E-Commerce: Beyond Fun And Games

 

By Karen Epper Hoffman

 

A fixture in online gaming, virtual currencies are moving into other digital markets and may break into the physical world. But will acceptance costs and regulatory concerns stymie their growth?

 

 

 

Virtual currency has long been seen as little more than the online counterpart of Monopoly money—a cash substitute largely used by online game players to spend in imaginary Internet worlds of their making.

 

But virtual currency is breaking out of its confines and becoming a valid payment option for other digital goods and possibly for real-world, point-of-sale purchases.

 

“Online gaming has been a key driver for virtual currency,” says Beth Robertson, payments research director for Javelin Strategy & Research, Pleasanton, Calif. “But that’s beginning to change because of the move to broaden the use of virtual currency … potentially even to physical goods.”

 

Over the years, closed-loop transactions involving game-specific currency in so-called massively multiplayer online role-playing games (MMORPGs) like Eve, Dungeons and Dragons Online, and World of Warcraft have grown to represent hundreds of millions of dollars. With the unprecedented growth of social networks, and subsequently social gaming, virtual currency has become the de facto payment of choice on sites like Facebook and Second Life.

 

“I think consumers like using virtual currency because it’s part of the game experience,” explains Karl Mehta, founder of PlaySpan, a Santa Clara, Calif.-based processor of digital-goods transactions recently acquired by Visa Inc. “Many game publishers design their currencies to match the theme of their games so it’s much more personalized.”

 

‘Developing Threats’

 

But just as the line between real life and online has blurred over the years, so too has the line between virtual currencies and traditional payment forms.

 

With the depth and breadth of digital goods increasing exponentially as more and more people download music singles, buy digital books and magazines to read on their iPads, and stream movies on-demand to televisions or tablets or PCs via Netflix or Amazon, it’s become clear that there’s a huge market of virtual goods that have a real value.

 

The new products and services also mean there is a growing base of consumers comfortable with new payment mechanisms. Industry observers see a stronger and broader market for virtual currency than existed a decade ago, when companies like Beenz and Flooz and Digicash attempted to establish their own online currencies.

 

Virtual currency has received a huge boost from its traditional mainstay, online gaming. Researcher eMarketer predicts that virtual-currency transactions in social gaming alone in the United States will exceed $1 billion in 2011. And as social gaming continues to segue onto mobile devices, virtual-currency transactions on that channel are expected to boom.

 

The market forecasts for how big and how quickly virtual-currency payments might grow—or even how large it stands now—vary widely. In a recent report, Javelin predicted the virtual-goods market would grow from $600 million in 2009 to $2.4 billion in 2012 in the U.S.

 

Javelin defined “virtual goods” as comprising virtual currency “as well as other intangible objects purchased for use in online games or communities, housed within the ‘virtual economy’—an artificial economy that originally developed within traditional online games but has since expanded to social networks and other online communities.”

 

Other industry prognosticators have pegged the virtual-goods market already as high as $20 billion, with a sharper growth curve ahead.

 

“Following the growth of the virtual economy, virtual currency has also experienced substantial growth and has now moved beyond the online gaming realm,” Robertson wrote in a June report. “Virtual currency—which can be used to purchase virtual, digital, or physical goods and may also be exchanged for traditional currency—presents both new opportunities and developing threats to traditional payments services and providers.”

 

Facebook’s Cash Cow

 

As this monetary niche has grown more promising in recent years, new and existing players in the online world have launched their own efforts as virtual-payments purveyors or processors.

 

Among these new power players, the most significant and popular is Facebook, with its “Credits” virtual currency. Facebook users can spend Credits on virtual goods in all games on Facebook, using any major credit or debit card to fund their currency purchases.

 

Facebook does not release the number of Credits payers or the volume of virtual transactions conducted with Credits. But, with more than 750 million active users worldwide on the social network, even if just a small fraction of those are using Credits, it could represent tens of millions of Credits-based transactions.

 

Indeed, more than 12 million unique users pay for virtual goods each month, according to data released in August by PayPal Inc., with many of those making purchases in so-called “social games” within Facebook like Farmville or Bejeweled.

 

While virtual-currency purchases typically are seen as low-value transactions, the market already is changing. In social games, 58% of the virtual-currency purchases are between $10 and $50, and another 9% are for $50 or more, according to PayPal. The group Consumer Watchdog says Facebook alone controls well north of half of the market for virtual goods in social gaming.

