Virtual Currencies – From WoW Gold to Bitcoin, with a stop in Second Life.

It is difficult to talk about currency in any form these days without the whole topic getting muddled and mired into politics. The economics surrounding the behavior of companies and governments and the attendant problems and crises are on everyone's minds, and they extend in particular to this blog. (After all, if not for unemployment, I'd just be the “Geek.”) However, there's one place where we don't have to worry about taxes, inflation, volatility of currency, government regulations, interest rates and the global banking community. The internet. Sure, there are a few places that you might have to pay sales tax online depending on where you live, and if you make money online you're probably taxed on that, but our day-to-day transactions online, whether they are in gold pieces in an MMORPG or credits on any number of websites... surely those are free from the standard economic worries and the politics that come with them. Or are they?

So I have to fill out form 1099-WOW and append it... can I claim my non-combat
pets as dependents?

There has been a bit in the news recently about a virtual currency that on its surface doesn't have much in common with a gold piece picked up from the purse of a dead virtual orc. Bitcoin has surfaced in reports several times in the last week with the United States Congress taking an interest in the system in light of its connection to buying and selling drugs, and a user recently reported that a hacker compromised a system he was storing bitcoins on to the tune of $500,000USD gone in a flash. The interest in the virtual currency has gotten a lot of attention, with attention comes people doing research, getting excited and participating, which increased the value of the coins in the system. Though highly volatile, each bitcoin is currently (as of June 2011) worth about twenty dollars in US currency. The upward trend attracts speculators, which drives the value up further.

So what is it and how does it work? Each bitcoin is a piece of code with encryption designed to prevent counterfeiting or duplication or other fraud, including transfer fraud. The verification of transactions using coins are distributed across the peer-to-peer network, making all transfers of coins public and verifiable, but the addresses of the people making the transactions secure and private. Without a centralized authority, currency goes from one person's hands to another without fees or regulations, and no government or bank can devalue the currency by injecting more into the system to create inflation. Libertarians, cryptology geeks, conspiracy theorists and criminals love the idea. It is like a digital version of briefcases full of cash. Governments and bankers aren't so keen on it. Individual coins are created by “mining” where the computing power to create the blocks of code in a new coin are purchased from any user running the mining program, rewarding the miner with a brand new coin after a lot of work on a powerful PC. Each coin takes exponentially longer to create than the last, so the amount of new coins entering the system is controlled and stable.

There aren't a lot of places to spend these coins for real world goods, at least not yet. There are virtual currency exchanges set up to turn regular money into bitcoins and vice-versa, and websites that allow purchases to be made using them. The anonymous and secure nature of the coins means that some are used to buy illegal goods online, such as the Silk Road marketplace that sells illegal drugs online, or for money laundering. Currency proponents insist that legitimate uses outnumber illegal uses for bitcoins, and they are no different from cash in what they can be used for or by whom. Governments, especially in the United States don't like currencies involved in untracable, untaxable transactions, and the future of the currency may well rest in its decentralized, peer-to-peer system's ability to resist governmental interference. (If the same strategy that makes it nearly impossible to stamp out piracy in P2P is effective in this, things could get interesting.)

This isn't the first time that a virtual currency has attracted the interest of powerful people who would really prefer you use the currencies they, not coincidentally, already have a lot of. The online game Second Life and its currency, the Linden Dollar gained a lot of attention from around 2004-2007 based on the idea that the currency could be traded for “real” money through a currency exchange using PayPal, and businesses could be run in-game to earn more Linden Dollars, including trading in real estate in-game and playing the currency market as a speculator. The fact that the company that ran Second Life explicitly retained ownership of all these credits and they acted as a combination central bank and clearinghouse for all exchanges and markets drew criticism concerning whether or not these Linden Dollars were currency at all. With regard to taxation, European users were charged the VAT (Value Added Tax) on certain Second Life transactions, including some dealing only in Linden Dollars.

I messed with Second Life for a while, off and on. A lot of it looks like the Sims, with a lot
more elves, catgirls, winged angels and porn. Hard to describe.

With the established value of virtual currency as something that can bring real, non-internet wealth, thinking about taxation and tracking of income is changing. Many online gamers know about the “gold farmers” who play MMORPGs to earn virtual currency for sale in online semi-legal or illegal transactions. In China, where many of these operations were run, the issues concerning running many virtual black markets up to and including theft of in game currency and property made it to real-world court systems. In 2009, China limited transactions concerning virtual currencies and how they could and could not be used to interact with “real money trading.” South Korea has ruled virtual currency the same as any other currency, and taxation on virtual goods as a policy is being floated throughout Asia.

New Class - Certified Public Accountant.

Are we inevitably heading towards a world with some sort of taxation on the transfer of digital goods and whenever gold pieces, credits, or coins change hands? Some economists say that we are, and there is no reason why we shouldn't. I wonder about the possibilities inherent in having to report gaming income, or on the flip side, being able to pay bills and buy groceries with currency I got by blowing up monsters in a fantasy world. Will I be able to write off repair costs for broken armor? Will we see prosecution for ninja looters, indictments for insider traders on the Auction House? When do the walls between the game world and the real world come down, and when does reasonable economic policy cross that line into the absurd? I expect many attorneys will make a lot of money answering these questions, and I further assert that they won't be taking their fees in gold pieces, Linden Dollars or Bitcoins.