The economic analysis hidden behind the virtual world: supply and demand, property rights, and transactions

This article is from rct studio, the original title is “Economic Analysis Hidden Behind the Virtual World”.
We live in a random world, where randomness seems to make this world feel more real, rather than a predictable simulator. At the same time, we are also creating another world through code, a world that has both predictable and unpredictable parts.

As this world gradually develops, it seems we have new ways to rethink and understand the real world we live in. Looking back at the development of online games, one can't help but marvel at the gradual birth of this "cloud ball" created by us, the players of the real world.

According to Statista, the revenue from online gaming is expected to reach $23.582 billion in 2021, and the market size is projected to reach $31.328 billion by 2025, with the number of players expected to rise from 1.097 billion in 2021 to 1.277 billion in 2025.

The continuously expanding market size, the steadily increasing number of players, and the gradually longer online hours compared to real-world living time all proclaim that this virtual world is gradually developing and improving.

In Statista's market definition, online games are defined as Massively Multiplayer Online Games (MMOG) and casual and social games.
In this process, our research and thinking about the virtual world may have a transformative impact on our cognition, similar to the overview effect mentioned by Frank White in his book Space Exploration and Human Evolution, which refers to the cognitive shift that occurs when some astronauts and cosmonauts view Earth from space or the surface of the Moon.
Now we attempt to start from the virtual world and view everything happening in this world from an economic perspective, which may reconstruct our understanding of the objective world.

Games and Economics

Games and economics, two seemingly unrelated terms, are actually intricately connected.

In the game world, players enter this virtual world as game characters, displaying various microeconomic behaviors: choices, cooperation, and competition, etc. In this artificially constructed economic system, various economic principles are also present: scarcity, supply and demand, and institutional design, etc.

Essentially, this is a reflection of the real world in the virtual world, but the economic explanations of the two differ. The reason why the virtual and the real are different is that they are two distinct worlds.

In the real world, we engage in many rational and irrational behaviors. Economists, at least classical or neoclassical economists, study individuals and market efficiency from a rational perspective, attempting to open the Edgeworth box and find the welfare economics laws that describe that "invisible hand" and the Walrasian equilibrium point in perfect conditions.

Of course, there are also behavioral economists and other schools that study chaotic, nonlinear, and unpredictable economic systems from the perspective of human irrationality.

However, in the game world, or in the larger virtual world, all these behaviors are reflected in the players' attempts to find optimal solutions, or rather, they are recorded in the computer's programs.

This virtual world possesses huge data mining capabilities and the ability to accurately track player behavior, which in some ways opens new doors for economists and sociologists.

Moreover, the exploration of economics in the virtual world also provides new ideas for us to better understand ourselves.

This requires rethinking from another perspective. We all know that there are mainly two ways for humans to understand the world: observation and learning. In the path of learning, we actively or passively learn two major scientific fields: social sciences and natural sciences, but what exactly is the difference between the two?

In discussing this issue, economist Felix Martin, who studies monetary theory, mentioned a viewpoint that the difference between social sciences and natural sciences is that "a fish does not know water," which to some extent explains why sociology, economics, and anthropology differ from natural sciences like physics, chemistry, and biology.

In fact, in the field of natural sciences, we study the physical world, constantly discovering the underlying laws that govern how this world operates, or in other words, this world can be objectively understood.

However, social sciences are not that simple; we often target individuals, groups, and society to study ourselves. We cannot detach ourselves from society, nor can we detach ourselves from ourselves, which makes it very difficult to objectively understand things.

The closer we get to the core institutions or frameworks of our daily lives, the harder it becomes to step outside this circle to analyze it. This is also why, for Felix Martin, the study of the nature of money is so controversial, as it is a very important part of our economic life.

Therefore, to become a fish out of water and better understand ourselves living in the real world, we need to conduct research from different temporal and spatial environments, which can lead to a relatively objective understanding.

Starting from the perspective of the virtual world undoubtedly provides us with a new way to further understand the objective world.

