Second Life's economy is said to be worth $200m a year, based on the goods that change hands inside the virtual avatar paradise.

But the economy is largely a pyramid scheme that is based on new players pumping in addition funds and thereby driving up overall prices. But as soon as players try to cash in, they quickly find out that their virtual profits are all hype, alleges a Randolph Harrison on his Capitalism 2.0 blog.

25 Jan 2007

Second Life has its own online currency, called Linden Dollars that can be openly exchanged for US Dollars. Players claim to have made real world billions trading virtual properties – mostly land, but also from selling clothing and other accessories as well as virtual prostitution (phone sex for the 21st century) and gambling.

But don’t try investing in some virtual property, sell it for a profit after several months and cash in your Linden Dollars for some real world green. Harrison claims that trying to exchange those funds without facing a severe loss is in practically impossible.

The official exchange run by the game developer functions as an open auction that brings buyers and sellers together. But that also makes it impossible to do large transactions there.

That leaves private exchanges that lack any volume. As a result, any attempt to trade a large amount of Linden Dollars will result in an instant drop in the exchange rate.

Example: mid July 2006 SLL/USD was 293.0/279.2 bid/ask on the primary open exchange. Our attempts to trade L$650,000 resulted in settlement bids of 350-450. Interestingly, these trades tended to net returns of right around 4%, which was the prevailing dollar deposit rate.

As we scratched our heads trying to figure out if there weren’t a more clever way of disguising our trades, or perhaps creating our own in-game banks and exchanges in order to arbitrage the other direction, it suddenly dawned upon me.

This game was just a pyramid scheme.

Second Life may offer some great entertainment. But anyone waiting to invest their hard earned cash to start up a flourishing business in the booming economy is dearly mistaken.

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