How virtual economies created the digital wild west

In June 2020, months before the US-backed opposition to the dictatorship collapsed, a group of Venezuelans had found a better way of earning money than turning up for work: playing video games online.

Players were mulling around an area known as the Revenant Caves, an area ripe for “gold farming”, a spot in the game where characters could be levelled up quickly and then traded for US dollars online.

The process involved waiting for in-game enemies to appear before killing them as a means of rapidly building a high-profile account. Do this for long enough, and the next step is to sell the account to someone with a disposable income willing to pay up in order to skip the time investment required to build a high-level character.

The practice of “farming” in the game became so common that the March 2019 blackouts in Venezuela effectively crashed the virtual economy of runescape, causing a supply issue when the industrious farmers went offline.

According to professional Runescape players, Venezuelan gold farmers can make between $4-7 per day playing for an average of sixteen hours. This equals between B$1.3 -2.27 trillion in Venezuelan Bolívar, which can often be more than a month’s wages for nurses or even doctors.

In Runescape currency, Venezuelans require around 30m of “gold” a week to buy food and other necessities. This amount of digital gold will fetch you more than the equivalent in many currencies simply because it is stored on an American video game and therefore exchangeable, albeit by backdoor channels, with the US dollar. 

The world has seen many examples of what happens to countries where hyperinflation becomes rampant, stretching from the Zimbabwean dollar to Weimar Germany. But Venezuela has proven to be the harshest case in recent history.

At its peak, Zimbabwe inflation went from 10% in 2018 to 557% in 2020. By comparison, the biggest jump in Venezuela over a two-year period was between 2016 and 2018, when inflation rose from 254% to 65,374%, IMF data claimed.

The US Federal Reserve and the European Central Bank try to target between 2-3% inflation annually.

But in October 2020, the administrators of Runescape (called admins, or Jagex) cottoned on to the “gold farming”. They moved to implement a 100,000 gold fine for entering the cave, shutting down the access to capital which kept many Venezuelans above the poverty line.

In 2021, their online avenue is severed. But the move reflects a growing surge in online crackdowns as video game publishers and regulators alike move to prevent digital currencies from spilling over into real world economics.

Digital laundromats

The long road on this journey starts with an obscure economics professor's rise and fall, pivoting from Greek Minister of Finance to in-house video game economist at Valve Software: Yanis Varoufakis.

What attracted the Greek economist to the video games company was Valve’s dabbling in multiplayer games, specifically in communities where social economies had arisen. Varoufakis’ sandbox playcentre was Team Fortress 2, an online shooter.

But soon after its release, virtual hats were soon introduced. The hats appear in a players inventory randomly, but some appear less frequently than others, increasing their value.

When a glitch caused a rare hat to duplicate, increasing the volume of hats which players could wear, the value of the hat went down — effectively causing inflation and crashing the value of the hat economy as traders lost faith in the long-term value of the virtual hats.

This is not dissimilar from the way the Runescape economy crashed when Venezuelan gamers no longer had access because of blackouts, except the first crash was caused by oversupply not undersupply.

Varoufakis’ idea was to introduce an element of gambling into the virtual economy. In order to find rare hats and items, players can purchase a virtual “key” which then unlocks randomly allocated “crates'' which then offer items or hats of random value, giving players who want to spend a bit of real-world cash in exchange for the possibility of winning rare items the chance to do so.

“I don’t have a great deal of respect for their views [of the Austrian school of economics] when it comes to the real economy, but it seems to me that these digital economies, it’s [almost as if video games] were created for the purposes of giving as a real-life example of seeing Hayek, and Von Mises and Adam Smith at work.”

Later, in virtual worlds, this gambling system would soon become a target of the EU and the FBI.

From the “key and crate” gambling system comes modern-day microtransactions, a term gamers use to describe small purchases in online multiplayer games where real world cash is exchanged for virtual items.

Years later, after Varoufakis had left the company, these keys would become the means by which criminal gangs would launder millions in and out of different countries. 

