Second Chance for Second Life

During a summer of (virtual) scandals, lawyers and the press routinely referred to the financial markets of the immersive digital playground Second Life as “lawless” and “a Wild West” (see “The Fleecing of the Avatars”). The flip side of these derogatory terms is that Second Life is a libertarian’s dream. As one who studies financial markets, I hope regulators will give markets such as Second Life’s enough freedom for us to learn something about how to regulate real-world markets, and when not to try.

In medicine, we assess the effectiveness of a drug partly by denying it to a control group. But the high stakes of experimenting with deregulation of large real-world markets make it hard to get much empirical evidence about what kind and degree of regulation make the most sense, or what practices, in the absence of regulation, are most successful in protecting investors and fostering liquid markets. That’s one reason Second Life excites economists: at little cost, they can create a regulation-free control group.

Linden Lab, which owns Second Life, maintains a largely hands-off policy regarding disputes between residents. If you start a business selling virtual televisions that don’t work, Linden Lab is unlikely to step in when people complain. It’s also unlikely to take action if you list a new company on a Second Life stock exchange, then take investors’ money and spend it on virtual clothing or real-world pizza. Instead, residents are forced to take matters into their own hands. One started the Virtual World Business Bureau, a virtual version of the Better Business Bureau that seeks to resolve business disputes and provide information that will help people avoid untrustworthy parties. Residents running and listing on stock exchanges created the Second Life Exchange Commission to set minimum standards for identity and financial disclosure.

How will this experiment in unregulated commerce turn out? If these two bureaus cannot earn the respect of the Second Life community, I see two possibilities. One is that as commercial ac­tivity grows in Second Life, scandals will get large enough to attract the attention of real-world regulators. Alternatively, the markets might fail to thrive because they cannot engender enough trust, and residents will gladly invite the regulators in. Of course, if the efforts within Second Life actually turn out to work–reducing incidence of fraud, increasing business transparency, and establishing mechanisms for trusted interactions–regulators will probably be willing to delegate oversight (as they largely do in the case of real-world accounting standards, for example). And it might just show that actual economies can operate with less or lighter regulation. Any of these three outcomes will teach us some valuable lessons. I hope regulators will have the patience to learn from Second Life’s small mistakes.