The Necessity of Government Regulation of Virtual Economies

Due to the tumultuous events of the past year, the stability of the national and global economies and its effect on their daily lives is usually not far from the minds of the average person.  During that period, a frequent question on the minds of people around the world was how so many financial markets were able to spiral out of control so quickly.  A (greatly) simplified explanation is that the regulations and safeguards intended to prevent market failure had not been enforced by world governments and oversight agencies had grown lax.  After living through daily reports of yet another “toxic” investment absorbed by a financial institution and the worth of overvalued stocks plummeting, it seems inconceivable that self-regulation could be seen as an effective protection on investments.  However, the current state of virtual economies ask market participants to do just that – trust that virtual markets can remain stable free of external regulation.  This approach is doomed to failure.

Necessity of Virtual Market Regulation

Under the status quo, virtual markets have escaped existing securities regulations.  18 U.S.C. § 1348 governing securities fraud is limited in application to either securities registered in accordance with Section 12 of the Securities Exchange Act of 1934 or securities required to file reports under  Section 15(d) of the same Act.  Using that standard, virtual markets do not qualify as being subject to securities fraud regulations.

Arguably, existing statutes may afford virtual market participants some protection.  The “wire” portion of 18 U.S.C. § 1343 regulating fraud by wire, radio or television has been construed through case law to apply to the internet, as well as borrowing many of the same principles as the mail fraud statute codified in 18 U.S.C. § 1341.  However, this would be an inadequate solution to cope with the specific crime of securities fraud, as the body of case law that has been built to address that line of criminal activity in the “real” world would not be applicable under a different charge.  By drawing an artificial distinction between “real” and “virtual” securities markets, courts may needlessly be deprived of the legal framework constructed over the past century to address the regulation of all securities markets.

Opponents to regulation of virtual markets may argue that the economies of virtual worlds are merely part of the “game” and thus should not be subject to government regulation.  There are several flaws with that argument.  First, although virtual worlds each have their own currency, all virtual currency has an equivalent “real world” exchange value.  Even virtual world platforms that do not encourage (or even prohibit) virtual currency-to-real world currency exchanges would be forced to acknowledge that an exchange ratio exists, in the black market if nowhere else.  In cases where conversion is technically prohibited, a savvy inhabitant merely needs to be craftier to circumvent obstacles in their path to financial gain.  This returns the focus to the crux of the problem – a significant number of the virtual inhabitants participating in virtual markets do not have similar experience in “real world” markets.  These are the very individuals for which laws and regulations were designed to protect.  Discounting virtual markets as a mere “game” is tantamount to turning a blind eye to a segment of the population that requires protection.

A different problem rises for the virtual environments where exchanges from virtual currency to “real” world currency are permitted – such exchanges have a significant, immediate impact on the global financial markets.  Although there have been few empirical examples of large-scale currency transactions, this will become a larger problem as the popularity of virtual environments continues to rise.  The recent Chinese ban on gold farming is further evidence that the spillover effect of virtual economies on “real” world economies will only increase in the absence of government regulation.  As more “real world” money flows into virtual worlds, virtual inhabitants will have more to lose in both worlds.  Regulation will be key to key to maintaining the stability of all markets.

Regulation opponents may also argue that regulation of virtual markets is inappropriate because economic patterns can be influenced and controlled by the creators of the various virtual worlds.  Jeremy Hsu explained this phenomenon by describing how raw materials in “EVE Online” are often more valuable than finished products.  While it is true that virtual environment operators can control the availability of raw materials

Benefits of Virtual Market Regulation

Virtual economies mirror the economies of the real world or, if looked through the classic question of whether the chicken or the egg came first, the markets of the real world have also reflected the same challenges of the virtual markets.  Virtual inhabitants that participate in virtual markets are faced with the same dangers that participants face in “real world” markets.  Distinguishing between identical behavior of financial institutions merely because one financial institution has a physical building while the other only occupies virtual space risks destabilizing the “real world” markets as much as the virtual markets.

As Caroline Brady discusses, a portion of virtual inhabitants participating in virtual markets have no previous experience participating in “real world” markets.  This may be due to age, with adolescent or young adults embracing virtual worlds more readily than their older cohorts, or greater ease of access to virtual markets.  Regulations are needed for the virtual markets so that inexperienced market participants can be educated and “trained” in the event that they decide to apply their experience in virtual environments to “real world” ventures.

Conclusion

Much like other criminal issues examined in a virtual context, claiming that there is some fundamental difference between criminal activity committed face-to-face as opposed to in a virtual environment is taking the easy way out.  Some virtual inhabitants from around the “real” world are already turning to virtual economies as their primary source of income.  While many, if not most, of these careers have legitimate bases, it is inevitable that fraudulent activity will flourish at an equal (if not greater) pace.  It may be easy today to write off small losses of “real world” currency when virtual inhabitants are the victims of fraud, but it is likely that the day when the blurred line between the “virtual” and “real” worlds disappears completely.  It would be best if regulations are put into place now, before the lessons learned by participating in virtual markets diverge too much from “real world” markets and before participant confidence in both markets is shaken beyond repair.

