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Virtual currencies on their way to conquer the real economy

Have you heard of Twollars yet? Maybe not, but by now you've probably heard of Facebook credits. Social networks are developing virtual currencies who could be used by hundreds of millions of consumers, with consequences whose scale we are just beginning to measure. Where will the cash flows derived from these transactions transit?

November 2011
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Executive Summary

Money did not wait for Mark Zuckerberg to begin dematerializing. Our salary and our savings are not counted in gold coins, or even in bank notes: in today’s world, they are just a bunch of lines listed on our bank accounts. The same applies to financial transactions that take place in New York, London and Frankfurt, every day making and breaking the real economy. But these amounts, be they small or large, are denominated in legal tender.

Monopoly 2.0

However a new kind of currency is developing these days, which have no place in the real world – yet. They are virtual, in both senses of the term: they are only used on the Internet and have no equivalent in metal. They have no real value whatsoever, but do have use value: the value that people who use them are willing to grant them.

Only yesterday, such 2.0 currencies would have been overlooked as simple variations of Monopoly banknotes. In fact, the frame of virtual gaming worlds is the environment where these currencies have grown fastest, and specifically within massively multiplayer online games (MMOG, sometimes abbreviated in MMO). Online games like World of Warcraft or Star Wars - The Old Republic have created their own currency, which allow you to purchase accessories necessary to survive online. And the frenzy of players is such that they are willing to exchange real hard-won dollars or euros for such monkey monies. What we are witnessing here is the emergence of a draft of convertibility. Specialized websites, such as, have even opened genuine brokerage firms, where one can buy and sell diverse credits for different games, and where each virtual currency undergoes quotation daily.

In Second Life, a virtual 3D universe that was released in 2003, users can create game content (from clothing to buildings), but can also market it. Its economic ecosystem works with Linden dollars, which are convertible into dollars via the LindeX platform. Companies have invested, through communication or marketing budgets, and each Second Life paying subscriber gets a weekly amount in Linden$, that allows him or her to acquire virtual items and services from other users. Some internet users derive sizable virtual amounts from these services, soon converted into real incomes.

But Second Life is now losing steam and even though a real economy has developed inside of it, it has remained marginal in comparison to the real economy. It took the development of social networks, rooted in real life as they are, for virtual currencies to really take off and enter a new dimension. While Twollars used on Twitter to reward a good deed may seem purely anecdotal, Facebook Credits, on the other hand, virtually deal with over half a billion people – and what matters most is that their connection to the real world is much stronger than with Linden dollars or WoW Gold. It is no longer about trading for fun, between avatars, within a closed universe: it is about real transactions between real people.

The point, then, is no longer to organize economic flows within a world that is alternative to reality, but to set up a different way to circulate money in the real world. That is a whole new dimension. And to understand what is at stake today, we must broaden the scope of our references. The virtual currencies that are emerging nowadays may borrow experience from online games, but they also stem from two universes that were originally separate and that now tend to fertilize each other: counterculture and marketing.

Alternative currencies

The first one is characterized by an underlying aspiration to promote sharing and solidarity, a strong interest in non-commercial exchanges, and definitely a taste for self or collective management and basically anything that will allow society in general, or communities in particular, to organize freely, beyond the reach of states and outside the market economy. This is the mindset that fathered experiments in local exchange trading systems (LETS), which are among the first known examples of alternative currencies. Alternative trading systems operate within the framework of local associations to allow their members to exchange goods, services and knowledge without having to resort to traditional currency. Often cited is the example of Chiemgauer that have been developing in Bavaria since 2003 with remarkable success. But the experimentation boom that the world has witnessed has taken place both in developed countries and within emerging nations.

In Europe, LETS are usually associated with a leftist political culture, but in the United States they also trace back to a libertarian tradition, where incidentally the Tea Party movement also has its roots. In Canada, where the movement was born in 1983, local exchange trading systems were designed in a less ideological manner, as stated in the manual written by Michael Linton, founder of the first network.

The original idea was to provide a supplement to local currency to facilitate trade in services, particularly among and between people short in cash. For instance, a member of a LETS can earn credits by looking after an elderly person and later spend these credits with another person belonging to the same network. Transactions are recorded in a central registry that is open to all members. The purpose of a LETS is to get to boost and foster exchanges, especially those dealing in services that would have a hard time to be monetized in a market economy.

Customer loyalty programs constitute the second lineage of virtual currencies. The oldest ones purportedly go as far back as the late eighteenth century and, starting in the nineteenth century, large firms have set out to build customer loyalty through gift vouchers and other coupons. But it was in the 1980s, at about the same time that the first LETS appeared, that the models that are widespread today took off.

Airlines, in the context of deregulation launched by President Reagan, turned out to be the most inventive. American Airlines was the first to embark on this trend, soon followed by most large companies and by firms in other sectors. The first and foremost objective was to resist competition and thus to confront the tidal wave of liberalization that came in the 1980s. But this model also came into being in a particular context: that of developed economies reaching a stage of maturity where the natural growth in the number of customers of a given service becomes limited. The first aim of the famous “miles” that allow us to travel without spending a penny is to secure our brand loyalty, and to reconstitute a captive clientele. It is now a marketing classic – one of the very foundations of this discipline, actually.

