The Design of Online Economies

Part 1: The Role of Currency

The virtual economies of online persistent games are always good fodder for message board arguments and backseat designers. Everyone thinks that it's an easy job, and that if someone was just competent and put a little thought into it, a "perfect" economy could be made and left alone like a well oiled machine. Hell, everything that's in that economy is defined by the designers, it must be easy, right?

Wrong.

Designing or even moderating virtual economies is hard. It's very, very hard, because there are so many different variables at play that tweaking one may have rampant effects on others. For that reason, I've decided to write a series of articles (hopefully) about the basics of online economies. This is not intended to be a "how to design virtual economies" series, but more of a survey on "factors at play in online economies" -- an attempt to understand the problem before even thinking about solving it.

It's taken for granted that an online game will have some kind of standardized currency such as gold pieces, credits, or dollars. By converting goods and services to currency and then back again we can provide a handy intermediary facilitates easy trade between players. This is the idealized system, and in a perfect world it works.

But before we think too much about currency, let's first look at a simpler system that has no currency and then see what happens when we add currency to an economy.

An Economy Sans Currency

An economy that does not have currency can be a confusing environment. When Alex wants something from Beliza, he must have something she values equally. Not only must Alex have something that Beliza values, but he must have something in the right amount so that it is an equal exchange. Barter systems don't support fractional values very well (i.e. you can't make change).

Beliza has a nifty steel helm she's made. Alex could really use an upgrade from his old, battered bronze helmet. In the worst case (for Alex), he has nothing that Beliza is interested in -- she wants a horse, and Alex doesn't have a horse, so that's that. Alex might have something worth one horse, but he's still out of luck unless he can convince Beliza to accept "one horse by indirection" or unless he undertakes the work to convert his valuables into one horse.

For example, he might have a valuable scroll that Xavier would gladly trade for one of the horses from his stable. To make matters worse -- and more realistic -- what he'll find is that Xavier has horses, but wants two sheep, and Saul has the sheep, and wants a golden lamp, and Thomas has a golden lamp, but wants a steel dagger, and Chuck has a dagger, but wants...etc. etc. In a complex enough society, this can become so cumbersome that it's unworkable for individuals so you see the rise of a dedicated "market maker" class that handles all the indirection and skims a little off the top -- profiting through economic friction.

Let's take an easier situation, where Alex actually has the horse. But realistically, a steel helm is only worth about half a horse -- so how does Beliza make change? She can make more helms, but Alex might not need more helms. Or she can look for other items that Alex finds useful to make up for it, but then we're back to trying to find items of equal relative value.

There are two major problems here: finding items of equal value and making change. A standardized currency system can solve both of these problems. Beliza can trade her helmet plus 50 gold pieces to Alex for his horse, or she can just buy the horse outright for 100 gold pieces and Alex in turn can take the cash and buy a steel helmet and pocket the rest. They can even perform this exchange through an intermediary (a marketplace) without ever dealing with each other directly. Obviously, this is a much more efficient system than a pure barter economy.

For a currency to work, however, it requires the backing of an authoritative instituion such as a bank, religion or government. What if the authority figure doesn't want to get involved? What if the developer says, instead, "Hey, I know if I make a currency, I'll screw it up, so just deal with it"?

As we've seen, a pure barter system just doesn't scale well. But humans are pretty crafty and resourceful, so pure barter economies rapidly produce de facto currencies as humans attempt to optimize marketplace transactions. In human history, livestock is most likely the original currency in those cultures with domesticable animals.

Unfortunately, cows are pretty unwieldy for smaller payments because they don't fractionalize very well (without making a mess and ruining its non-food utility). If you want a pound of apples from the farmer, you're not going to give him a whole cow for them, but you may not want one whole cow's worth of apples.

The next step then is to reduce the size of the currency so that smaller payments are feasible. This smaller currency will still have intrinsic value, but now we might be looking at salt, deer skin, small pieces of metal, coffee beans, or tobacco leaves. In a virtual world the common form of currency that arises will almost always be something of universal value and that is fungible. If a game supports smithing or woodworking, the unit of currency may be a piece of iron ore or wood, since these are raw materials (relatively) easy to convert to items of real value such as weapons and tools.

