Over a year ago, around the time the sub-prime market started its melt-down, in fact. Wired reports:

The recent collapse of Ginko Financial, a “virtual investment bank” in Second Life, has spurred calls for more oversight, transparency and accountability, especially when it comes to business practices in the
metaverse. [...]

The declared insolvency meant the bank would be unable to repay approximately 200,000,000 Lindens (U.S. $750,000) to Second Life residents who had invested their money with the bank over the course of its three and a half years of existence. [...]

On Tuesday, Linden Lab itself issued a statement trying to clarify its stance on regulations and Second Life’s virtual economy.

“Linden Lab does not intend to recreate or subvert real-world laws in any way,” the statement says. “We caution our residents to be wary of anyone offering extremely high interest rates at no risk, either in the real world or in Second Life — if it sounds too good to be true, it probably is.”

The response was timely, considering Second Life currently has 20 to 30 banks that operate essentially the same way Ginko did. That fact, plus the large losses associated with Ginko, has led to a growing call for even more transparency and regulation among SL residents. [...]

Robert Bloomfield, an accounting professor at Cornell University, is of the same mind. Bloomfield says the collapse of Ginko and the recent closing of casinos, among other incidents of alleged fraud, are shocks to participants in the Second Life financial sector.

That said, Bloomfield believes residents are already responding by creating a variety of oversight institutions of their own, including companies that insure against fraud and homegrown regulatory institutions like the Second Life Exchange Commission, which is modeling itself on the SEC.

“It will be very interesting to see which organizations survive (if any), and how they reduce the risk of fraud,” he said in an e-mail. [...]

In the end, Bloomflield says SL’s financial and business sector can teach us a lot about the nature of regulation and oversight. Even with the unfortunate case of Ginko, he still believes the intervention of real-world regulation is remote.

“I am really hoping that RL (real life) regulation does not come to SL because right now SL has the chance to sort out what type of oversight and regulation it wants,” Bloomfield said. “If the RL authorities or Linden Lab do start meddling with business affairs, it could ruin a golden opportunity for real innovation and creativity, a chance to recreate a world in a new image.”

It doesn’t seem like such a utopia has come about, but banking regulations did come come to Second Life. At the beginning of this year, a few months after the collapse of Ginko, Linden Lab announced the new policy:

As of January 22, 2008, it will be prohibited to offer interest or any direct return on an investment (whether in L$ or other currency) from any object, such as an ATM, located in Second Life, without proof of an applicable government registration statement or financial institution charter. We‚Äôre implementing this policy after reviewing Resident complaints, banking activities, and the law, and we’re doing it to protect our Residents and the integrity of our economy.

Since the collapse of Ginko Financial in August 2007, Linden Lab has received complaints about several in-world “banks” defaulting on their
promises. These banks often promise unusually high rates of L$ return, reaching 20, 40, or even 60 percent annualized.

Usually, we don’t step in the middle of Resident-to-Resident conduct‚ letting Residents decide how to act, live, or play in Second Life.

But these “banks” have brought unique and substantial risks to Second Life, and we feel it‚Äôs our duty to step in. Offering unsustainably high interest rates, they are in most cases doomed to collapse, leaving upset “depositors” with nothing to show for their investments. As these activities grow, they become more likely to lead to destabilization of the virtual economy. At least as important, the legal and regulatory framework of these non-chartered, unregistered banks is unclear, i.e., what their duties are when they offer “interest” or “investments.”

There is no workable alternative. The so-called banks are not operated, overseen or insured by Linden Lab, nor can we predict which will fail or when. And Linden Lab isn’t, and can’t start acting as, a banking regulator.

Some may argue that Residents who deposit L$ with these “banks” must know they’re assuming a big risk: the high interest rates promised aren’t guaranteed, and the banks aren’t overseen by Linden Lab or anyone else. That may be true. But for all of the other reasons we’ve set out above, we can’t let this activity continue.

Now, there’s probably not a connection between financial troubles in Second Life and their more serious counterparts in “first life” (that is, reality). That hasn’t stopped some from discussing the issue in terms of a virtual sub-prime crisis. What is definitely similar is the core arguments for and against regulation–specifically, the concern quoted in the Wired piece that a fertile ground for experimentation would get hampered by controls.

It would be nice if Second Life were so detached from reality that value in that world had no connection to value in this world. If that were the case, it could be looked at as a big simulated economy from which lessons could be learned from innovation without cost to the participants. But that, of course, would be impossible. If Second Life currency and property weren’t worth anything, people wouldn’t be saving, or investing, or competing, or scamming, or engaging in any of the economic activities they’d have to be for anything to be learned.

Which is, of course, a basic pro-market argument. If people aren’t acting in their own self-interest and have their incentives externally distorted, the best outcomes won’t be achieved and innovation won’t be rewarded as much as it should be, decreasing the rate of new ideas and novel economic arrangements.

This is territory is both uncharted and heavily charted. There’s plenty of economic thought out there but not a lot of case studies of virtual economies.