The Lawrence Chan Blog

There are many MMORPG (massively multiplayer online role-playing game) available online where kids and adults alike spending hours everyday to live within these virtual worlds. Just like our world, these virtual worlds have their own economic systems that mimic what we have in real life. Recently my son and his friends experienced first hand what a market crash is like in one of these virtual worlds. I find it so interesting that I have them tracked down the sequence of events and how that affected their gaming experience.

The Economy

First, a short explanation of the eco system is in order.

Within this game, as in almost all other MMORPG, a currency exists for players to do things within the game. The currency is called gold. For example, you need gold to repair your clothes and weapons as they do wear down over time and use. Since gold is essential for basic survival within the system, it is also the medium of choice for players to trade useful items among themselves. The game has facilities available for each player to create their own little shops to sell their stuff within certain market areas. Overall it is a pretty healthy economic system.

There is a catch within the system though. The company that operates the game has to make money off their service somehow. While majority of players do not want to pay for the game, there are certain things in the game where players have to pay real money to obtain the extra services or a chance to get very rare items within the game.

Does this ring a bell to you?

It is operating with the same principle like those game machines available at the movie theatres where you have to put in several dollars to get the cute little items that the kids want. Among the prizes on display, however, some of these items are very rare. They are the ultimate prizes. They are the hook. They are there to lure the players to give the machines a few more tries before giving up. This strategy works very well with kids, oh well, and some adults too.

Some people, who are desperate to obtain the in-game money, gold, would pay real money to buy these special items from the game company and sell these virtual items in the open market within the game. This creates a unique flow of special items into the game in the form of high priced luxury goods as in real life.

The behaviour of the prices of these virtual items within such a system is well worth studying because it really shows you which economic theory works and which ones are just plain bad imaginations from economists.

The Alternative Currency

As in any other economic system, there is no real objective measures to control the pricing of the items within the game. Stability of prices was achieved when the players started to barter their holdings with one of the real money only item, a dye, which costs about 1 US dollar each. The moment this concept has been accepted, the pricing of all other items slowly fall into place.

This item, dye, is there for one function. The player can use it just once to color a part of their clothes, weapons, tools, etc. in one of the colors they pick from a random palette. Obviously, the results do not always meet the expectations of the players. Hence, dyes are in demand all the time.

In another words, the dye acts as an alternative currency or storage of value.

Things work out fine for a long time. Then a crisis came.

The Appearance of Fiat Alternative

The game company, for some reason, chose to host a 2 weeks event where the users can obtain a free version of this dye through participation in some mindless activities within the game. Unlike the regular version of the dye, this particular version has an expiration date stamped. Thus people who obtained the dye must use it or sell it within a week or it will expire worthless.

On the first day this event started, I was told about it because my input about the game helped the kids once.

At that point I asked for daily recording of the price and availability of the dyes in exchange for my advice.

The Great Market Crash

The ongoing price for a regular dye that does not expire was about 120,000 gold each before the event started. When availability is low, it can go up to 140,000 gold. The price is stable though. Even if there are players who needs gold quickly they know they can sell their dyes within a day by dropping the price just a bit lower.

First day of the event, the alternative dye was selling at 120,000 gold just like the regular one.

Second day, it started to drop a little to 110,000 gold and the regular dyes disappeared on the market totally.

Third day, it drops down to 100,000 gold with supply of the dye increased significantly.

Price keep declining until it hits the range of 60,000 to 70,000 where the market place in the game are flooded with dyes.

By last few days of the event, the price of the dye dropped down to 30,000 gold only and the supply of dye has dropped to around 50% from the peak.

The day after the event is over, price of remaining alternative dyes (not the regular ones) jumped back up to 70,000 and above.

I am speculating that a week later the alternative dye will all disappear from the market and the price of dye will return to normal.

Side-Effects of the Crash

The disruptive nature of the event is very clear in terms of the market price fluctuation on the dye. But there are other not so obvious impacts to the economy within the game that are very interesting. Following are a few observations.

• Regularly available items that players usually gather from the game to sell in their shops were in short supply throughout the event
• Many players who operate their own shops switched to collect and sell dye
• Prices of other rare items in the game went up steadily throughout the event and stayed at a higher price level still
• Bartering within the game using dye completely stopped

My Advices

All I could come up with was just 2 strategies.

First, I told the kids to keep gathering the dyes and fire sale them at market price of the day, everyday. Since the dyes cost nothing to produce within the game, it is just a matter of who work harder to farm them from the game. In a sense, it is free money from the game company translated into in-game money.

The kids actually figured out part of this first strategy themselves. It is just good old common sense. The only fine-tuning of their intuition that I offered is the importance to fire sale the inventory quickly as the price of dye can fall very fast.

Second, I told the kids to gather as many dyes as they can at basement bargain price by the last day of the event. Right after the event, they flipped out the inventories for at least double the average costs.

It is not practical to hold onto these fiat version of the dye as they will expire. Otherwise, the better strategy is to save them up to maximize the profit.

Last time I asked they each netted a few million gold.

They are now all virtual multi-millionaires.

Their first lesson on practical trading strategies.

End Notes

I am amused that 50% of the price acted as support.

Another proof that price is mainly a function of the behaviours of the participants?!

There are many more funny observations about these virtual economies I will write about in the future.

No comment yet

Is he signalling (or threatening) Fed to not taper QE?

http://www.zerohedge.com/news/2013-06-27/deutsche-bank-if-fed-concerned-about-popping-its-asset-bubbles-it-15-years-too-late

It is interesting that he dares to challenge the almighty Bennie’s point of view.

No comment yet

Yesterday S&P 500 finally tagged the primary short target on my long term call in the Market Bias Observer newsletter. People poked fun at me since S&P traded above 1650 when I said the market is due with a 5% (or at least 100 points) correction. Majority of the famous gurus at the time, including the bears, failed to see the signs.

It is my first time providing directional call in my newsletter. It feels different because of the responsibility and restrictions with a long term market call. I have to say it is more difficult to do than managing hedge fund.

Back in the old days when I was managing money for other people, I have many more tools available to me. I can day trade, hedge with options, etc. I can even change my mind intraday to improve performance when I see strong evidence that market will spend the day going against my long term positions.

When making a call in a newsletter, I cannot make the trading ideas too complex or it will be difficult to follow. In retrospect, I think the first call I made is already too complex for the purpose of a newsletter. Streamlining that is definitely something I have to work on.

For now, it feels good that the call worked out.

3 comments

We were talking about the importance to take notes during real-time chat today. That reminds me of a good article by Allen Sykora on Linda Raschke. Here is a link to the article in PDF format from LBR’s own website,

Linda Bradford Raschke: Trading as a game – the need to focus and why she keeps notebooks

Ms. Raschke’s website LBRGroup

No comment yet

What’s next?

http://www.marketwatch.com/story/uk-china-reach-currency-deal-2013-06-23-121035528?link=MW_story_latest_news

No comment yet