This de facto currency itself is not backed by anything of particular value other than its own raw materials. In the real world this is not a particularly robust system because of manipulation and fraud (counterfeiting, "shaving", etc.), but in an online world it is a stable system simply because the world's physics prevent exploitation (excepting the unfortunately common occurrence of bugs).

For such a currency to develop the designers must provide some type of in-game item of the appropriate portability and uncontested value. If they fail in this regard, then a pure barter system remain.

The Rise of Abstract Currencies

Now carrying around a few dozen pounds of base materials just so you can get a cup of tea seems a little extreme, so our next evolutionary step is the creation of abstract currencies, where accepted institutions write notes worth some fixed sum of currency. Alex has five hundred pounds of iron ore, but he doesn't want to lug it around with him everywhere. So he goes to his local bank, gives them the ore, and in exchange they issue him a note for any amount of ore he wants, redeemable by the note's bearer. Alex runs into Beliza and says "I'll give you twenty pounds of iron ore for that steel helm", which she gladly agrees to. He proffers a twenty pound note, and Beliza -- recognizing the validity of the note and the reputation of its issuer -- gladly makes the exchange.

And thus we have the rise of paper currencies backed by something of tangible value.

But do online economies need this level of standardization? That's a tough to say, because the real problems that paper currencies solved (and suffered from) don't really exist in online worlds. Players can usually carry or store their valuables safely (modulo system exploits and bugs), and there is no central in-game entity that has a vested interest in establishing a fixed currency.

Standardized Currencies

Players expect standardized currencies in their online worlds. They want credits, gold pieces, pounds, dollars, etc. They want to enter the world understanding the relative value of things, ideally established by prices they see in some store. They don't want to sit down and try to figure out how many pounds of salt a wolf pelt is worth.

But this is a convenience issue, not a mechanical one. It aids communication and understanding, but that's it (not to devalue those two attributes, but there is a fairly large difference between convenience and functionality).

For this reason the game's developers may decide that a standardize currency is still required, so now they're put in the position of creating one, which is trickier than you'd think.

The designer must make the player care about the currency. What does it buy them, literally? If every monster drops gold pieces but those coins can't be converted into something tangibly useful, well, it's not going to be worth too much. A standard currency must provide real value.

Such value can be provided in the form of goods or services acquired strictly through currency exchange (the transfer of currency from players back into the system). These goods and services ("monetary stabilizers") provide two important functions: first, they establish a real value for the currency (their primary purpose) and second, they pull money out of the system, offsetting inflation.

However, to be effective these monetary stabilizers must be universally valuable or necessary; they must scale with character wealth; and the costs must be recurring.

Items that are only necessary for a subset of players are ineffective monetary stabilizers -- their effect outside that core group is strictly the result of indirect costs when interacting with players that need those items. Goods and service that are at a fixed price have an over large effect on players that cannot afford the item, and a negligible impact on wealthy players, and thus their ability to stabilize a monetary system is relatively weak. Finally, goods and services that are purchased a single time, no matter how expensive, are relatively poor monetary stabilizers since they affect each player only once and then cease to be relevant.

One common stabilizer that tries to address these concerns is "rent", where you lose items if you do not pay some fee proportional to the value/power of your items before logging out. While appealing on the surface, in practice this technique is only partially successful. If you make the tax too exorbitant, everyone ends up scurrying for cash to pay rent -- and then the game moves from entertainment to work. If you make the tax too light, then people don't think about it and, again, money is devalued. Item wear, tear and repair is a similar taxation, where weapons and armor get damaged and must be repaired at a cost proportional to the value of the item. This is just "rent" dressed in different clothing.

Ultimately a standardized currency is feasible, but its true worth depends directly on the services and items that can be purchased. In an economy where any service or item that can be bought is also available for free (eg. dropped by monsters or as a player skill), then standardized currency is worthless. At the other extreme is an economy where currency is extremely valuable since all important items and services are available solely through currency exchange -- in effect, the system has a monopoly.