Worldwide fraud networks switched to another Valve game, Counter Strike Global Offensive, using the keys that Varoufakis created to liquidate their online holdings and funnel dirty cash into clean accounts.

Valve was forced to change its key system, but not before almost 100% of the keys were found to be used for the purpose of money laundering.

The Epic Games CEO Tim Sweeney has also risen alongside Newell as a video games tycoon in recent years. Their most popular title Fortnite, a game whose youngest professional player (making £23,600) is an eight-year-old, has seen a rise in money laundering.

“The game's digital currency is V-Bucks, and in-game weapons are used to purchase accessories,” said Sanction Scammer, an anti-money laundering compliance solutions firm. “Criminals sign up for Fortnite, create a profile, and buy lots of V-Bucks or accessories with illegal or illegal credit cards.”

The UK’s Financial Action Task Force (FAFT) has identified video games as a key area to push back against criminal activities, but video games are outside the realm of traditional regulation and it’s unclear to what degree authorities can trespass on to what is seen as being in the realms of private businesses.

The reason why criminals are turning to video games speaks in part to the success which authorities have had in policing money laundering activities. As in Venezuela, virtual economies are rapidly rising to replace elements of the real economy, making early founders rich in the process.

The new robber barons

But we need not imagine a future where entrepreneurs become rich for owning digital property. Anshe Chung, the online avatar of Ailin Graef, became the first virtual millionaire via her status as the largest landowner in the online virtual world Second Life.

While Chung was rich in virtual currency long before Second Life, she was never able to convert her online winnings into US currency until the studio behind the game, Linden Lab, introduced Linden Dollars, virtual currency which can be converted at a floating rate against the US dollar, making it a closed-loop digital currency.

As the ex-CEO of Second Life admitted in an interview with CNN, whose article dubbed Chung as the virtual equivalent of Rockefeller, the richest man in American history, Chung functions as something of a quasi-government in the game.

Owning an entire ‘zone’ of the game herself and operating it not unlike an 18th century robber baron. Chung buys and develops land, then sells or rents it to other residents. Current prices start at L$10,000, which at the time of writing is $31, but plots have sold for almost a million.

And she’s not alone. Investment funds from Wall Street are looking to muscle in on virtual real estate as well, with Republic setting up an investment fund solely for virtual real estate.

The world includes everything from currency exchanges to virtual sex clubs, and one hilarious anecdote involving Ginko Financial.

Ginko Financial was the virtual bank of Second Life, except it wasn’t set up by the developers. The person or persons who ran it remain anonymous, but it became clear after three years its creation that the owners were running a Ponzi scheme.

The bank promised people 40% of their cash back if they stored their money with the unregulated bank, but the managers were secretly paying the excess with new money coming in from unsuspecting investors, disguising the cash as profit.

When the scam came to light, a bank run ensued, causing US$750,000 to disappear overnight and the virtual bank managers to flee. The collapse drove calls for developer resignations and more transparency in the virtual financial world, just like equivalent financial crashes in the real world.

The move also led to the developer inviting FBI agents to examine the game’s economy, with the agency shutting down its virtual casinos and banning gambling, reported WIRED.

It should come as no surprise that a US Congressional Committee is currently investigating how to tax the game and its virtual economy.

Virtual real estate

Will virtual real estate ever eclipse physical real estate? That is akin to asking whether a virtual economy will ever replace the physical economy. But as the example of Venezuela demonstrates, in some cases it already has.

Economies, virtual or otherwise, which can offer more stable stores of value and have easier exchange mechanisms will always outcompete more cumbersome currencies, if government regulation does not prevent it.

Inefficient sections of the economy in the real world will inevitably give way to more liquid online economies, in a way which, far from being sinister, is a step which could enable struggling communities to make ends meet via online services.

But on inspecting Chung’s portfolio, it is clear the entrepreneur owns a sleugh of successful businesses, not all of which are online. She made a lot of her initial money via selling in-game animations, as well as renting out in-game servers, with virtual real estate making up only a portion.