Early Exploration of Virtual World Economics

Edward Castronova is an early scholar exploring the economics of virtual worlds. In an early paper titled Virtual Worlds: A First-Hand Account of Market And Society on The Cyberian Frontier (2001), he described the economy of a virtual world called Norrath (from the game EverQuest).

In the paper's description, this world resembles a normal economic entity, with economic activities such as production, labor supply, income, inflation, foreign trade, and foreign exchange. People live there, work there, consume there, and accumulate wealth there, just as they do on Earth.

However, the underlying operational mechanisms of these two worlds certainly differ. For example, Edward discussed a question in his paper On Virtual Economics (2002): Should the government attempt to control prices?

Most economists in the real world would say no to this question, as the costs of government intervention in prices would far outweigh the benefits. Moreover, these costs are often borne by the very people the policy is supposed to help.

These anomalous effects occur because: any attempt to control prices will ultimately lead to either a surplus of supply or a surplus of demand, which in turn generates various social costs. For example, excess goods need to be purchased or destroyed, while scarce goods must be allocated through a mechanism that is often proven to be both unfair and expensive.

But what if the government could purchase excess goods or destroy them at no cost? Or if the government could produce any quantity needed at no cost? If these two actions were possible, then government price control policies would be feasible.

In cyberspace or the virtual world, code can easily create or destroy any quantity of goods, so price control may be a good policy in cyberspace, but it may not be in the real world.

Additionally, for economists, the essence of human behavior is: a process of making choices under constraints where one cannot have everything they want. This "want" is often reflected in preferences, which we typically represent with utility functions, and we seek to maximize this function under our respective constraints.

If something happens that can release our constraints, such as the price of a desired good dropping, then our utility will increase. At this point, most economists would also assert that we would be happier.

So if we want to make people happier, we should eliminate or release their constraints and limitations. Following this reasoning, less challenging games should be what the market needs.

However, we can observe a profound conflict between this economic reasoning and the behavior observed in the gaming market: in fact, players hate less challenging games.

Thus, we can conclude that the utility function of players in the game world differs from that in the real world. Edward constructed a simple utility function and economic model for players by linking the difficulty level of games with the rewards players can obtain in games, exploring the distribution of game time and real-world wages, which was a remarkable study in virtual world economics at the time.

As games evolved, game developers needed to adhere more to the economic principles within the game world to enhance players' utility levels in the game world, designing more unique "game world operating mechanisms," relatively balanced economic systems, and solutions that align with the game world's Social Planning Problem.

The Development Process of Virtual World Economic Systems

As mentioned above, in the early research of virtual world economics, scholars discovered the similarities and differences between virtual world economies and real-world economies. Further, as research deepened, Tanla E. Bilir summarized three important characteristics of virtual world economies in her paper Real Economics in Virtual Worlds: A Massively Multiplayer Online Game Case Study, RUNESCAPE (2009):

• Comparability: The virtual world economy has obvious similarities to the real-world economy.

• Reality: The virtual world economy involves real, well-functioning economic systems.

• Laboratory: The virtual world economy serves as a laboratory for experimental economic theories and behaviors.

Regarding the second point of reality, taking the game virtual worlds we are most familiar with as an example, we can see that game economic systems are continuously developing and becoming increasingly realistic.

Establishment of Economic Systems

In the early era of home consoles and console games, economic activities in games mainly revolved around picking up items, system distributions, or purchasing from stores, such as the classic game "Super Mario" with coin collection and "Resident Evil" with weapon shops.

Players collect coins and resources by consuming labor or time to clear levels, which they can use themselves or accumulate a certain amount to purchase other resources or unlock new levels. Essentially, players trade with the system to obtain what they want after acquiring coins and resources through production.

Weapons with higher attributes or levels with greater difficulty often require more coins, thus requiring players to invest more "labor" (time, energy, money, etc.). This indicates that high-attribute items have exclusivity, meaning only a few players willing to invest more labor can obtain the items, while those who do not invest equivalent labor cannot acquire them.

Such settings delineate a simple economic hierarchy, stimulating mid- to low-tier players to invest more in the game world to unlock advanced weapons or difficult levels.

