You probably haven’t heard of Joshua Zarwel (Second Life’s ‘Teufel Hauptmann’), but he was the very first person I thought of when Linden Lab banned banking last week. ‘Hauptmann’ doesn’t get a lot of press. He’s never been accused of insider trading or blackmail in the Second Life Herald, he doesn’t spend much money on his avatar, he doesn’t issue cringe-inducing press releases, and he doesn’t have his name in diamonds above his virtual door. In short, he’s the kind of guy you want managing your money.

You probably haven’t heard of SL Bank, Zarwel’s investment fund, either — its consistent, honest, 27-30% return rate pales in comparison to claims of 100% to 300% from other banks. The fund’s web site is plain, and its entire in-world presence consists of one tiny, unremarkable virtual building. The building has standard-issue white walls and a bright blue tile floor. It just fits on the 512m plot of land that is included with Zarwel’s Second Life account. It does not have a waterfront view or a private heliport; it is wedged between one store selling costumes for avatars and another selling construction supplies.

SL Bank’s whole in-world presence, from floor to ceiling, uses 102 prims (prims are the basic shapes used to build, the more you use the more you pay). That is about half as many prims as are used in the gilded fountain on the landscaped lawn in front of the sprawling headquarters of one of SL Bank’s better-known competitors. SL Bank has no plush conference rooms, no scrolling tickers for buddies’ virtual stock prices, no flat-panel TVs hanging from the ceiling, no glittering dollar signs on the walls, and no menacing avatar bodyguards.

What SL Bank does have is integrity — lots of it. When Linden Lab ended banking in Second Life last week, Zarwel did something I’ve not heard of any other banker doing: he quietly announced that every single Linden Dollar in his customers’ accounts was available for immediate withdrawal. No compulsory shifts to shady bonds, no “liquidity problems,” no complex deals with friends. ‘Hauptmann’ didn’t have to make excuses because SL Bank was not insolvent.

He made money by taking advantage of an inefficient market for Linden Dollars and, until landbots became common, an inefficient market for virtual land. He bought for less than he sold. Consistently. It is not glamorous, and it takes a lot of effort, but it works. It is easier to make large returns (like Zarwel’s 27-30%) in an emerging economy than a mature one using this method because emerging economies have less efficient markets. This is something ‘Hauptmann’ can point to with specificity. It is real and quantifiable, unlike other Second Life bankers’ vague incantations about the “speed of the economy” and the “stupendous growth rate” of the virtual world.

This story is an important coda to a point I have felt compelled to make far too often over the last year. Many banks in Second Life were ponzi schemes, many relied on phony accounting, and many are now insolvent — but not all of them. SL Bank, and, in all likelihood, a few others, quietly built legitimate, highly profitable operations that would have easily satisfied any auditor, and more importantly, at least from the standpoint of those who would like to see virtual worlds remain as free from further regulation as possible, would not have attracted unwanted attention in the first place.

It is easy for lawyers and journalists to focus on the negatives in the virtual world banking industry, but that is only part of the story. The other part is the story of SL Bank, and that story is best told by ‘Hauptmann’ himself.

“VB” is Virtually Blind, “TH” is ‘Teufel Hauptmann.’

VB: You go by ‘Teufel Hauptmann’ in-world, but you’ve been pretty open about who you are. Can you tell readers a bit about yourself?

TH: I’m 29 years old, 30 this February (oh my god!). I was born in Germany, grew up just outside of Washington, DC and now live in New York City where I work as a consultant and study at New York University where I completed a BA in Economics and am now slowly working on a graduate degree with a focus on Development Economics & Globalization Studies.

I became interested in virtual worlds after my cousin introduced me to Ultima Online in early 1998. There had been other massive multiplayer online games before it (MUDs I believe they were called) but this was the first I had seen with a graphical interface. After a few hours, I was hooked. A few months into playing I noticed a surprisingly high level of inflation in the economy. I began to investigate and found that the hyperinflationary state was due to constant injection of “gold” into the virtual economy. (After each virtual kill, you would often be rewarded with “loot” in the form of gold, which could then be traded with other players or used to buy virtual goods such as weapons or reagents from Non-Player Characters.) This was the first time I asked myself an economic question pertaining to a virtual world. When I learned about Second Life and its open and often volatile economy, I joined the next day. That was back in 2005, when Second Life was MUCH smaller and no one but us true geeks had any idea of what Second Life was.

