Virtual Money

A little over a year ago a virtual world, Second Life, shut down all virtual banks (except those with an applicable government registration statement or financial institution charter) that promised interest to its investors. This occurred because of complaints aboutGinko Financial, a bank in Second Life that offered interest rates of forty percent and more on its deposits.

Ginko collapsed in August 2007 and it was later learned that Ginko's investment strategy was simply a Ponzi scheme involving very real US dollars, reminiscent of Bernard Madoff's recent $50 billion scam. The failure of Ginko inevitably led to calls for regulation, which caused the inventor of Second Life to ban all institutions offering interest in the virtual world.

How can anyone lose real money in a virtual world? Simple. Linden dollars, the currency of Second Life, could be readily bought with very real US dollars. So… you have people enticed by high returns changing real US dollars into virtual Linden dollars, thinking wrongly that they can then change the Linden dollars back into hard US currency. They could, but not easily, and there was a run on banks in this virtual world.

It turned out that more than a few of the virtual banks promised returns that they couldn't sustain. This was a precursor of what was to happen in the real world of banking...

In the latter part of 2008, a number of very real banks in the real world began to experience similar financial troubles for notdissimilar reasons, as the value of many of their assets shrunk due to the subprime-mortage lending crisis that, among a number of other factors, helped cause a general worldwide financial meltdown. Over the course of a few weeks trillions in very real dollars were virtually (pun intended) wiped out.

Instead of being summarily shut down or made to not offer returns on investments, as banks in Second Life were, they instead went begging for money from the federal government, along with a number of other financial institutions.

Though the losses in the virtual world due to Ginko's collapse were only $750,000, it shows what can happen when financial institutions are completely unregulated. And perhaps we can take some solace in the fact that real banks are returning to Second Life, as it provides a ray of hope for real world investors.

So... what can we learn from this? Perhaps that the old adage that if something sounds too good to be true, it probably is...

(Originally published at The Creating Wealth Blog on 1/2/09)