At the same time, single-player games that do not require an internet connection mean that players cannot interact with each other; each player faces an independent virtual world. This also means that these items are non-competitive, i.e., if player A possesses a high-attribute weapon, it does not prevent player B from obtaining the same weapon in their independent game world. Therefore, as long as most players are willing to invest enough labor to acquire sufficient coins, they can ultimately possess these high-attribute items.

Based on these two characteristics, trading in early games enhanced the playability and operability of the game, but did not form a complete economic system, unable to facilitate spontaneous exchanges or sales, and individuals did not affect each other.

The efficiency of production or purchasing power classified players into levels in the early stages of the game. However, as the game progressed, the number of players possessing advanced weapons or levels would continually increase, causing the value of items to be squeezed, and the delineated levels would naturally collapse.

Ultimately, the game would end with the protagonist's death or the conclusion of the storyline, and the accumulated coins and equipment would only be abandoned, having no other use or exchange channels.

Super Mario & Resident Evil

Development of Economic Systems

In the early 21st century, with the rise of online games, the interactivity between players greatly increased, providing new channels for the buying and selling of items. At this stage, players still obtained money and item rewards through labor (completing resource gathering, defeating NPCs, etc.) and consumed purchases in stores.

However, unlike before, the game world began to exhibit division of labor, such as in World of Warcraft, where there are multiple professions like mining, blacksmithing, leatherworking, engineering, and alchemy, forming a natural supply-demand relationship between different professions—players have limited time and energy, creating a demand for trading or exchanging surplus items.

This reflects the overall process of social production described by economics, which includes:

• Production: The main actors are the game players, who are the laborers in the game world. Here, labor refers to activities with a certain purpose in the game world, such as gathering, monster fighting, and crafting.

• Distribution: Refers to the allocation of production materials to laborers or the allocation of consumption materials to consumers. This distribution method determines the position of social members in the production process, and the creators of this distribution method are the game designers.

• Exchange: Refers to interactive transactions in the game, mainly including transactions between game players and the game mall, as well as between players.

• Consumption: Mainly refers to the virtual items that players need to consume during their growth, such as props, skill books, etc.

Total Process of Social Production in Games

Further, from an overall perspective, the economic system of online games is composed of supply and player demand. Players obtain supply through their actions in the game world and consume these supplies to improve their character performance and development status.

Supply and Demand Relationship in Online Game Economic Systems

Taking Stone Age, known as the pioneer of domestic online games, as an example, in terms of production and distribution, players obtain money or production materials through gathering, monster fighting, leveling up, and completing tasks; in terms of exchange, it can be divided into transactions with system NPCs and exchanges between players. The former allows players to buy and sell various props in stores with different attributes in the game, while the latter can exchange items through the trading function key; after obtaining money or props, players can consume or use them.

Unlike in reality, items in the virtual world are merely strings of code and do not get consumed like real items. If items in the game or virtual world appear continuously and arbitrarily, this world will become very crowded, leading to item inflation.

This is also one of the culprits that destroy the experience of all online games. Over time, almost all players will possess some items that seemed very scarce in early game experiences, and eventually, even newcomers will not want them.

Therefore, developers have strengthened the limitations on virtual items, making them closer to real items.

First, they endow high-attribute items with scarcity. In Stone Age, the upgrading and refining of weapons introduced the possibility of failure, and the abilities of captured pets also varied significantly, with the probability of higher-attribute weapons and pets being strictly limited. The acquisition of high-attribute items is no longer solely based on the quantity of labor; luck also becomes one of the determining factors.

Second, they limit the consumption speed of resources, such as props that restore health, mana, or enhance skills, which are mostly single-use, and weapons and equipment will wear out during combat.

Thus, the setting that restricts the quantity of virtual items fundamentally suppresses the inflation of resources (especially high-attribute resources) in the virtual world, ensuring that their value does not excessively depreciate as the game progresses, and laying the foundation for the long-term stability of the market.

