Does Linden Lab put its economy first?

The evolution of the Linden Dollar from a strictly virtual currency and economy to a currency that intertwines with recognized currencies and economies has created many issues that need to be addressed in order for Second Life to continue to flourish as a developing world and be a viable blueprint for future online worlds.

Linden Lab is the actual owner of all of the software and server-side hardware that make up Second Life, so it has the ultimate authority to change all aspects of the Second Life world, including its currency and economy.

Linden Lab has made some changes over the last few years that have destroyed or removed the value of in-world currency and virtual goods markets or has inadvertently given a particular market leader advantages that would enable that leader to remain in that position in the future. Most believe that the Linden economy will be unlikely to attract large investments unless this power is better managed and transparent to all Second Life users.

For example, until December 2005, teleportation in Second Life was limited to telehubs – teleportation landing points from where users would walk or fly to their destination. Land values spiked around these telehubs, which became popular with merchants and mall owners. When the telehubs were removed, land prices in these areas plummeted.

But the story doesn’t end there. Telehubs didn’t just provide a simple teleport landing point. They also provided news and information. This information function disappeared along with the telehubs – but was replaced by InfoHubs. These weren’t run by Linden Lab, however, but by a private company, Gnat Technologies, which operates the in-world InfoNet, a for-profit newspaper and information delivery service.

These InfoHubs are hosted for free on system-owned land, but are also placed in Welcome Areas where new users to Second Life first arrive. Since no one is allowed to place business-related objects in these Welcome Areas, InfoNet now has a considerable advantage over its competitors.

In 2007, Linden Act eliminated wagering on games of random chance and real-life sporting events with Linden Dollars. After this announcement, casinos were given a few days to close down. Casino owners and game makers either found other areas of business or ceased trading entirely, which led to the collapse of the largest bank in Second Life, Ginko Financial, as it had ATMs in most of the major casinos.

Ginko Financial saw its reserves drained completely within hours and was only able to pay L$55 million (around US$204,000) out of L$180 million ($667,000) in withdrawal requests, as most of Ginko’s assets were invested in things of poor or no liquidity. This resulted in Ginko becoming insolvent and converting its depositors into bondholders on the World Stock Exchange, one of several in-world stock exchanges.

One other action that year also sparked controversy and the in-world economy – the collection of European Union’s VAT tax. Originally, Linden Lab absorbed the collection of the Value Added Tax (VAT), but Linden Lab started to collect it from those customers living in the European Union on all types of transactions, including land purchase, land maintenance, and membership fees that are paid in real world currency. It also tried to collect any theoretically applicable VAT on Linden Dollar transactions between individual Second Life residents.

The added VAT fee made many Europeans question whether they should leave Second Life, transfer their lands to American partners such as American land barons, or work in occupations that did not require paying fees to Linden Lab.

Some European Second Life users have claimed that Linden Labs forced this tax on them without notice and is charging tax on property that doesn’t really exist, thereby making the tax illegal. However, according to a 2003 E.U. directive, VAT is a tax on both goods and services, including digital services, thereby making it legal to collect VAT on a digital service like Second Life.

However, that same E.U. directive also states that European businesses should be able to reclaim VAT paid for business items so that the VAT cost does not cripple their ability to compete in non-European markets. The problem lies in the fact that Second Life does not offer a way for a business holder to establish whether a customer is European or not, which prevents that business from collecting VAT from Europeans.

What complicates the matter further is that, the same directive does not state whether Europeans are required to pay VAT in Second Life, since Linden Dollars are not legally classified as a currency. If Linden dollars were a recognized currency, VAT would only be chargeable on the conversion fees and not on the whole transaction. However, this would open Linden Labs up to much oversight by European financial regulators and require compliance with the Electronic Money Directive and associated anti-terrorist financing and anti-money laundering legislation, which would likely lead to greater changes to Second Life and more costs to its users.

Alex.Johnson@hypergridbusiness.com'

Alex Johnson

Alex Johnson is a staff writer with CurrencyConverter, a free resource and information site dedicated to those who want to learn more about currencies and how foreign exchange markets work.

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  • http://eastrivercommunity.posterous.com Indigo Mertel

    It looks like WordPress has mungled my comments. The paragraphs are all mixed up. Could you please delete the previous comment? Hopefully, this will show up correctly. Thank you.

    Interesting post, Alex. I agree with most of what you say. However, there are a couple of things in your post I am not convinced with. You say:

    — However, that same E.U. directive also states that European businesses should be able to reclaim VAT paid for business items so that the VAT cost does not cripple their ability to compete in non-European markets. The problem lies in the fact that Second Life does not offer a way for a business holder to establish whether a customer is European or not, which prevents that business from collecting VAT from Europeans. —

    Correct… however, it’s a moot point. An European SL user who is registered as a business is exempt of VAT, as he/she can submit a VAT number to Linden Lab. That user never pays VAT, thus he/she has nothing to recover. One could argue that a SL merchant is a business, but in such case that merchant is making a taxable income, thus subject to tax regulations.

    — What complicates the matter further is that, the same directive does not state whether Europeans are required to pay VAT in Second Life, since Linden Dollars are not legally classified as a currency. —

    I see from your profile that you are an expert on currencies. I am not an expert so I may be wrong on this, however I am not convinced by the above comment. Linden Lab applies VAT on the digital service they provide, as you say in your post. Thus, there is a first distinction to be made, because applying VAT on, say, an annual free for premium accounts has nothing to do with purchasing SL currency. As for the currency, I am not aware that Linden Lab applies VAT on every Linden dollar purchased by European users. If this is indeed the case, I believe that the Linden currency should be considered the equivalent of a service.

    You also say:

    — according to a 2003 E.U. directive, VAT is a tax on both goods and services, including digital services, thereby making it legal to collect VAT on a digital service like Second Life. —

    It’s not legal, it’s mandatory. Else, Linden Lab would be in violation of EU tax regulations.

    As an European user I am in a better position than most, as I have a VAT number and I don’t pay it. But, I certainly understand the frustration of those who complain about this issue. What I disagree with is when European users blame Linden Lab for charging VAT, arguing that the Lab should pay for it. No company would curtail its revenues from hundreds of thousands of customers an amount that varies from 14 to 20 percent or more. Simply put, it never happens.

  • http://sorornishi.blogspot.com/ sorornishi

    …and the changes didn't stop there. Next the Lab decided to provide 512 m2 to Premium Accounts thus ruining the land businesses that had grown up and the 'first time' house sales of builders…. and etc etc. I have seen land prices fall by 2000% in the last 4 years.

  • http://www.facebook.com/profile.php?id=622664200 Eurominuteman

    Every EU business needs a formal VAT-IdNo., so identification as consumer or business has been enabled… and SL allows EU residents to enter their VAT-IdNo. via their website profile.