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~ by heatherharmer on October 19, 2009.

5 Responses to “The Necessity of Government Regulation of Virtual Economies”

  1. I think I agree that virtual economies need to be regulated, mostly because it’s so disturbing that $750,000 of real U.S. dollars evaporated in the Ginko Financial bust. But I can’t imagine how those regulations would be enforced. One of the news items we read said that Ginko Financial’s operator was “faceless” and that his identity is still unknown. I guess that’s because Linden Labs doesn’t release that information. How can we enforce regulations of virtual economies if we can’t identify the actual people involved? To be effective, wouldn’t laws governing virtual finances have to require that administrators of virtual worlds provide prosecutors with the real-world identities behind avatars involved in misconduct? That would change everything! It seems like anonymity is really important to most people who participate in virtual worlds.

    Also, does anyone know what Duranske means when he says Second Life is already governed by U.S. law and the laws of California? Does he mean the wire fraud statutes?

  2. My views come in somewhere between the two principle blog postings. While I do believe there should be some governmental regulation of virtual worlds, I do not think there should be so much so as to hamper creativity or infringe upon individuals’ rights. To the extent that financial fraud exists “in world,” it should be regulated if it has a real financial detriment to a person in the real world. If a game is just a game and everything, including the money, is just pretend, there is clearly no need for governmental regulation. How do we monitor these two situations and what about a situation that walks a fine line? How can we regulate in anticipation of a potential outcome and how can the Government regulate without being too strict?

    If we were to bring the Government into virtual worlds, would there need to be a complete overhaul of such systems and websites? Should there be some type of registration system for a company running a virtual world if there is a possibility that virtual money can be converted into real money and affect the real world and real people? Would people have to provide all of their information, of their real identity, in order to have an avatar because something illegal might occur? This could be an answer to the problem that another classmate pointed out of how we would know the identities of people in world in order to regulate and then prosecute? If all of these checks were in place, would people still want to participate? Would it even be fun anymore or would the existence of a virtual world be obsolete?

  3. Virtual securities sold in virtual environments like Second Life, where Linden dollars can be easily converted into real currency, fall under the current securities laws and should be regulated. The piece of legislation that governs the issuance and offers of securities – the 1933 Securities Act – is by no means contemporary, nor (like most other current laws) does it handle internet transactions very well. However, the intent of its creators – to protect the public from investment fraud and provide stability in the investment markets – should be applied to substance rather than form. Furthermore, the current statutory framework does not have to be stretched far to provide some meaningful protections in the virtual worlds. As the blog points out, the current fraud provisions have been interpreted to apply to the Internet. Also, the securities sold at stock exchanges in Second Life fit well in the definition of a real “security”, thus triggering the need for federal and state registration unless they fit in some exemption. Since the current available exemptions are extremely restrictive and cumbersome, most virtual offerings would have to be registered. The failure to register invalidates the entire offering and gives private purchasers the right to file an action and obtain their investment money back. SEC can also go after the stock exchanges themselves, as they also do not comply with the current SEC standards. I think some of the reasons SEC has not gone after virtual securities are the still relatively low amounts of money involved (last year total trade was about $300,000), lack of understanding of virtual environments, and of course – the overwhelming demands of the current financial crisis. The argument that virtual markets should be left alone as experiments is weak – too many businesses and real money are involved to maintain such “experiment” status.True, existing laws might need to be amended a bit to accommodate the virtual realities, but they are absolutely necessary in the virtual world.

  4. I think the majority of the class wants to find a happy medium for the regulation of in world activities. We want to discourage crime in world, but we also want to avoid overreaching that stifles creativity and enjoyment. Perhaps all of these issues would be better resolved by resigning to the fact that we need a combination of adaptations to existing law as well as the creation of new law. The key, however, would not be whether we need regulation but WHO the regulations are coming from. We can balance interests by making sure that we include law enforcement, online companies, and the end users in identifying needs, goals, and interests in regulation.

  5. I think that government regulation is absolutely necessary in-world because there is real money at stake, e.g. the $75,000 Ginko bank scandal. Many people write off these fraudulent activities as “part of the game” or that they are too small of an amount of money to be bothered with, but the reality is that this is a growing market that can have devastating real-world effects. I think that service providers like secondlife should be regulating these types of fraudulent activities, but the cancelling of the offender’s account is not enough, in my opinion. The service providers need to work with government agencies to go after those who are defrauding others on a large scale, even if that means revealing the users’ identity. I understand that people have privacy expectations in their avatar, but I think as soon as they start using their avatars for criminal endeavors, they lose that right of privacy. I believe that, as this becomes more of a problem, real-life agencies will be stepping in to regulate, under existing wire fraud law. These agencies would not have to interfere with the day to day goings on in-world if the service providers are fully cooperative with the authorities in prosecuting fraudulent activity.

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