Inflation and Currency

The simple description of inflation is "too much money chasing too few goods", a common quote you'll find in many banking and economic discussions. While a reasonable summation, it's far too simplistic for any real analysis of inflation in any complex economy (including virtual ones).

For starters, it is trivial to envision inflation in a society that lacks any currency. In a barter economy a sudden shortage in a key product such as livestock or produce will drive all "prices" higher. If a chicken used to cost you, a blacksmith, one horseshoe, and now it costs you five horseshoes, then you're going to find that you'll charge your own customers roughly five time as much for one horseshoe. You have to pass the costs on to your customers, which is one of the classic inflationary drivers.

Conversely, when there is a glut -- say, a chicken invasion -- then Farmer Dave may not get anything for one chicken since you can just grab one running around your smithy. This time over supply has driven the relative price of a commodity downwards.

So supply and demand affect inflation equally, irrespective of the presence of a standardized currency.

However, the introduction of a standardize currency can complicate things, since you now have an intermediate representation of worth that may or may not have actual value. A chicken is worth one chicken, by definition, but what, exactly, is a note inscribed with the phrase "one dollar" worth? This indirection of value can have significant repercussions to the complexity of a system.

If the currency in question is effectively worthless, literally "not worth the paper it's printed on", then you'll have price inflation even if the relative supply and demand of goods is stable -- if a dollar is worthless, you can bring me a barrel full of dollars and I still won't find it any more valuable. Zero times infinity is still zero.

In other words: inflation is not the direct result of too much money in the system. Inflation can exist without money, and inflation can still exist when there is a limited or even diminishing money supply if scarcity is great enough.

Contrary to popular belief, the most common reason for inflation in an online adventure oriented economy isn't due to monsters dropping money all the time, it's because that money translates directly into an overabundance of goods (through the exchange of coins for goods). If loot drops were strictly coinage, and that coinage could not be transformed into anything of value, then it literally would be worthless and irrelevant and you're back to a pure barter economy again.

So in the end, an oversupply of money (from constant loot drops from monsters) is just an indirect form of an oversupply of goods, which is why item inflation and monetary inflation are effectively the same thing.

Obviously, an excess of money that can be transformed into an excess of goods will cause inflation. Likewise, if goods or services are available inexpensively or for free through other means then money loses value.

This means that both looted items and "free" player generated goods or services will affect inflation dramatically. For example, if every town has an NPC that for a nominal fee will "bind" you to that town, then there is a valuable service available that only money can buy -- by extension, this increases the marginal value of currency throughout the system. But if you give that ability to some players, then you have just caused a slight bump in inflation by increasing the supply of a service heretofore only available through currency exchange. Even worse, you've now dropped the value of the currency in general since there is one less service exclusive to currency exchange.

There are ways to reduce the inflationary spiral, which I will discuss in a later article, but for now I really wanted to illuminate the fact that inflation is not just about item drops or looted money, it's about the complex interaction between supply and demand, and how small changes can have large effects on a virtual world's economies.

Summary

Standardized currencies, either official or de facto, provide economic lubrication -- transactions happen more efficiently and with less overhead and strain for all participants. A currency is only as valuable as players believe it is, which means that the currency itself must possess inherent value (iron ore) or the currency must be backed by something valuable (e.g. goods and services only available from NPC merchants).

A game world can function just fine without an official currency so long as some de facto currency of global economic value and limited supply establishes itself, but this leaves a great deal up to chance and an expectation of emergent behaviour.

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Acknowledgments and Bibliography

None of this information is particularly new or insightful, but I haven't seen it put all down in one place before. Much of the content here is based on discussions in the Book of Hook forums; conversations with others, either directly or on mailing lists or messageboards; and various other resources, which I'll try to list here.

The MUD-Dev Mailing List

Designing Virtual Worlds by Richard Bartles

The In-game Economics of Ultima Online by Zachary Booth Simpson