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Technology & Innovation

The Rise of Virtual Economies

As our lives become ever more virtual, retailers are betting there will be increasing demand for virtual goods as well. In the future, gaming and retail will be a fully integrated experience.

Thomas Jefferson envisioned America as a nation of small farmers. But today millions more Americans cultivate virtual farms in online games like FarmVille and Ranch Town than work in real cornfields. Over 200 million people around the globe play Facebook games each month, and millions more play online role playing games like World of Warcraft or interact in the virtual world Second Life. And as our social lives become more and more virtual, retailers and advertisers are betting there will be increasing demand for virtual goods as well. In the future, gaming and retail will be a fully integrated experience. 

The U.S. virtual goods market is expected to grow to $2.1 billion in 2011, about half of which are items purchased in popular Facebook games. With over 80 million active users, FarmVille is currently the most popular online game on Facebook, but it is just one of many online games in which thousands of players can interact and spend real money on virtual goods. In Farmville, players can buy seeds to plant in their farm; they can even give a cow or horse to a friend. In Sorority Life, another game from Farmville developers Zynga, players can spend money on formal wear, gifts for friends, and limited edition boyfriends. 

Jesse Schell, CEO of Schell Games, explains to Big Think that convincing people to spend real money inside video games is not naturally intuitive to video game designers—but they’re getting better at it. “What you have to do is you have to create a situation where people are going to want to put money in,” he says. “So you have to find a way that people are going to feel invested, and if you look at the way a lot of the successful online games are created—particularly the free ones—they create a situation where they work hard to get you psychologically invested, and then they find exactly the appropriate time to kind of say, ‘You know, this game could be a little better if you would just put five bucks or if you would just put ten dollars in.'”

The prospect of paying real money for something that doesn’t exist may sound like a waste of money, but Edward Castronova, a professor of telecommunications at Indiana University, says that virtual goods are not that different from real ones. People buy virtual goods for a variety of reasons: they can provide entertainment, indicate social status, or boost social capital through gifting. Aside from basic necessities, don’t we buy real goods for similar reasons, he asks. With so much of what we consume, the value is essentially “virtual,” not tied to any objective use, says Castronova. According to the Department of Labor, entertainment makes up only 5.49% of household expenditures, but much of the remaining 77% for housing, food, apparel, transportation, and miscellaneous expenditures is tied to social status. As more consumers begin to play online games, virtual goods will “unquestionably” take a chunk out of the market for these real goods, he believes.

Until recently, a major limitation of virtual purchases was that each online economy, whether FarmVille, World of Warcraft, or Second Life, had its own currency. But Facebook is looking to change all that with its new currency, Facebook Credits. The company plans to make Credits a universal virtual currency that can be used not only across all Facebook applications but also outside of Facebook. Currently, Facebook Credits aren’t technically a currency; they are a commodity, like airline miles, that can be exchanged for virtual goods in many of the half-million Facebook applications. The next logical step is that Facebook would allow people to use this virtual commodity to purchase real goods and services in an online marketplace.

Facebook Credits won’t become a “real” currency until they are tradable or until one can exchange them for cash. “There needs to be a mechanism for setting a value for Facebook Credits in the currency/foreign exchange market,” says Brett King, author of “Bank 2.0.” He is optimistic that “once speculators can trade on Facebook credits, then that is when we know that it is a real currency.” But how exactly will this transaction occur? King envisions a company like Western Union offering a physical exchange office. “Bring USD, walk out with FB credits in your Facebook account, or vice-versa.” Or the transaction could remain entirely online. “Imagine PayPal offering you the option to cash out Facebook Credits for a fixed fee of $1.00 or similar. Then if you need to pay your plumber, dog sitter, or cleaning lady, you could do it via Facebook. They could then transfer the money from Facebook to their bank account via PayPal.”

Obviously there are reasons why nations wouldn’t want a corporation to issue its own currency. If it were a country, Facebook would be the third largest in the world. So its currency could theoretically exert strong pressures on the dollar, the Euro, or other “real” currencies. “If people feel that Facebook Credits are going to rise in value, then they might take U.S. dollars and exchange them for Facebook Credits; if enough people do that then the value of the USD starts to decline against Facebook’s currency,” says King. “Then it is just a matter of time before the reverse happens. Think about the fact that Facebook has a population of 500 million people. If even 10 per cent of those start trading Facebook Credits then it would potentially be a more powerful currency than say the Aussie, Hong Kong or Singapore dollars.”

Something similar has already happened. In China in 2007, a virtual currency called the QQ coin made the jump from commodity to real currency. In rural areas of China, where the Internet is far more prevalent than credit cards, stores began to accept virtual QQ coins as payment for real goods and services. “QQ coins become so ubiquitous and were being traded with such volume and frequency that they did start to drag down the value of the Yuan,” King says. “People were essentially cashing in their real Chinese currency (Yuan/RMB) to buy QQ coins. QQ coins were appreciating in value against the Yuan. Thus, within China the Yuan was starting to get devalued against a virtual currency, meaning you had more buying power with QQ coins than physical notes. This was pretty scary for the Chinese government—even the US couldn’t achieve this level of disruption to the Yuan.”

Is it far-fetched to think that virtual goods and Facebook Credits could have such a large impact on the real economy in the U.S. or Europe? Stranger things have happened. Surely Jefferson couldn’t have imagined a day when we would spend real money to plant digital seeds made up of ones and zeros. 

More Resources:

— Department of Labor infographic on American household expenditures.

— TechCrunch feature on the business of virtual goods.


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