*Item Inventory Pages of *Stone Age* and Legend of Blood *

With the rapid development of online games, Legend of Blood, under the banner of Shanda (later renamed Shengqu), pushed the market economic system in online games into a mature stage.

The processes and channels from production, distribution to exchange and consumption are quite complete, with dedicated markets for buying and selling necessary materials, and transactions between players are guaranteed. In addition, high-attribute items have become rarer, and their high scarcity drives players to engage in repetitive labor in the game, making the acquisition of rare items a direct goal for players.

At this point, the market economy in the game has become mature and orderly, with goods freely circulating and exchanging, and surplus materials can also be exchanged for more liquid currency.

Prices fluctuate like those in the real world, influenced by various factors, but overall, they do not deviate significantly. This aligns with the basic economic laws of commodity production and exchange: "Prices fluctuate around value, the value of commodities depends on the socially necessary labor time, and commodities are exchanged according to the principle of equal value."

Improvement of Economic Systems

The biggest difference from the real world is that the economic system in games essentially exists to enhance gameplay and meet players' needs for consumption and trading in the virtual world. Therefore, the designers of virtual worlds will, to some extent, impose restrictions and management on the game's economy, such as item grading, item wear, trading mechanisms, resource production efficiency, and closed economic systems, to construct a "perfect" economic system.

It can be said that the game world initially operated under a planned economy, then gradually opened up for players to trade, forming an internal market, and the overall economic system is continuously adjusted and optimized either artificially or spontaneously to achieve a final equilibrium state.

However, since the economic system in games is subjectively created by developers, it lacks long-term and dynamic considerations to some extent. After operating for a period, various problems will emerge. Among them, the most common issue is wealth surplus and inflation.

(1) Wealth Surplus

Wealth surplus can lead to the depreciation of wealth in virtual games in the short term, harming players' interests. The main reasons behind this are twofold:

First, the production mechanism is unreasonable; output is uncontrolled, leading players to receive excessive unnecessary materials during gameplay.

Second, there are no channels to consume materials; excessive accumulation can lead to demand saturation, causing materials to become increasingly worthless.

To address this issue, developers typically reduce the drop rate of materials or provide raw materials for players to craft finished products themselves, while also setting item wear properties to accelerate consumption rates.

(2) Inflation

Severe inflation can cause the price level in the game to continuously rise, prompting players to exchange currency for goods. This can lead to a loss of trust in the game's currency among players, resulting in the collapse of the currency system and even the economic system.

The fundamental reason is that the amount of currency issued is excessive, far exceeding the demand for currency. In response, developers need to control the amount of currency, reducing the issuance rate; on the other hand, they need to increase channels for recovering excess currency, such as introducing new materials to stimulate player purchases.

However, since economic issues are difficult to detect intuitively and there are numerous influencing factors, even if game developers have the power to modify economic settings at will, it is still challenging to grasp the equilibrium point of a "perfect" economic system.

Therefore, after entering the mobile game era, most online mobile games no longer set up trading systems within the game, but instead make the in-game mall the only place for buying and selling game materials.

Closed management weakens gameplay and deprives players of the joy of trading, but it is undeniable that the game's economic system becomes more stable, largely avoiding significant fluctuations.

The mobile version of Dream Journey to the West has established a compromise economic system: it has opened a unified trading platform called "Treasure Pavilion," allowing players to trade freely, but with restrictions on the price range of item transactions, acquisition and sale of high-end items, etc. This semi-open system increases the stability of the economic system but also limits free trading among players.

*Official Trading Platform "Treasure Pavilion" of *Dream Journey to the West*

The economic system of the game world is still in a state of exploration. How to balance developers' artificial intervention and the spontaneous adjustment of the market?

Can the game world truly achieve equilibrium and construct a perfect system? Is it possible to have a completely free, unregulated virtual economic system?

For these questions, we currently do not have answers, but a closed market will not be the endpoint of the game economic system.

The Invasion of Virtual World Economics into Reality

In the previous discussion of economic systems, we mentioned that players mainly obtain virtual currency in the game through monster fighting, completing tasks, participating in activities, and trading virtual items.

