Two recent articles on the growing expectation in tech circles that virtual currencies are going to be the next big thing:

http://venturebeat.com/2009/05/29/the-universal-currency-wars-are-coming/

http://venturebeat.com/2009/05/29/universal-virtual-currency-wars-begin-facebook-payments-system-now-testing-live/

The current motivation is that the big online networks want a piece of any transactions that occur within the system. Social networks, most recently Facebook, basically want to earn a fee as transaction processors. In the long term though "virtual currencies" will necessarily revolutionize the monetary regime.

Consider for example the position this puts Facebook in. Initially they will roll out this feature in terms of only US$ at a standard conversion rate. But, Facebook is a global network. They will have to expand this feature to allow participation by users in all markets. At that point Facebook has two option: a) allow FB credits to float, becoming a sovereign currency b) peg the rate, becoming an implicit provider of foreign exchange services (I could buy FB credits in $ and cash out in yen at the market rate).

I think option A is inevitable in the long term because I don't see how option B could be maintained, for all the reasons that sovereign currency pegs can't be maintained. Facebook is not going to keep a massive cash reserve to enable them to redeem credits for hard currency in all situations. The only option will be to eventually float credits against sovereign currencies when the market becomes too large for them to intervene in. At that point FB, or google, or amazon, or paypal, essentially become a private central bank.

We have argued in the past, to what degree central bank rates can really shift the economy. I would argue that that ability is a function of the efficiency of the markets in alternative currencies. In other words the Fed has high influence when people are stuck with dollars and low influence when people can move out of dollars very quickly. If people can instantly shift their currency holdings into privately administered currencies that dramatically changes the market dynamic.

do you think it can do that, float credit, and people will choose it without legal tender laws. In a way 9and this is very superficial reasoning) they're damned if they do and damned if they don't: if their currency is a good one, Gresham's law will come into play and the legal tender bad currencies will win, and if they have a bad currency then nobody is going to bother anyway without legal tender laws for them.

Does this (what I wrote) even make sense?

(also, to what countries would the FB currency flow if it's a good currency?)

Why would Facebook develop their own currency?

There are no transactions that occur within Facebook for which Facebook isn't already one of the parties. There are lots of third-party applications, but Facebook doesn't charge them anything. Of course you may think they're going to start charging, but that's kind of a supposition.

Facebook isn't the only large network in this position, though. Amazon and eBay currently do charge their affiliates on a per transaction basis. Are they going to develop their own currency? Could they even if they wanted to? And if they could, why would they want to?

*I realized after writing this that "credit" may be very confusing here, Facebook Credits is the name they have given this virtual currency. In all cases I am using credit as a proper noun not in the general sense.

To Stewart's question first:
There are many very successful applications that use some form of virtual currency. These include many of the games like mob wars which use currency as a scoring system, card games (poker, blackjack), other sorts of games that sell in game enhancements (special objects, levels or whatever). There are other applications that would benefit from being able to use a universal currency by providing premium options, selling virtual junk like facebook's in house gift app, etc.

Facebook's angle is that if they can control the currency then they can take a commission on each transaction; they are trying to monetize the interactions between users and between user and application. Monetizing the relationship between Facebook and the app developer isn't the issue. This is not supposition; the feature is in semi-public testing now.

Conrad wrote:

Does this (what I wrote) even make sense?

I don't think Gresham's law applies though I may not be seeing the whole picture. Gresham's law applies when a heterogeneous supply of stuff is all defined as legal tender. Then people take the good stuff out of circulation and only the bad stuff continues to circulate.

In the FB context there would be only one homogeneous supply of currency for any of the transactions that occur in the FB system. You could exchange an inflated (bad) currency for FB credits but you would have to do so at the inflated exchange rate so there is no potential market distortion.

I am not sure what you mean by "legal tender" in this context. FB is essentially saying that credits are legal tender within its system. Whether those credits are "legal" outside the system is irrelevant if someone is willing to give you "legal tender" ($) for your FB credits.

Your question about flows is a very interesting one. I don't think the important question is where it flows geographically. The currency will flow to whoever creates value in the system, whoever finds innovative ways to deliver entertainment or some other sort of service. The interesting question I think is how the market develops. Does it catch on enough that people flock to it as a means to monetize previously inefficient transactions? Does it become large enough to draw interest outside of the app developer crowd? If it does become large, does Facebook continue to try to intervene, selling new credits for buy in $s, or does it shut down new money creation and just have people exchange with each other; essentially, how does it manage its monetary policy?

I recoil in horror at the idea that the virtual currency revolution will be spearheaded by big creepy centralized "social networking" sites like Facebook.

Ugh. In my book, Facebook is totally lame and sucks donkey dong. I hope to hell I won't be forced to use it just to trade some lousy e-bucks.