Initially, the only rewards were travels. This was a simple reallocation of cash flows within the company: a fraction of customer revenues was used to finance these awards given to the most loyal passengers. But soon more elaborated models followed, in which a monetization of reward points was developed so that they could be used to acquire goods or services in other brands and shops. A good example of multi-enterprise programs is the one that has been set up in France, revolving around the national railway company, SNCF. Six major outlet brand names and one bank reward spendings and cash withdrawals through a common system: loyalty points can be redeemed for gifts, vouchers, train tickets, gift cards and “Savings certificates”, i.e. money. Thus, this model communicates with the real economy. But it was designed to primarily operate in-house, by redirecting customers towards the goods and services provided by companies that are members of the network.

Currencies 2.0

Such a networked model is also at the heart of the monetary ecosystems that thrive on the Internet today. But with the C Coins of the Chinese company Tencent QQ and now with Facebook Credits, we are moving into high gear. And inside this change in dimension something radically new is emerging, so much so that as soon as 2007 the Chinese Central Bank raised the alarm on a competing risk between Q Coins and the yuan.Let us try to understand what is at stake by taking the example of Facebook Credits.

Launched in late 2009, they can be purchased with a credit card, a PayPal account, and through systems such as Zong mobile payments. In Asia they are even available in 7-Eleven stores. Since 1 July 2011, their use is mandatory for game and services publishers on Facebook, even if the latter are entitled to keep their own virtual currency (like FarmCash in the famous game Farmville). No need to be a rocket scientist to guess that between “local” currencies like Farmville’s, and one used on the entire network, the choice will be a no-brainer.

Just like Amazon and Apple in online business, Facebook takes a 30% percentage on any transaction carried out in Facebook Credits. The stakes are already considerable, as the market for virtual goods totaled incomes in excess of two billion dollars in the United States just for 2011, according to an investigation by Inside Network, a specialist firm.

But Facebook Credits are not limited to purchasing virtual goods, because while Facebook is home to online gaming, social networking is also at the heart of a much larger set of exchanges, of consumption of cultural goods and services but also of human interaction, part of which is liable to be monetized. Examples abound. In the U.S., through Facebook Credits, not only can you vote for game show contestants (as an alternative to premium SMS), you can also buy Warner movies with them. The ambition of the social network is to turn them into the common currency for everything that will be acquired by downloading from its website – eBooks, music, movies, newspaper articles, tickets (including airplane tickets) ... Quite a significant fraction of online business could eventually be involved.

And it's not just about collecting a percentage on sales, but about monetizing what, at present, is still free: a recommendation, for instance, or clicking on an advertisement, could bring in Facebook Credits to the network’s members. Facebooks Credits are thus acquiring a use value that is almost comparable to that of a real currency, insofar as they can be used in multiple types of transactions.

One of the benefits of Facebook Credits is to streamline online transactions. For the Californian company, the challenge is both to develop these transactions, to monetize them, and to turn its virtual currency into some kind of universal currency. What’s at stake? Soaking up a significant share of online business, and more generally of Internet transactions, so as to collect a commission on these cash flows.

Already, a number of activities have sprouted up around the new currencies. In 2010, Google paid out $ 70 million to take over Jambool, a company specializing in virtual currency solutions.

The widespread use of Facebook Credits in the Facebook ecosystem is just the beginning. Facebook announced on Oct. 25 that it would encourage the dissemination of its credits outside its network.

A Challenge for States

What is happening is not merely a business revolution. It is also a tectonic shift whose consequences are still difficult to assess for the time being. For what we are witnessing is indeed the emergence of a new international currency.

Theorically, both stocks and flows of currency are tightly controlled by the states, which having the sole right to issue currency derive a significant portion of their resources from taxes imposed on transactions – starting with the tax on added value. The California company, which has the monopoly on the issuing of its currency and collects tax on transactions, effectively acts exactly as a state – a private and transnational state, which would be several hundred millions of virtual citizens strong. Granted, today neither you nor I have used those credits, but what of tomorrow?

One of the first problems posed by these developments is tax evasion. Of course, Facebook is taxed on its income. But the money circulating internally is not taxed – or rather it is taxed, but by Facebook itself, not by public entities. As noted by the Swedish blogger Rick Falkvinge: “From a political perspective, this development means that taxation and welfare systems and rethought must be rethought and rewired considerably and immediately”. Moreover, Falkvinge recently announced that he was investing all his savings in bitcoins, one virtual currency he slates as having a very promising future.

This poses the problem of speculation and bubbles. Do companies that control the emission of virtual currencies have the technical competence of central banks? We can seriously feel dubious about it.

Another risk is arising, that of money laundering, or, on another level, the development of a labor market outside the legal framework. Cases have been reported, known as gold farming, where people working from home (or youngsters in developing countries spending hours in Internet cafes) earn points on behalf of online players who are otherwise too busy to play themselves. And to make things worse, the former are paid in virtual currency.

There is growing concern all over the world among officials as they are confronted to the most glaring problems posed by virtual currencies. The fastest to react were the Chinese, ever watchful about the rate of the yuan: in the face of the rapid development of Q Coins and the threat this posed to the management of the national currency, the authorities have banned virtual currencies with variable exchange rate, restricting their use to the purchase of virtual goods and services only. Physical assets have therefore been excluded. Such interventions however are unlikely to curb a phenomenon of global magnitude such as the one unfolding around Facebook as we speak. Let us just wager that the issue at hand will sooner or later make the headlines.

Richard Robert
Executive Director, Paris Innovation Review