Real estate, when talked about as an investment, is valuable because we have the option of living in it or else using it for business purposes. It’s value increases because we have only limited space on the planet, and far less space in desirable locations.

Virtual real estate, by comparison, has none of those constraints. Games like No Man’s Sky and Minecraft have virtual worlds which procedurally generate themselves as the user moves through them, making the space inhabited by the user limitless, and, by extension, valueless.

Servers are a different kettle of fish. Ninety percent of all the world’s data has been created in the last two years, with technology companies like Microsoft, the world’ largest owner of web servers, scrambling to meet the demand.

The data storage crisis has pushed researchers to look for alternative methods of storage which will prove more efficient in the long run, such as synthetic DNA technology. But for now, the limit on the physical storage is what drives the value of the online servers.

Web servers require physical space, and so the value they hold in the virtual world is in fact a reflection of the physical space they take up.

The same is true of virtual worlds... to an extent. While procedurally generated worlds side step the idea of limited virtual space, real estate in high-demand games like Second Life where the world is pre-set and finite will remain valuable so long as users keep playing.

In this case, virtual real estate functions more like a currency than physical real estate. Users of Second Life have faith that the developer Linden Lab will not arbitrarily create more.

However, as has happened with many governments previously, it is not uncommon for an authority to seize assets when under financial strain. If the value of virtual property in Second Life rose into the multi-billions, it would of course be possible for the game developers to create more in-game property and sell it for huge profit margins.

This is known in economics as the Triffin dilemma. The dilemma is usually used to describe the role of the US dollar as a reserve currency, but can be explained as follows:

People demand that the authority which controls the most valuable currency lend out more of it in order for wealth to increase. But it is precisely the belief that the authority will not lend without restraint which gives the currency its value. This creates the Triffin paradox.

The trust which exists between Linden Lab and the game players is the same trust which exists between the government and its people.

Scarcity

Varoufakis pointed out that the Austrian school of economics, particularly Hayek’s free market theories, are in many cases more applicable to virtual economies than they are to real life economies. This is because behavioural economics is much less relevant online than it is in the real world.

From a Hayekian point of view, video-game market places are closer to a free market than anything comparable in the real world, even though they are regulated to a degree.

But the same is true for other schools of economic thought. The Labour Theory of Value, in Marxists economic theory, states that the value of something is determined by the total amount of labour required to produce it.

We can find numerous examples in the real world where this theory fails to hold water. Blank canvases at art galleries sell for US$15 million at art galleries, while inversely authors can spend decades on books which make little to no money.

Online, however, the theory proves better at holding water. Eve Online, an online space flight-sim, saw factions clash in a virtual battle which cost US$378,012 in real damage, part of an ongoing virtual war which has seen almost US$1 million of asset destruction.

In this case, the value is created precisely because the ships destroyed in the conflict take thousands of in-game hours aggregated to build up. The labour which went into creating the ships is real and equates to real-world value.

Here, I propose a marriage of the two theories. The Marxist school is correct in asserting that the labour determined the value of the online asset, but the Austrian school is correct in that this value is derived because of scarcity; the ships take a long time to build, therefore they are very rare, making them valuable.

When labour is able to create a scarce resource, then its value will increase. The labour is a source of the value, but only indirectly, with scarcity being the dominating factor. Non-fungible tokens demonstrate the point that rarity triumphs over labour cost in the online world.

With online worlds becoming an ever-more important part of our lives, it is not hard to imagine whole societies inhabiting a double-life. Countries like Venezuela with floundering economies may find they are able to export services in virtual worlds, with the “fake” economy becoming more structurally important to developing countries than the “real”.

As more virtual worlds begin to cross boundaries between fake and real currencies, the distinction between real assets and virtual assets will continue to blur. As long as scarcity is maintained for virtual items in the online world, then as Varoufakis asserted, the Hayekian breeding ground of virtual economies could well seep into the offline world far sooner than anticipated.