Thursday, January 10, 2008

Reflections on Second Life's new policy on banks

Well, it's been an eventful week in the financial sector of the metaverse. Linden Research has released a new policy regarding the banking business, which has already begun to cause widespread panic in some quarters. The meat of the new policy, as quoted from the release, is this:

"As of January 22, 2008, it will be prohibited to offer interest or any direct return on an investment (whether in L$ or other currency) from any object, such as an ATM, located in Second Life, without proof of an applicable government registration statement or financial institution charter."

I'm not a lawyer. I dated a lawyer once, but that probably doesn't count... I don't know the applicable laws, particularly since I am not in the US. However, I have read the post and FAQ carefully, and this post looks at what it actually says and how it is said, to get some insight into what it actually means...

The wording of this is quite interesting, as are the implications and limitations it suggests. Clearly, any of the "banks" that have been operating in SL recently, which have used ATM's to receive deposits, and have provided interest on balances, will be affected by the new policy, and basically have until January 22nd to settle with their customers and remove the offending objects. Also clearly, however, the policy is limited in its application to removing objects that interact with residents inworld. While the spirit of the new policy clearly implies that Linden Research wants to shut down the banks, the method of implementation at this point seems limited to removing ATM's and other objects that collect or disburse money which has garnered interest, or any other direct return.

At this point, and based on the policy as posted, and the associated FAQ, it appears to me at least that LL is limiting the policy to interest-bearing vehicles, and businesses such as stock exchanges that do not offer interest on balances should be exempt. Investing in a virtual business and receiving dividends based on profits or market performance, for example, is not interest or direct return, and so should not be included in the targets of this new policy. The quote from the FAQ is a bit vague, as is a lot of it...

"As of today, this policy is generally focused on objects and schemes that involve real-time transfers of L$ and payment of interest or rates of return. Exchanges may or may not do this, so they may or may not be covered. In addition, we reserve the right to remove any objects and take action against any Residents who are violating U.S. or other laws. If you are unsure whether a business you’re operating abides by applicable laws (e.g., banking, securities laws), you should get a formal legal opinion, from a personal lawyer acting on your behalf. "

The wording of this is very interesting. Clearly, Linden Research is targeting payment of interest, but leaves the door open to censure other types of businesses as well, if they break the law. At the moment, however, based on what the announcement and FAQ actually say, they have not yet decided exactly what to do about any businesses other than banks. Whether or not the policy will be expanded in the future to include a wider range of activities remains to be seen. The FAQ does contain some language that implies that it may,

"There’s no guiding law or precedent we know of that tells us whether these practices are legal. Depending on what statements these so-called “banks” make, and what depositors’ expectations are, they raise the possibility that banking or securities laws may apply. If so, they would need to be chartered or registered with applicable real world regulators, and to our knowledge, none of them is."

Although only "banks" are specifically mentioned in this passage, the reference to security laws might be telegraphing future plans to regulate, or outlaw, stock exchanges and other businesses that require registration and regulation to operate in RL. We will have to wait and see. In part, I presume it will be based on the behaviour of the stock exchanges, for example, and/or the number of complaints that are received from LL about them.

What is clear is that the rampant speculations being made about the new policy are just that - speculations. What it actually says, at the root, is that LL will begin to remove the ATM's and other objects of banks that have promised interest and other direct returns on investment. Everything else is implied, hinted at, or being left as LL reserving the right to do something else in the future...

So, if you have money in a bank, what to do? Well, clearly there will be a rush on all of the banks, and a lucky few will be able to get their money out. Some banks will close their ATM's and restrict withdrawals. None of the banks will be able to honour withdrawals of all of their depositors balances before January 22nd, and so will simply run out of cash. The good ones will likely keep track of investor balances and develop a plan to recompense them as they are able to liquidate their assets. Some will likely go underground and try to continue to operate without an inworld presence.

In short, who knows?? Try to get your money out of the banks if you can, and then wait for developments. There's nothing else you can do.

As for the WSE, Luke's announcement seemed pretty upbeat and unconcerned about the new policy, and I think for the time being, the WSE should be ok. how long this lasts is anyone's guess. I would expect a serious run on all the exchanges as people try to cash out once the WSE is back up and running. You'll need to make your own educated guess about whether or not WSE will be viable into the future and act accordingly.

