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.

Read the rest of the post »

VB is pleased to bring readers a new, notable paper in virtual law, Leave Those Orcs Alone: Property Rights in Virtual Worlds, (.pdf) by UCLA law student Kevin Deenihan.

The paper argues that virtual worlds and games should be essentially free from real life legal intervention. In reaching this conclusion, Deenihan provides a solid overview of the existing arguments against commodification, and adds several wrinkles of his own. His big-picture look at the assumption that real life law should apply to these spaces should resonate with both developers and users who advocate in-world solutions.

From the summary of Leave Those Orcs Alone:

Players and their characters earn virtual property to socialize, for fun, or for status, not for protection or investment. Shoehorning in a legal system that protects investment and ignores the value of fun and communality would do terrible violence to these societies. Far better utility results from allowing users and developers to continue elaborating on their quasi-legal systems in peace.

Among many other intriguing points, Deenihan argues that real world legal intervention is more likely to result in rules that benefit bad elements than average users.

The litigants with the most incentive to sue, and thus to have their interest recognized, are typically those whose role in Virtual Worlds is considered negative by wide swathes of the playerbase: gold farmers, account sellers, and exploiters.

The paper is to some degree at odds with much of the recent academic literature on legal issues in virtual worlds, and indeed, with the very premise of this site. Most writers, including VB’s editor, take commodification and subsequent legal intervention as a foregone conclusion at this point. That is in no way a criticism of the paper — Deenihan raises questions that are fundamental and important, and that are all too often overlooked.

Deenihan is a student at UCLA School of Law. He is a native of the San Francisco Bay Area, and graduated from UC Berkeley with an Economics degree. His main is a Paladin (and if you don’t know what that means, you need to spend more time “earning virtual property to socialize, for fun, and for status”).

With Deenihan’s paper, VB is launching a new feature, “Reading Room,” where we will periodically feature notable papers in virtual law which are, at least for the moment, exclusively available here. If you have written or are writing a virtual law-related paper that you would like to have hosted at VB, email the editor for more information.

As virtual worlds continue suffering through legal growing pains, both mainstream press and the blogosphere are covering virtual law more often. There are a number of errors that pop up in these stories with surprising regularity. Here, in the opinion of VB’s editor, are the top five fumbles.

Fumble #5: “The cases are settling, so the lawsuits will stop!” For better or worse, this is pretty silly. First, about 95% of all lawsuits settle — that’s just how it works. Second, only one of the three major virtual law cases last year actually did settle outright (the Bragg case) and since Bragg got his virtual land back and is, once again, a Second Life resident, you have to figure he did fine in that deal. The other two cases (Eros v. Leatherwood, and the six-creator lawsuit against Thomas Simon, aka ‘Rase Kenzo’) in fact ended in formal judgments of liability (albeit, respectively, by default and consent). These are all, in some sense, plaintiff wins, and wins encourage lawsuits. In reality, three things will dictate whether there are more or fewer suits in the future: (1) the number of people using virtual worlds, (2) the amount of money at stake in actionable claims, and (3) the availability of effective in-world dispute resolution tools.

Fumble #4: “People shouldn’t go to jail for negligence!” This usually shows up as an outraged response to an article where a lawyer says that a company or individual could be held “liable” for something fairly innocuous. Generally, all the lawyer is saying is that the person or company might be subject to civil liability — a lawsuit. There’s no prison for people who breach contracts or, in most cases, for executives who act negligently, just a loss of money and some bad press following a videotaped deposition, hundreds of interrogatories, and a lengthy trial… of course, some might argue that fate is actually worse. [Addendum: criminal negligence exists, though it is not usually what "liability" is referring to here. See comment #2.]

Fumble #3: “Real life law doesn’t apply to virtual worlds!” This argument pops up less and less now, largely thanks to the three fairly high profile lawsuits that concluded last year, discussed above. You still see it in the comments following mainstream articles about virtual law, however, and not infrequently in “whoa, dude,” blog posts too. It’s just a knee-jerk reaction to the fact that virtual worlds appear game-like. The law, of course, is widely applied to the “virtual” already — consider domain names, websites, electronic books, file sharing services, and more. These spaces are no different.

Fumble #2: “The contract says it’s not money, so the law doesn’t apply!” Two people cannot privately contract to change the law. Consider this case: an employer and an employee sign an agreement that the employee will be paid $2.00 an hour, well under the federal minimum wage, but include language that “the payment of this amount of money shall represent a full payment of minimum wage under federal law.” The clause means nothing, because employment law isn’t concerned with what these people privately agreed — the employer is still on the hook for the violation. Similarly, users of virtual worlds have TOS agreements with the provider that say that the provider does not have to buy back the currency, and that under the agreement, the currency represents merely the right to use the service. That does not mean that the currency, in fact, has no value from the standpoint of criminal law, tax law, securities law, or any other area that invites analysis of value.

Fumble #1: “If no one’s been convicted, it must be legal!” This is by far the most common fumble analysts make regarding questions in virtual law. It is fed by the (admittedly appealing) idea that virtual worlds are “just different.” It is nonsense. Consider this: nobody has figured out how to kill with a blue laser beam yet. If someone does so though, it would be completely reasonable to say that the act is illegal even before a jury finds a defendant guilty of that particular method of murder. Juries evaluate facts, the law is what it is. The fact that people just recently figured out how to defraud each other using prim-based ATMs, in-world messages, and avatars, doesn’t change the fact that the underlying fraud is, itself, illegal.

[Edited 1/14/2008 re: Comment #2.]

The US branch of Internet Gaming Entertainment (IGE U.S. LLC) recently answered plaintiff Hernandez’s complaint. The answer is available here (.pdf). I usually run excerpts from filings, but there’s really not much point in running excerpts from an answer (this is true of all answers, not just this one). An “answer” is a formal legal document where if you don’t say that you “deny” an allegation, you admit it, so it is typically just a big string of denials. That’s true here too. IGE denies everything… yawn. Worth posting for posterity, but not worth your click.

The real news here is that filing an answer means the case keeps moving forward. An answer opens the gates for discovery requests (and responses) and those can be interesting. Though discovery request are not always available publicly, VB very much hopes that requests and responses will be made available on the Hernandez v. IGE class action website.

For the full background of this case, see VB’s complete coverage. In brief, plaintiff is suing IGE U.S. (IGE’s Hong Kong branch was dropped from the suit earlier this month) on behalf of essentially all World of Warcraft players on the grounds that IGE, by farming gold, spamming chat, camping spawns, and generally diminishing the World of Warcraft experience, allegedly prevented players from receiving the full benefits Blizzard intended them to receive as third party beneficiaries of Blizzard’s Terms of Use and EULA.