The lack of formal regulation of financial transactions between players in virtual worlds such as Second Life leaves the gaming system open to abuse, reports Nathan Skinner

Financial transactions in virtual “worlds” such as Second Life should be subject to the same reporting and monitoring requirements that apply to real-life financial services firms, an expert has warned.

For the best part of a decade, since the terrorist attacks of September 11, banks and other financial firms have been required to monitor their customers more strictly to crack down on the financing of terrorist organisations. These powers have also been used to restrict the ability of criminals to use financial services as a means of money laundering.

The more rigorous climate, however, has meant that terrorists and criminals are looking for new ways of moving their money around.

Second Life is one of the most popular of the online gaming worlds that have sprung up over the past decade. Developed and launched by Linden Lab in 2003, Second Life is a 3D virtual world environment. Its “residents” (estimated at more than 6 million) can create content, interact with each other and launch businesses. Players use “Linden dollars” which are converted from real currencies.

Anti-fraud experts warn that participants in online communities can transfer money with little risk of detection. There are few checks to ensure these transfers are legitimate and criminals can hide behind their avatars (the virtual identities they create for themselves).

In September 2009, Linden Lab announced that transactions between Second Life users added up to the equivalent of more than $1bn. The Second Life economy grew 94% between 2008 and 2009. Now, with nearly $50m each month in user transactions, the Second Life economy is on an annual run rate of more than a half billion US dollars, making Second Life the largest virtual economy in the online gaming industry.

As in the real world, there is scope for both legitimate and illegitimate activity. Several entrepreneurs have built successful businesses in Second Life. But Mark Johnson, who heads risk management firm TRMG, is concerned about players’ ability to trade currency online with fictitious identities. “It is impossible to say how much misuse is happening but the model is open to abuse. That’s the concern.”

The game companies say there are caps on the permitted number of transactions per day per account. Linden Lab says it has a fraud protection mechanism and works hard with law enforcement authorities to counter illegal activity. Second Life’s economy is dominated by small transactions, it says, and therefore large transactions would stand out.

But Johnson believes the controls are “rudimentary”. The key issue, he says, is players hiding behind virtual identities. “If you look at the financial world, the important thing is identity: knowing the identity of your customers and being able to track transactions. Although these worlds set up limits on what you can do to set up an account they don’t do anything to make sure that the account is tied back to a real person in the real world,” adds Johnson.

On the need for better regulation of online credit systems, he says: “It is an economic mechanism for storing value and transferring value between individuals and therefore it is money and should be subject to the same controls and reporting requirements as any other set of financial transactions. And then the regulators can get involved. But as it’s not yet clear if this is money in a legal sense, the regulator has no interest. Technology is just staying ahead of the legislation as it always tends to do.”

Financing of terrorism is another concern. The sum of money transferred tends to be much smaller than money launderers, but terrorists have the same motivation for concealing their transactions from the authorities. Given the amount of surveillance and supervisions of real-life financial transactions to prevent terrorist financing it appears that online money laundering presents a “massive loophole”, says Johnson. “It’s very simple to move funds from one part of the world to another through an online game and not be monitored.”

Paedophilia is another concern related to virtual identity monitoring. Since online worlds are popular with young people there’s a tremendous scope for grooming and stalking.

Johnson believes that little will change until there’s a big money laundering case or funding for a terrorist operation is linked back to an online community. “Law enforcement authorities are far more aware of the issue than they were previously and sensitive to the threat but until a big case hits the headlines and gets political attention I don’t expect things to change."