 

“Facebook Credits will be the most interesting simply because of Facebook’s enormous 700 million-plus users,” says Mehta of PlaySpan. “While they are starting with online games and expected to expand to other digital content on their site, what’s to stop them from becoming an issuer and enabling consumers to use Facebook Credits at retail to purchase goods just like they do today with debit and gift cards?”

 

In March, Digital Transactions News reported that the mammoth social network established a subsidiary called Facebook Payments Inc., which would seem to indicate broader plans for its digital currency.

 

For now, the subsidiary is said to be helping the more than 300 software developers that accept Credits-based payments, a business that arguably is a cash cow for Facebook since the network reportedly collects a hefty 30% fee on all Credits-based transactions. Facebook did not respond to Digital Transactions’ requests for comment.

 

‘Accepted Everywhere’

 

Startups also are eyeing the market in hopes that the rising tide of digital payments could lift many boats. Founded in January of this year, the Palo Alto, Calif.-based Minno Inc. payment service already has changed its brand from Minno to BuySimple to better reflect its mission, which, in the words of business development executive Dan Lindholm, is to “make the user experience [in purchasing] as simple as possible.”

 

To that end, merchants or individuals can sell their goods for BuySimple Credit, which users can buy through a traditional funding source like a credit card or be awarded for purchasing habits or introducing new users. BuySimple offers an open application programming interface (API) that can be embedded on a merchant’s Web site or onto a Facebook account. Merchant partners include SoundCloud, HackerNews, and FutureMe.

 

Lindholm says that BuySimple hopes to attract other digital-goods merchants like publishers and premium video sites that currently may be limited in their ability to charge users on an à la carte basis for what they want to download.

 

Meanwhile, big-name payments players are dipping a toe in these virtual waters. Last November, American Express Co. launched a deal with social-gaming king Zynga, creator of Farmville and Mafia Wars, to allow cardholders to redeem their card-based reward points. Such points, analysts point out, are essentially a form of virtual currency themselves to buy digital goods on Zynga’s games.

 

In essence, Javelin’s Robertson says, “AmEx is offering virtual currency as a reward.” Partnerships like these, she believes, will pave an easy route for virtual currency to soon extend into the “brick-and-mortar world of retail.”

 

Jesse Schell, a video-game designer and professor at Pittsburgh’s Carnegie Mellon University who is also chief executive of Schell Games, says the convergence has already begun.

 

“Technologies always diverge, economies always converge,” Schell says. “We’re already seeing some serious convergence in the form of Facebook Credits. There will be a lot more convergence still. The biggest, most interesting thing that will happen will be partnerships between game companies and retail establishments.”

 

PayPal, the leader in alternative payments, clearly has seen the digital-currency market’s momentum. Last year, PayPal processed more than $3.4 billion in transactions for digital goods.

 

In a June 29 blog post, PayPal president Scott Thompson expressed his belief that “by 2015 digital currency will be accepted everywhere in the U.S.—from your local corner store to Wal-Mart. We will no longer need to carry a wallet.”

 

Indeed, the market already is expanding beyond the bread-and-butter of online games and into other mainstream digital entertainment. In March, Warner Bros. Digital announced that it would begin accepting Facebook Credits for movie purchases and rentals, delivering content as streaming video without requiring users to leave Warner’s Facebook page.

 

A Huge Target Market

 

As people become accustomed to the idea of buying intangible goods and services—downloading a song as opposed to buying a CD, or streaming a movie instead of renting a DVD—industry observers say that consumers will become just as comfortable paying with virtual currency.

 

“Whenever we invent a new method of buying or selling, we invent a new method of paying,” says Scott Goldthwaite, senior vice president of product management and marketing for Planet Payment Inc., a New York City-based multicurrency processor that operates in 17 countries. “As consumers change the way they shop, they’re going to change the way they pay.”

 

The under-banked audience—often a younger consumer who doesn’t have a credit or debit card, or even a PayPal account—could be a huge target market for virtual currency, according to Goldthwaite.

 

As merchants aspire to expand their global reach, virtual currency also allows them to reach out to geographic market segments that might not have a bank card and may be entrenched in a regional currency.

 

According to Julian Artope, vice president of marketing for London-based Skrill Holdings Ltd., the 10-year-old online payments processor formerly called Moneybookers, there are still areas in Germany and Spain and other parts of the world where “not offering wider payment options [outside of cards and bank transfers] will lose you 75% to 85% of the market.”

 

Skrill processes transactions via more than 100 payment options, including Facebook Credits, for 100,000 (mostly European) merchants, including Live Gamer Inc., which in turn markets e-commerce services that include payments and analytics to game publishers. Skrill recently debuted in the United States.