VB: Were you surprised by Linden Lab’s decision to ban banking?

TH: Simple answer, no. I had been expecting it for years. When I saw the blog post, my immediate reaction was “Oh, it finally happened.” I wasn’t happy about it, but not upset. The fact is that it was simply too easy for anyone to set themselves up as a “bank”, “fund” “stock exchange” or whatever, and take in deposits even if they had no idea of what they were doing and/or if they were someone there to simply steal deposited funds.

VB: How rampant do you feel fraud was in the virtual world banking industry prior to the Linden Lab policy change?

TH: That is difficult for me to gauge. I have definitely heard of at least three “banks” which had shut down operation and simply left the world, never returning a large majority of deposits. I have also heard of at least five “CEOs” of virtual companies which raised capital via a virtual stock exchange and then left Second Life with the raised IPO funds never to be heard from again. The main problem I saw was with accountability. Many people in Second Life seem to feel that it is a normal thing to not disclose who you are in real life; bank owner or not. Because of this, people may have felt it was normal to invest in a virtual bank, fund, stock or stock exchange which did not disclose any real world information. Some “scammers” may have taken advantage of this train of thought and the human being’s weakness of greed and opened such projects with the intent to steal deposited funds with little to no fear of anyone calling them out on their lack of transparency. Simply open a fancy looking bank or stock market, tell anyone who asks that you don’t wish to disclose who you are as that is your right in a virtual world, offer an eye catching rate, sit back and wait for deposits, shut down shop and go on a six month vacation.

VB: I was really impressed with SL Bank when we communicated last summer, to the degree that I intended (though I never got around to it) to deposit some Linden Dollars with you, even though I felt there was a lot of fraud in the industry as a whole. Can you explain to readers what your business model was?

TH: SL Bank is/was an arbitrage fund. In virtual worlds, due to smaller populations and higher risks (LL could turn off the L$ anytime or simply shut down SL all together), markets are less efficient than similar markets in the real world. SL Bank took advantage of this situation by arbitraging those inefficiencies. We would, for example, buy L$ on the LindeX and then sell them again at a profit on the same exchange. SL Bank would also buy and sell virtual land, but we moved away from land trading after “land bots” made the land market more efficient and less profitable. Because our deposits were used to arbitrage L$ exchange inefficiencies, they remained liquid, which is important in a virtual world where the economy is volatile and change is frequent.

We did not invest in any other financial projects in SL. This allowed us to maintain complete control over our holdings. As we now see, some banks, exchanges and funds in SL are having trouble liquidating because their funds are tied up in yet other banking and exchange projects which are having the same problem.

We kept our bank location to a minimum. Why buy entire sims to place one measly ATM? SL Bank’s in world location consists of one 512 plot on which the ATM sits. The plot is paid for by my SL account, which provides one free 512 plot with your subscription to the SL service. Thus, none of our funds were tied up in lavish banking locations.

And finally, we tried to be as transparent as possible. If you check our website and/or in world note card you will see that we provide our real world names, addresses, backgrounds, profitability, fund allocation, etc. We had nothing to hide, nor did we ever wish to be anonymous.

Our goal was to remain highly liquid, profitable, to retain complete control over all of our holdings at all times, to be transparent and to be as thrifty with in world purchases and land holdings as possible.

VB: The rate of return you paid hovered around 27-30%, that’s high by real world standards, but it is much, much lower than most virtual banks — one was offering over 350% when the new policy went into effect. How did you attract customers?

