Virtual Exchanges Get Real

A virtual heist in Second Life spurs some community members to call for oversight and regulationmaybe even the real world kindof virtual stock markets

In late July, a perpetrator with privileged information hacked into a stock exchange's computers, made false deposits, then ran off with what appears to be the equivalent of $10,000, disappearing into thin air. Despite the seemingly small haul, this heist left investors feeling outraged and vulnerable.

Oh, yes…none of this transpired in the real world. The robbery took place in Second Life, an online virtual world created by Linden Lab. Residents of this realm can take on any name and persona they choose, then wander about in the form of cartoon-like avatars. There are virtual companies courting their business, and some of them are listed on virtual stock exchanges where their shares are bought and sold by avatars with "Linden Dollars" and other virtual currencies.

Not Just Funny Money

It's here where the virtual begins to blur with the real: Linden Dollars can be swapped on virtual currency exchanges for real U.S. dollars. Though the stolen amount, 2.8 million Linden Dollars, only translates to roughly $10,000 in real money, the heist has spurred many Second Lifers to debate whether these exchanges are just a game or serious business.

At present, only Linden, with its power to remove avatars that violate its terms of use, wields any real authority in Second Life. Yet as societal overlord, Linden is declining all public comment on what it calls a third-party affair, suggesting it sees no obligation to serve as an exchange watchdog (though it reportedly helped to recover some of the stolen money). With that, some participants wonder whether other regulators, possibly even a real-world version of the Securities & Exchange Commission, may be needed to police these markets. The SEC has not discussed this issue at all, a spokesman says.

The World Stock Exchange, the market victimized in the Second Life robbery, closed temporarily after the theft for an investigation and system upgrades. The operator of the exchange, which sports an automated trading platform and integrated banking system, suspects the crime was committed by an anonymous software developer WSE hired as a consultant. The programmer, who goes by the Second Life name Thurston Hallard, also worked as a chairman of a virtual company, Mystik Designs, that was listed on the WSE until the robbery.

Competing Virtual Exchanges

Before the incident, the WSE was the dominant exchange in the virtual world with 5,800 trading accounts and 65 listed companies; trading volume on a recent day totaled 1.1 million shares worth 1.3 million Linden Dollars and 4,603 units of another currency called World Internet Currency. ("Historical" trading data can be viewed at the WSE's Web site.)

Since the security breach, some companies have left the WSE, though many were recent initial public offerings that sold poorly or firms that were in danger of being delisted because they violated WSE rules, says WSE Chief Executive Luke Connell, better known in Second Life as LukeConnell Vandeverre.

Residents say another market, the International Stock Exchange, has gotten more positive attention in light of the WSE's troubles. And a Second Life resident named Arbitrage Wise recently purchased another market, the AVIX, with a pledge to bring new transparency to virtual trading. Soon to be renamed SL Capital Exchange, the market plans to offer extensive disclosure of trading data and to adopt listing requirements recommended by Robert Bloomfield, a professor at Cornell University's Johnson Graduate School of Management who has spent the summer studying virtual markets. His recommended policies include weekly and monthly financial updates by listed companies and a requirement they carry virtual insurance.

But despite such efforts at law and order, some suggest that a Wild West atmosphere, a break from the real-life chains of rules and societal norms, may be somewhat appropriate to a realm such as Second Life. "In other virtual worlds, you can play a thief," says Bloomfield (aka Beyers Sellers). "Maybe in Second Life, if you can convince a fool to give you his money, you win."

What's In a Game?

Most virtual business experts, though wary of regulators and regulations, recognize that fraud is easier in a land where anonymity is the norm. If it were just a game, then that might be all right. But people are using these virtual businesses and exchanges to accumulate wealth that's transferable to the real world. It's still unclear how many people actually convert Lindens back to dollars, but some Second Lifers have reaped real-world fortunes (see, 11/26/06, "Second Life's First Millionaire").

At a recent panel discussion in Second Life, many participants were outraged when exchange CEOs referred to their markets as a game (see, 7/24/07, "Theory Meets Practice Online"). "There is potential for serious loss in real money that is being converted to licensed game currency," writes Shania Stewart, a proponent of increased regulation who doubles on Second Life as Mystik Boucher, the CEO of Mystik Designs, the virtual design company that employed the robbery suspect as its chairman. This person, she says, "was released immediately upon my knowledge" of his potential involvement.

Stewart, whose avatar was the first to report the alleged fraud on the WSE, says via e-mail that her virtual company is no longer listed on the WSE because she believed the exchange had no intention of disclosing what happened. WSE CEO Connell rejects that allegation.

There is no shortage of opinions among Second Lifers about whether regulations are necessary and if they are, how to approach them.

Who Will Govern Cyberspace?

One possibility pondered by the community is that a real government will step in. Lots of residents throw around this idea that the real-world U.S. government will eventually arrive in the virtual world—especially if residents start making lots of U.S. dollars that could be taxed by the Internal Revenue Service. That said, there are people with avatars from across the globe, making Second Life a potential concern among market regulators and tax authorities in other countries.

Catherine Fitzpatrick, a real-life Russian translator and virtual-world real estate manager who goes by the name Prokofy Neva, suggests that the most appropriate government body might be the U.N., even though it has little track record as a market regulator.

Of course, no government or international entity has signaled any interest in regulating the virtual world thus far. Yet with reports from Europe suggesting that terrorists might be using these otherworldly realms to launder real-world money for their activities, some residents suspect that real intelligence agencies may already be monitoring or participating in Second Life and other virtual worlds.

Most avatars seem to prefer a solution where the community starts policing itself, reducing the likelihood a government body—real or virtual—will see a need to step in. Few, however, agree on how this will or should happen.

Bloomfield is working with the Second Life Exchange Commission, a new body formed to educate residents on the exchanges and to set up guidelines. He also may organize a group of students studying business, law, computer science, and political science to create a Second Life nonprofit that recommends best practices for the stock exchanges.

But these kinds of groups are controversial among participants because the leaders are not elected and have no real authority.

Ethical and Legal Thickets

John Margarella (aka TraderJohn Susa), a real-life stockbroker who serves as chairman of the SLEC, says he'd like to develop guidelines to prevent fraud. Assessing the validity of virtual companies that want to be listed on an exchange should be easier than it is in the real world, adds Margarella. "If someone is claiming land on five [virtual] continents, you can zip there fast and check to see if they're evaluating land properly."

Some residents, of course, suggest the best solution is "buyer beware"—that there's no need for regulation in a land of make-believe.

"It's a game," says Connell, who in the physical world is the managing director of an investment firm called Hope Capital. "You don't regulate something that's not real." He says that what happened to his exchange in recent weeks was an "ethical fraud," but not a criminal act, because this is all fictional. Others disagree, as participants make real money, even if it's not much, through these virtual businesses and exchanges.

Anonymity No Longer an Option

Despite his desire to do without market regulation, Connell has made some changes. For starters, he is no longer hiring anonymous avatars to help him. Instead, software development and upgrades will now be done by people Connell knows in his first life.

Mark Bell, a doctoral student at Indiana University who is writing Second Life for Dummies, due for publication in December, says reputation and accountability will come to rule the day: The people running and participating in virtual exchanges will need to be open about their first-life identities. Such transparency will make it hard to disappear, building confidence in the market.

Even if fraud persists, no one expects the exchanges to close altogether. "It's just too fun for the residents," says Bloomfield. "Some of them think they're on the verge of creating a new economy."

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