 

Indeed, even companies that are not offering their own virtual currency are rising on the opportunity of being able to process a wider array of transactions. PlaySpan is one entrant. Founded about five years ago, the processor was built around a flagship product dubbed “Ultimate Pay” that handles more than 85 different payment options, mostly for applications, games, videos, and other types of digital goods.

 

PlaySpan has deals with a number of social networks and gaming and media companies, including Disney, Facebook, Viacom, and Ubisoft. PlaySpan also is testing a mobile version of Ultimate Pay in Japan, according to Mehta.

 

‘Opportunity Costs’

 

Despite its promise, the case for virtual currency is hardly a done deal. Even some of the market’s most optimistic supporters see potential merchant costs and regulatory issues as uncertainties.

 

For consumers, paying with virtual currency offers the perks of ease of use, since most of these schemes offer one-button payment to buy digital goods. And they often give consumers perks or incentives, and make the purchasing experience more fun, which can be key, since the currency is often used to make entertainment purchases.

 

But for merchants, while it’s enticing to open their offerings to more buyers and, in some cases, monetize goods or services that they would otherwise give away, the cost of supporting these payment schemes can seem prohibitive.

 

Facebook Credits’ 30% service fee to merchants for all Credits-based purchases can be a heavy burden. What’s more, the ubiquitous social network imposed new terms in July, under which game developers must exclusively use Facebook Credits as payment for digital goods in the operation of their games.

 

Initially, the policy that went into effect was also going to prevent game developers from offering lower prices on their virtual goods when purchased on a platform outside of Facebook. That rule was removed when consumer groups complained that it would limit price competition.

 

While Facebook offers a popular platform and hundreds of millions of willing users, analysts and vendors agree that its existing service fees could limit growth. “I don’t think the 30% take that Facebook Credits is requiring is sustainable,” Robertson says.

 

With the Durbin Amendment effectively reducing debit card interchange fees and a well-established market for using credit and debit online, charging such a high fee for usage takes away much of “the immediate incentive to move to virtual currencies,” she adds.

 

Mehta of PlaySpan concurs. “The challenges would really be around costs to the merchants and the exchange rate between the real currency and the virtual currency,” he says. “This includes opportunity costs as well because many merchants with private-label credit cards or gift cards may not want to lose the revenue they gain from those payment instruments unless they see that accepting these new virtual currencies brings them incremental business.”

 

‘No Real Answer’

 

Regulatory issues could prove to be an even more daunting hurdle. Since virtual currency does not fall under any one regulator’s coverage, some observers worry about how virtual currency can be tracked, or misused for criminal purposes.

 

Goldthwaite points out that, like conventional cash, the digital equivalent is hard to track, making it a potential foil for money laundering or financial arbitrage, as well as outright theft.

 

“There’s the question of who’s backing the deposit,” Goldthwaite says. “If there’s a major breach, is [the virtual currency] worthless?” In addition, questions abound regarding chargebacks on digital goods, and the potential for a “run” on the currency. What if providers had to pay in real money hordes of virtual-currency users who simultaneously demanded to cash out?

 

The case for government oversight is building. Virtual-currency scams already are rife. At prisons in China, Robertson says, guards were using prisoners to play games online and win virtual currency that the guards could then cash in for real-world currency.

 

In June, U.S. Sen. Charles Schumer, D-N.Y., a member of the Senate Finance Committee, condemned the virtual currency Bitcoin, noting that it was usable on a Web site that reportedly sells illicit drugs.

 

“It’s a very unregulated environment, with different ways to amass or buy currency. Money could easily be moved in an out of virtual currency,” Robertson says. “There could be money laundering.”

 

Government oversight could put boundaries around usage in individual countries. But since virtual currency, like the digital goods it pays for and the platforms on which it operates, is global in nature, it’s hard to say if that alone would quell any risk.

 

Online-currency provider Beenz shuttered its operation a decade ago after three relatively successful years of growth, during which the company operated in the U.S., Sweden, France, Germany, Italy, Japan, Singapore, Australia, and China. At the time, analysts pointed to the payment scheme’s growing scope as the primary reason it failed. In developing a system where users exchanged different currencies for a virtual one, it had created an unregulated foreign-exchange market.

 

Money laundering is “one challenge where there’s no real answer,” Skrill’s Artope admits. The tried-and-true approach of “know your customer”—always a challenge in the online channel—may have to be adapted for this new audience of digital spenders, he suggests.