Any thoughts and comments would be appreciated.



Kailen Juran said...

It seems that Linden Lab pushed to implement this policy without having taken into account the diversity of the SL economy. Given that some banks operate legitimately and openly, this portends of either carelessness, apathy, or something sinister with LL's intent.

With that said, the spirit of the policy is of major concern as dividend payments may be considered in the same class as interest. After all, a bank could simply change to a credit union style format and technically pay dividends on deposits rather than interest, but that would violate the spirit of the policy. In that paradigm, any corporation will be under scrutiny.

I hope that my scepticism is misplaced. I'll try to continue as normal, but one eye will be on LL's actions at all times.

Delicious Demar said...

I hear what you are saying Kailen. But as I think about this, I reflect on what LL's main goal is - and that is simply to protect LL. Oh, I think that they don't like to see residents taken advantage of by unscrupulous people, but really, they are concerned about protecting themselves legally.
I think that might be why the application of the policy specifically talks about interest being prohibited "from any object, such as an ATM, located in Second Life". They DON'T say, for example, that someone can't set up a webpage, and figure out another way for money to change hands, without having an object inworld. Presumabaly, their liability in a case like that is limited. The wording is obviously carefully chosen. The ban applies to inworld transactions, where the exchange of currency happens through an object inworld.

Which might just make Hope Capital's World Internet Currency (WIC's) a stroke of genious, if you think about it...

The more I think about this new policy, the less worried I become about the WSE - as long as Luke is careful in how things are structured, I think the WSE should be fine.

I posted a link to this blog on the WSE site, and Luke sent me an email to tell me it had been removed, because he thought the blog was damaging to the WSE. That's within his purview, of course, but I strongly believe that open and honest communication and disclosure is far superior to scripted messages and sound bites.. Luke is well aware of my views on the subject, and we talk about it often. lol.

Make no mistake, I am a huge supporter of the WSE. I agree with Kailen that it is LL that has put the whole financial/securities sector in jeopardy, precisely because they don't disclose what their thinking is, and they use carefully scripted messagin. I suppose they have to, but it doesn't really help. The speed with which they are doing this is, in my opinion, unreasonable, and will result in short term panic and losses to many people in the banking world.

Luke tells me that saying things like that is actually what causes panic - but the fact is that we all need to talk this out and have it all on the table. Pretending that there is nothing wrong is just silly. There is going to be a bloodbath as everyone tries to withdraw their money from the banks, and only time will tell exactly how big it is going to be, which banks are honest and upstanding, etc...

But please be clear - I differentiate banking from the WSE. Luke has made it clear that to comply with the new policy, WSE won't be able to give interest on balances, but unless LL changes their current stance, stock exchanges should be exempt from the policy.

I still believe that some people will cash out of the WSE once it is back up (Luke told me not to say that either... lol), because they will have lost their trust in the whole SL financial sector, and maybe not specifically the WSE. Again, the effects of this are yet to be seen.


Kailen Juran said...

Thanks for the follow-up. The more that I think about it, I believe that the immunisation from liability is a principal goal of Linden Lab. They are acting at this juncture because of complaints they have received from residents about Ginko and other defaults. Obviously LL did not have anything to do with such defaults and never stipulated that they were in anyway responsible, but how does one tell that to a customer that has lost perhaps thousands of Linden dollars due to said defaults?

I now believe that the heart of the policy has to do with where grievances can be taken. Because the mechanics of SL do not allow for a user-run organisation to perform oversight (think of how SLEC bombed), then it falls to either Linden Lab or some government agency. For every plausible reason, LL would prefer the latter.

I think that you are right in that WSE may have less to worry about, if they are incorporated that is (which they might be in Australia, not sure). I know of three other institutions that are seeking corporate backing. On that note, I see this extending to businesses that operate in SL which rely on investment funding. Some will wisely seek some form of corporate status in that situation.

Looking also at non-ATM methods of investment, the FAQ tends to suggest that is in violation of the new policy. However, that is still rather vague in its meaning. I suspect that the explicit mention of ATMs or other objects is to remove LL from any appearance of involvement. It's hard to criticise LL if one pays another directly.

Obviously discretion will be important for businesses at this point. I agree that WSE is at the forfront of this, taking a proactive stance. I simply hope that LL becomes more forthcoming about specific soon.

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