However, most currencies in games are independently produced rather than issued based on economic needs, so the currency in games does not serve as a general equivalent representing the value of items like real-world currency.

In fact, coins and currency are representations, used to record the basic system of credit records and implement the basic process of clearing. However, currency itself is not money; money is a system composed of credit records and credit clearing mechanisms, while currency is merely a representative of this system.

Thus, the essence of money is actually the system composed of credit records and clearing mechanisms behind it. Money is not a commodity used as a medium of exchange but a set of social technology composed of three basic elements:

• First, an abstract unit of value used to measure the value of money.

• Second, a credit record system that can track and record the credit balance or debt balance of individuals or institutions engaging in trade with others.

• Third, the original creditor can transfer the debtor's obligations to a third party to settle unrelated debts.

Therefore, to create a more authentic virtual world economic system, it is necessary to utilize this set of social technology to connect the currency circulation of the two worlds. For example, Roblox has created a larger world where people can create new games and content, and then consume and trade using a currency called "Robux." This currency cannot be generated by any generator and must be purchased with real-world currency.

Roblox undoubtedly creates a larger virtual world, giving us more space for imagination and inspiration. On another dimension, blockchain technology has also made significant contributions to connecting the economic systems of the two worlds.

Confirmation of Game Assets, Reuse, and Trading

The impact of combining blockchain technology with games mainly manifests in three aspects: confirmation of game assets, reuse, and trading.

1. Confirmation

First, let's talk about the issue of cognition. As information from the physical world is continuously uploaded and recreated in the digital world, we have, to some extent, uploaded another version of ourselves into the digital world, while also continuously generating new "value" for the digital world.

However, in reality, we do not have a clear sense of this value, mainly because we lack clarity regarding ownership of digital world information assets.

Coase stated in describing his theoretical framework that when transaction costs are zero, regardless of who is initially granted property rights, these property rights will ultimately flow to the person who can best utilize their value, achieving Pareto optimal resource allocation.

Of course, this can help understand from an economic perspective why it is often the giants or monopolists who further realize the value of the information we create, but there is also a starting point in this process, which is the initial confirmation of rights.

Blockchain undoubtedly materializes some assets in the digital world. As we gradually enhance our understanding of ownership of digital world assets, we will also gradually accept this form of technology. The process of gradually accepting and applying blockchain is also a process of enhancing our understanding of ownership of digital assets.

When data assets in games cannot be genuinely owned by players, any payment method other than copy sales is essentially "renting." Although players invest a lot of time and real money, they do not truly "own" any virtual assets in the game.

When game developers stop the game for various reasons, the levels and characters that players have invested hundreds of hours in will all be lost.

Although game designers tend to adjust and plan future development directions from the perspective of long-term revenue, the gaming experience players hope to gain often differs from what game developers envision, and there will be discrepancies between game updates and what players want.

Of course, many have discussed that some characteristics of blockchain can solve these problems. For example, a game running on the blockchain cannot be forcibly shut down by anyone. As long as there are players willing to pay the corresponding costs, the game can continue to exist on the blockchain.

If most players are dissatisfied with the game for some reason, they can vote with their feet, allowing the game's content to deviate from the original plan and develop according to the wishes of these players.

At the same time, players' game states and game information are permanently stored on the blockchain, allowing players' characters, items, and other digital assets to be used across different games, meaning that any game can call data from other game worlds.

2. Reuse

Once the confirmation of players' game assets is achieved, we naturally begin to think about the next question: Can players reuse the assets they own, and which virtual assets can be reused? To answer these questions, we first need to classify the virtual assets owned by players.

The first category includes virtual currencies (such as points, diamonds, coins, etc.) that players recharge or receive as game rewards for consumption in the game store.

The second category includes weapons, equipment, skins, characters, etc., that players obtain through purchases or rewards.

The third category includes personalized data and records about players generated by the game.

If players own the first category of assets—virtual currency assets—they naturally have the right to freely dispose of these assets. However, at this stage, given that the currency payment systems between games are mutually independent, the currency obtained or recharged in Game A is only allowed to be used or traded in Game A.

