words, your next cubicle could well be inside a virtual world."

There's no there, there

We can only speculate on why business journalists have inflated Second Life's importance. Perhaps it fulfills their predictions that commerce will become "weightless" and move beyond government control. Or, it's simply a great place to have a mid-life crisis - certainly a safer one than the saddle of a Harley or the au pair's bed. But what is not in doubt is that they haven't let the facts poop their party.

But, what of those ordinary users drawn to Second Life by the promise of a new economy where new millionaires will be created? They are expected to invest real money and then conduct their "in world" transactions in Linden Dollars.

Linden Lab also has been careless with enforcing property rights, the foundation of a typical capitalist economy, as entrepreneurs have seen their work cloned within seconds. Jennifer Granick, of the Stanford Law School, has written that Second Life users' rights are unenforceable without the expense of a federal lawsuit.

Finally, after the US's recent crackdown on internet gambling, in a Linden Lab statement on the legality of Second Life's many casinos, the status of Linden Dollars was at last explained:

"Linden Dollars are not money, they are neither funds nor credit for funds. Linden Dollars represent a limited license right to use a feature of the simulated environment. Linden Lab does not offer any right of redemption for any sum of money, or any other guarantee of monetary value, for Linden Dollars."

Second Life's "virtual economy" with "real money" has yet to be visited by the Feds. If it is, then Linden Lab will reserve the right to say that Second Life is only a game