by Alphaville Herald on 21/06/10 at 4:40 am
by IntLibber Brautigan
Under a normal market, where there is a healthy flow of cash in and out of a given economy, those operating currency exchanges make significant profits in ways most people do not realize. With the LindeX, for example, the spread, i.e. the distance between the lowest sell price vs the highest buy price, rarely exceeded the exchange fee that LL charges users to use the LindeX. Many LindeX day traders would set up framing orders a mere 1 linden above and below the zero profit spread point, in hopes of catching some market activity to profit from. For instance, if you sell L$, you pay a 3.5% fee to LL, which comes out to 9.275L$ if you are selling 265L$ at 265L$/USD. If you buy L$, the fee is US$0.30 per transaction, which is pretty minimal unless you are buying paltry amounts. Still, it narrows the daytraders profit so that a 10L$ spread in prices means zero profit for the normal day trader.
Sudden volatility in the L$ currency exchange
Supply Linden, however, doesn’t pay a fee. He can trade at less than the spread and still make a profit, and more profit than most people perceive, because when Supply Linden buys up L$ that people are selling, the sellers are still paying a 3.5% fee and at the same time Supply Linden can be selling L$ on the other side of the spread for zero net change in the L$ money supply, but Supply Linden just earned 7+%. This is why Supply Linden would always stabilize the LindeX with large framing orders, of 10-20 million L$ on each side of the spread, making sure that, in order for other people to sell by limit orders, they would trade in a narrower spread so they could not profit from trading both ways. It doubled Linden Lab’s profits on the LindeX by doing so and boosted public confidence in the L$ economy by having exchange rates so stable.
LindeX would only have an excursion from this pattern on the weekend when whoever was running Supply Linden was out of the office and his outstanding limit orders ran out.
This was how things used to be run, when SL was a growing, happy, productive, expanding economy where people were putting more money into SL than was taken out.
This started turning around with the gambling ban in August 2007, when the size of the SL GDP dropped by almost half. Casino owners exited with their life savings, and gamblers who still had cash took their money out and went to the other internet casino sites. Along with subsequent bans of other legitimate economic activity (banking, advertising, as well as the homstead tier hike) more and more residents lost confidence in the SL economy and those managing it. They started taking their money out of SL in greater numbers than people were putting money into it.
When this shifted the flows of capital, then the LindeX became a liability to Linden Lab. While they were still making a 7% profit on trading activity, this profit was being drained by having to buy back more L$ than they were selling as capital fled the grid. At first this was a mere trickle. More users stopped bringing money into SL and only lived off of what they earned inworld, paying their US bills to LL with these earnings. As these numbers grew, they synergized on each other, accellerating the liability drain upon Linden Lab’s earnings. Their 7% profit shrunk so that some days they didn’t earn anything on the LindeX, in fact, it cost them more money than they profited.
At this point, it started to become economically advantageous for Linden Lab to cease this prior trading behavior, and let the L$ float freely on the open market, without the deep pockets of Supply Linden to keep it stable. Apparently the decision to make this change happened this past week.
Whether it was because LL didn’t have the money (the recent firing of over 100 employees speaks to their need to cut costs), or was merely trying to maximize profits prior to being sold off or doing an IPO, or perhaps Mark Kingdon forgot to assign someone to manage Supply Linden after whoever was managing that account was laid off a week prior. We will never know the truth, I suppose. Some have proposed that some disgruntled former Lindens are liquidating their L$ savings from their off-duty businesses. If so, they have had substantial savings of over a half a million USD to liquidate.
I believe that Mark Kingdon has realized that with the shrinking economy of SL, it maximizes profits for LL to no longer regulate the exchange rate of the L$. The recent exchange panic has put such a large quantity of sell limit orders on the market that it would cost LL over 6% of its monthly revenues to stabilize the exchange rate again at its former level. In addition to these 6% savings, he doesn’t have to employ someone to babysit Supply Linden’s trading activities, which should save the company at least another $150,000 a year in salary eliminated.
Boosting your profit margin by 6% is something most CEO’s aspire to. It is the thing that pays big bonuses and stock options at the end of the quarter. If the company is for sale, it helps ensure the company is sold for top dollar. Frans Charming commented over on New World Notes that IBM is considering buying Linden Lab. If this comes through, this may explain a lot of things that have happened lately. IBM certainly has plenty of its own staff who can handle all the things that those laid off used to do, so eliminating this redundancy is understandable. We’ll see what happens over the next weeks and months.