This greatly limits the usability and effectiveness of players' virtual currency assets. Especially when players experience multiple games, they need to start from scratch to acquire currency in each game, requiring them to invest multiple times the labor or money. The virtual currency previously acquired in games becomes "invalid currency," losing its value once they leave the game.

This issue can easily lead to a solution. If players use a central account while playing games and bind their virtual currency assets to the central account rather than individual games, they could reuse their virtual currency across different games.

However, due to the differing consumption and currency conversion rules within each game, the process of implementing a central account is overly cumbersome and complex, thus requiring independent systems.

The same applies to the second category of virtual assets. Weapons, equipment, skins, characters, etc., often cannot achieve direct interoperability and reuse between games due to differences in game types or gameplay. Leaving a specific game also renders them "invalid assets."

At this point, we think of blockchain technology. If every currency, weapon, character, and other assets in each game are put on the blockchain, introducing NFTs as intermediaries for transfers on the chain, it seems possible to achieve conversion and reuse between games. Thus, the issue of "invalid assets" can be resolved, and players do not have to waste time and money.

Additionally, some players purchase and acquire assets for appreciation and collection. The reuse of these collectible virtual assets can provide players with satisfaction, benefiting both player retention and gaming experience, while also stimulating players' purchases of virtual assets to some extent.

For the third category of assets, players' personalized information such as preferences, abilities, and experiences can be extracted through algorithms and big data, with each game player's personal data coming from the player themselves.

However, at this stage, players have no means to obtain their personalized data, as player data is concentrated in the hands of game manufacturers, becoming tools for accelerating commercialization and expanding profits.

If we then envision using blockchain, the information becomes transparent once on the chain. Manufacturers can collect personal information by paying a certain reward, but at the same time, the information assets belong to the individual. Thus, the personalized data generated by players in games can be extracted and reused repeatedly, for example, by synchronizing information to new games through artificial intelligence, thereby creating the most suitable personalized game difficulty and experience for players.

3. Trading

After investing time and money, players will shape their characters into very personalized images. Based on the confirmation of digital assets, these images can be traded by players.

In the non-blockchain game market, there is already a demand for account trading primarily based on buying and renting, but both demanders and suppliers of accounts worry about various issues, such as accounts being hacked again during transactions, game assets being deleted or moved, and secondary trading.

Players' demand for digital content in games is about experience, and trading demands related to this experience include: acquiring other accounts through trading and obtaining sensory and psychological satisfaction through collection.

Of course, the above refers to account trading during the operational phase of the game, representing that users can experience different games with different identities, appearances, and states after trading. However, when the game is shut down, these digital contents will disappear, and no user can continue to experience them.

When blockchain secures part of the ownership of digital assets for players, they can not only trade accounts more securely during the game's operation but also view them as collectibles, allowing their digital images to appreciate through continuous investment in the game and external operations.

The cessation of the game will not deprive players of their collection rights; players can, in some way, allow their characters to perform simple actions and interactions for appreciation. If players possess certain rare items or costumes, then this digital character is likely to have higher collectible value.

Players can continuously use this tool, service, or platform to appreciate their characters from previous games, interact with them in simple ways, and showcase skills, etc., and they can also trade them and engage in other content-based operations.

In Conclusion

Whether through natural sciences to understand the essence of the objective world or through social sciences to understand the self within society, this is all part of humanity's process of better understanding the world and the universe.

And this process is bound to be long and painful; only through the emergence of pain can our cognition be enhanced and evolved.

Starting from the virtual world to re-understand the operational mechanisms of the real world is a very challenging task, and conducting research from an economic perspective is an even more massive undertaking, because from the perspective of economic imperialism, there are still many things in the virtual world worth examining through the lens of economics, including player behavior, the implementation of policies in the game world, and the economic mechanisms driven by algorithms, etc. All of these can provide us with insights to some extent.

We believe that pain is merely a byproduct of human evolution, and there are still many unknowns waiting for us to explore on the road to understanding the world, but this is also the reason we will continue to move forward.