Bank Run: How Ginko Financial Went Down

A string of bank collapses prompted Alan Greenspan, U.S. economic guru and former head of the Federal Reserve, to admit last month that lending institutions could not always be trusted to regulate themselves. He could have taken a cue sooner by looking at the 2007 collapse of Ginko Financial, a virtual investment bank in the online game "Second Life."

Virtual economies in games such as "Second Life" and "EVE Online" may seem trivial, but they actually can provide real-life lessons on the patterns of free markets and unfettered capitalism. Researchers and self-described virtual economists have observed how virtual entrepreneurs establish themselves and compete, as well as how a lack of self-regulation can lead to dramatic banking failures, scams and even corporate espionage.

"I don't view 'Second Life' as a game," said Robert Bloomfield, an accounting researcher at Cornell University in Ithaca, New York. "I view it as a market space."

When virtual banks go bad

Ginko had all the trademarks of a bad investment idea. It promised that people who deposited their virtual money would earn an astronomical interest rate of more than 40 percent, and similarly loaned out money with absurdly high interest rates attached to repayments. Thousands of "Second Life" residents opened accounts with the bank.

The end came when panicked investors began withdrawing their virtual money, known as Linden dollars in the game and exchangeable for U.S. dollars at a rate of roughly 250 Linden dollars to one U.S. dollar. Ginko did not have enough reserves to pay up. When the bank finally announced it was finished, an equivalent of $750,000 in real-world U.S. dollars went up in smoke. The collapse not only wiped out time spent earning Linden dollars in the game, but also hit the wallets of players who had legally paid U.S. dollars to buy Linden dollars.

"The 'Second Life' financial markets have pretty much been unregulated," Bloomfield told LiveScience. "There are accusations that people are doing everything from questionable behavior to outright fraud."

Bloomfield drew direct comparisons between the "Second Life" incident and the real-world financial crisis in a post on his blog, "Metanomics," which echoed Greenspan's comments — financial markets cannot simply be left alone to self-regulate. His weekly in-game talk show recently hosted a "Second Life" conversation with Maureen O'Hara, a real-world banking and markets expert from Cornell University, and Michael Lorrey, a player who runs a virtual investment fund within the game.

Virtual economy worth studying

Not all online games host virtual economies that operate like free markets. Most games, such as the popular online role-playing game "World of Warcraft," put artificial controls over supplies of certain resources, products and money, and almost everything is created by game developers.

"'World of Warcraft' is kind of like Disneyworld," Bloomfield explained. "You go to Disneyworld to pay your money to Disney, because they created all the attractions."

By contrast, Linden Lab, creator of "Second Life," treats players as entrepreneurs by giving them virtual tools to create their own buildings, products and services. That creates a system of supply and demand that more closely parallels a real-world economy.

"If you want to compete with Disneyworld, well here's the land and tools to build a rollercoaster," Bloomfield said while describing the "Second Life" approach. "If you can get people to ride it, go for it."

Wild West business

Another game that has attracted economists is "EVE Online," a freewheeling online space simulation where players form huge corporations and alliances to do everything from mining to trading, and even piracy. Game company CCP went so far as to hire its own economist to manage the sprawling virtual economy.

The laissez-faire approach to both business and the law has allowed EVE players to enact spectacular scams, with other players paying the price. One player opened a bank and then walked off with about 700 billion in the game's ISK currency, or close to $120,000 in U.S. dollars if sold illegally to other players on eBay.

Yet another grand scheme involved an insider's job where players worked their way up the ladder of one of EVE Online's largest corporations. They then seized valuable ships, emptied out virtual bank accounts, "killed" the corporation leaders, and laid waste to most of the remaining assets.

However, many economic patterns within "EVE Online" do not resemble anything like those of the real world. For instance, raw materials often become more valuable in-game than finished products, because many players covet the raw materials to "skill up" professions and churn out products.

"Restrictions on the availability of virtual goods have sometimes been called artificial scarcity," said Tuukka Lehtiniemi, a researcher at the Helsinki Institute for Information Technology in Finland. "This simply means that the operator makes some virtual goods easy to come by and others harder."

Hands off?

Despite the imperfect parallels to a real-world economy, virtual economies can still provide economists with an unrestricted view of what could happen if free markets ran unregulated — at least until a higher authority steps in.

Previous "Second Life" banks had dubious operations and spectacular collapses, but the Ginko collapse led to renewed outcry for regulatory action from "Second Life" residents. Linden Lab responded by outright banning banks that promised any sort of interest rate returns on deposits. By contrast, the United States and other nations have responded to the real-world financial crisis by trying to save banks and encourage responsible lending.

Bloomfield admitted to disappointment that Linden Lab had clamped down so harshly on banks, noting that "Second Life" provided a "fascinating experiment in libertarianism and self-regulation." That perhaps points to the great advantage of virtual economies, where economic scenarios can play out (mostly) without real-world consequences. But for Bloomfield and other researchers, the lessons they can draw from virtual worlds as experimental platforms are very real.

"I'm an accountant," Bloomfield said. "My primary interest is the real world economy."

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