TH: Accountability and transparency. Our niche in the market was those who were looking for a lower risk investment. By providing our clients with our real world identities and a model which focused on liquidity, clients, who normally would not invest in Second Life finance, came to us. Our interest rates were lower than most if not all of the other financial projects in Second Life, but with this lower return came lower risk. And now, at the end, we see that the choice of taking a less risky investment has paid off. As many virtual financial firms are struggling to liquidate and pay off what they owe their clients, SL Bank has all funds available for withdraw with no withdraw limit and no restrictions.

VB: I know you were open about the land and currency arbitrage business model with me, but how much of that did you disclose to your depositors?

TH: Everything which has been disclosed to you has been available on our in world note card and our website which actually provides slightly more details than what I have given you thus far. In fact, our website goes into details about the risks of trading virtual currency, land and the natural risks of investing in a virtual world.

VB: How reasonable are claims that other banks made that they could pay more than 300% interest due to the “economic growth” of Second Life?

TH: I have a policy of not commenting on other specific projects in Second Life, bank or not. But I can say that a promised return of 300% is highly unlikely, I don’t care how quickly the economy may have been growing. The only way to attempt to cover such a rate would be through highly risky, unethical or even illegal means. And any loans given out to try and cover such a rate must have such an astronomically high default rate, it would seem counterproductive.

VB: Beyond the straightforward land and currency arbitrage business model, what made your bank different from other banks in Second Life?

TH: I’d say that our willingness to disclose information about ourselves and how the fund functioned is what truly separated us from the rest. No secret formulas or models “which would be disclosed later.” No hiding behind avatars. Just a simple business model that worked and a couple of guys who wanted to make people a few extra L$ while making a little extra for themselves.

VB: Have your customers been able to withdraw the funds they had on deposit with you? Describe the wind-down process.

Yes, about an hour after I read the Linden Lab policy blog post, all funds were made available for withdraw and the withdraw limit eliminated. At first the bank was full of confused clients wondering about the new policy, some were angry with the policy but all were happy their funds were available for withdraw. We have discontinued interest payments and are allowing all of our clients to withdraw their balance with no restrictions. I plan to keep the ATM up and available until the LL deadline at which point I will shut down the ATM, but keep the bank location open as a kind of memorial to a hobby I enjoyed for close to two years.

VB: How have your clients reacted to the end of SL Bank?

That’s the saddest part. I have received many IMs and emails wishing us the best and thanking us for our service. Some relied on us to help them cover tier payments. Others just enjoyed watching their balance grow as they “explored” the grid. Some were real world investors who placed a percentage of their real world portfolio into Second Life and SL Bank. They were clients of ours, so naturally they found the project appealing and so many are upset that we will no longer be providing the service.

VB: What do you see as the future of banking in virtual worlds?

TH: In virtual worlds with open economies such as Second Life, where the exchange of currency and products can be conducted between the virtual and real world, I believe banking and investing will become more and more regulated and mundane. The number of real world financial institutions moving into virtual worlds such as Second Life will probably increase, but they will more than likely focus on marketing for real world services rather than offer in world investment platforms. Those who do offer in world “investments” will probably do so with the hopes that those investing very small amounts in the virtual world, will eventually invest real world money with the firm in question at their real world location. At this point, I feel the risks, high level of opportunity cost, and the uncertainty of investing in virtual worlds will keep most real world financial firms from offering in world services beyond basic advising or investing seminars. But this could change as virtual populations and the amount of money involved increases as well as the security and reliability of in world transactions.

VB: Will you be part of it? What are your plans for your future in virtual worlds?

TH: I’ll probably take a sit back and watch approach. I have been working on a couple of papers outlining my experience and have given several presentations on virtual finance and virtual economies, focusing mainly on the histories of these economies, how they have evolved, problems with them, benefits, etc. I have done some consulting for a couple of real world firms regarding virtual economies and “metanomics” if you will, and hope to continue to do so in the future, although I may no longer be directly involved in virtual finance.

VB: Is there anything else you’d like to tell VB readers?

TH: The thing I’ll miss most about SL Bank will be the joy I received knowing that people used and appreciated the service. I just wanted to thank anyone who may have used or even checked out our service and wish everyone the best. If anyone ever has any questions, they can always reach me via email at: jzarwel@nyu.edu.