Second Life Indicator Contracts (SLICs)

The Iowa Electronic Markets and Tradesports.com allow people to trade contracts that pay off based on the outcome of the 2008 US presidential campaign.  Prices in these 'prediction markets' appear to be superior to traditional polls.  This superiority is consistent with economic theory, because traders' price influence is tied to their trading aggressiveness, which in turn reflects their confidence.  As long traders' confidence is tied closely enough to the quality of their information, prices in prediction markets will be superior to an equally-weighted average of people’s beliefs.

In this post, I throw down the gauntlet to those running (or considering running) a trading exchange in Second Life—create a 'Second Life Indicator Contract' (SLIC) that would predict the future user base or economic activity in Second Life.

Prediction markets could provide very useful information for individuals and businesses debating whether develop a presence in a virtual world, and choosing which one.  World selection is a difficult issue, because the metaverse is so fragmented.  And lack of portability makes the stakes very high—it isn’t possible to transfer assets across worlds, so whether you are an individual looking for a social network, game play or profit, or a corporation looking for teleconferencing or marketing opportunities, your investment comes with a serious risk:  your fortunes rise and fall with the particular platform you have chosen.

If virtual worlds do become an important engine of global business, prediction markets could be an important economic force, and could even allow those investing heavily in a world to hedge their investments (offsetting the risk of their investments by taking positions that would be profitable in the event of a downturn in the prospects of the world they chose).  SLIC markets within SL would be an excellent way to provide proof-of-concept for this idea, at a low-stakes level.

To make my proposal a little more specific, let’s assume that we can get a reasonable measure of Second Life’s economy by measuring the total US dollar value of all Linden’s currently in circulation—currently around $13M.   An exchange could create a futures contracts in which one party agrees to pay another party L$100*(M-$13), where M represents how many millions of Lindens are in circulation on March 30th, 2008.  For example, if there were 15.4 million Lindens in circulation on March 30th, the party buying the contract would receive a payment of L$240 from the seller.  The price paid by the buyer today would therefore indicate the markets’ expectation of the money supply in March. Introducing a new 6-month contract every 3 months would guarantee a look-ahead of at least 3 months every day.

Anyone trying to create a futures market like this will face a few challenges.  One hurdle will be to develop metrics of virtual world success that are relevant, and not too subject to manipulation either by the game developer or its residents.  The supply of Lindens seems reasonably objective and hard to manipulate, but doubtless there are better measures of the success of Linden’s economy that would capture the value of land, the user base, etc.

Another challenge is that, for everyone who takes the winning side of a contract, someone else takes the losing side, and losses can be larger than the initial investment.  Thus, people would probably need to deposit collateral to cover losses.

Finally, the exchange would need to make sure that they don’t face trouble from the Commodities and Futures Commission.  The IEM received a no-action letter from the CFTC, but they have a purely educational mission.  Tradesports is now viewed as an illegal gaming site by the US. However, my understanding is that the extensive sports betting is the real problem; the contracts they create based on stock indexes could be legal, if only they could convince the CFTC that there is a real business reason for someone to hold them.  I believe the hedging argument I laid out above might justify the existence of the market.

Despite these challenges, I encourage exchanges in Second Life to take up the challenge.  My guess is that they would be far higher volume than what we see now, because what is traded would be a known quantity. A small commission on each trade, and someone can probably make a fair bit of profit. 

Anyone interested?

Comments

[malachi]

1.

The supply of Lindens seems reasonably objective and hard to manipulate...

Unless you are a Linden employee, then your reports of M1 are whatever you wish them to be.

Unlike the prediction markets you cite, Linden Lab is a privately held firm with no audits and no accountability. There is no doubt about who gets inaugurated, but LL reports could be anything they want them to be which throws any predictability out the door. Indeed, they have perfect ability to alter any measures used by any potential "SLIC".

Picking up this gauntlet would be a fool's errand.

[Peter S. Jenkins]

2.

@ Robert

I am doing my PhD dissertation on the legal and public policy aspects of Robin Hanson's futarchy concept, which as you may know is a system of government based on prediction markets. The role of the legislative branch would be limited to determining the appropriate measure of national welfare, and the proposed laws would be automatically adopted or not based on the results of trading in the PM. I have approached Second Life about testing out a futarchy there, and am still waiting for a response. I had also approached Ted about piloting it in Arden, but that seems unlikely now in view of his recent announcement. Any suggestions? I would be pleased to e-mail you a copy of my dissertation proposal.

Regards,

Peter

[Ace Albion]

3.

Gambling is banned in Second Life.

[Peter S. Jenkins]

4.

@ Ace

PMs conducted for purposes of academic research and teaching, such as the one I am doing my dissertation on, are exempt from CFTC rules. See, for example, the Iowa Electronic Markets conducted by the University of Iowa, that Robert referred to in his post. As for non-academic ones involving financial indicia, Robert has raised the hedging argument.

[Andy Havens]

5.

"...your investment comes with a serious risk: your fortunes rise and fall with the particular platform you have chosen."

The money most companies put into something like SL is sub-trivial when compared to advertising spends on traditional media. At this point, having a presence in multiple worlds isn't like the decision of whether to buy fewer spots in "The Office," or do more direct mail. It's more akin to, "Where should we host a conference." Yes, important for that event. But if it doesn't work out, you just go across the street next time.

[Darniaq]

6.

I'd like to see something like this in virtual worlds with far more activity in them. Granted, most worlds don't offer the openness of SL. But I think this is offset by the sheer number of transactions that take place in worlds like Habbo and Audition.

I also think those worlds represent a better cross section of humanity than SL.

[Robert Bloomfield]

7.

Thanks for the comments.

@Malachi, I agree that data reliability is a key issue. Money supply is just an example. Another possibility would be to cull data from SL itself, as there is so much that is publicly available (on land values, for example). In addition, an exchange would need to spell out what to do in case the data was changed in some drastic why by a Linden Lab policy. (This might be arbitration or cancellation of contracts and refunding of money paid).

@Ace, Peter has addressed your question just as I would have.

@Andy, this is a bit of chicken-and-egg. Why are firms investing so little now? Because they have such poor information! My SLIC proposal is hardly going to help the major players--this would just be a "proof of concept." After all, 100 lindens is only about 40 cents. But once we have more reliable data, we may be able to address this.

I am working in just this direction, with the Metaverse Market Index that will be formally announced by Christian Renaud of Cisco Systems at his keynote address at the Virtual Worlds Conference (see this Metaversed.com post for details.

@Peter, I would be very happy to see your proposal. (Before even seeing it, though, let me offer some standard advice--whatever you are planning, narrow your scope. The key to a better dissertation is almost always to do a more careful job on a more specific topic. For example, don't try to establish a futarchy in Second Life; identify one factor that is likely to alter one key element of futarchy outcomes, and then conduct research to test that theory.)

[Robert Bloomfield]

8.

...oh, and my reply to Andy is for Darniaq too: the Metaversed Market Index will be providing data for many worlds, so eventually we could see the Habbo or even WoW Indicator Contracts too.

[Unoti Quonset]

9.

I'm looking in to creating a system to do this now. I'm the one the wrote www.slcapex.com and www.myllbt.com.