Today, Linden Lab updated its Terms of Service. The updated Terms of Service “make it clear that trading of Linden dollars (L$) on exchanges other than the LindeX, Second Life’s official L$ exchange, is not authorized or allowed.” This change has a lot of people concerned, because many of those third party exchangers are popular.
Why has LL made this change, and what does it mean to you?
Here’s why LL has (probably) made the change: FinCEN changed stuff first.
In March, the Financial Crimes Enforcement Network (FinCEN), the federal agency charged with enforcing the nation’s laws against money laundering, issued new regulatory guidelines regarding virtual currencies. This new guideline applies the Bank Secrecy Act to virtual currencies and businesses that administrate and exchange virtual currencies.
The Bank Secrecy Act contains numerous anti-money laundering and anti-fraud provisions. These provisions place certain requirements on “Money Services Businesses” (MSBs) and money transmitters, including registration requirements; requirements to collect information on any potentially suspicions transactions and keep extensive records on users; and requirements to report suspicious transactions to the federal government. A regulatory change applying the Bank Secrecy Act to virtual currencies, as FinCEN’s did, has some significant effects on any business relying on virtual currencies.
Let’s take a closer look. What did this change do?
First, FinCEN had to define who was and was not subject to the regulations. FinCEN acknowledged that there were “users,” “exchangers,” and “administrators” of virtual currencies. Users are people who obtain virtual currency, and are not MSBs: they are not subject to the registration, reporting, and recordkeeping regulations. However, exchangers (who have the ability to exchange virtual currency for real currency) and administrators (who have the ability to issue or withdraw virtual currency) are MSBs. They are subject to strict regulation.
Next, FinCEN had to sort out different kinds of exchangers and administrators. It identified three: those who trade in e-currencies and e-precious metals; centralized virtual currencies; and decentralized virtual currencies. Let’s look at the last two, because those affect Linden Lab.
A centralized convertible virtual currency, as defined by FinCEN, is a virtual currency “banked” in a centralized repository, controlled by a centralized administrator. Any exchanger of currency provides its services through access granted by the administrator. A clear example of a centralized virtual currency is Facebook’s virtual money.
A decentralized convertible virtual currency has no central repository and no single administrator. Users may obtain it through their own computing or manufacturing effort. Users who create or obtain that virtual currency and transmit it to other users in exchange for real currency, funds, or different forms of virtual currency are acting as exchangers, and are subject to regulation. Bitcoin is a clear example of a decentralized virtual currency.
Okay. And it applies to Linden Lab how?
Now things are a little more clear. As of this past March, Linden Lab is an MSB, regulated by FinCEN under the Bank Secrecy Act. It is subject to some strict reporting, registration, and recordkeeping requirements. Linden Lab is an administrator and an exchanger of a centralized convertible virtual currency.
Have you been following along? Because here’s the payoff: Because of the very strict reporting, registration, and recordkeeping requirements placed on LL by the Bank Secrecy Act, LL has to distance itself from any exchangers it does not control. Those exchangers might not be paying attention to the new FinCEN laws. They might not be keeping records. They might not be reporting suspicious transactions. They might be permitting money laundering. LL has to make it very, very clear that those exchangers aren’t authorized; they’re not part of LL; and LL isn’t responsible for them.
So what does this mean to you?
It may mean nothing at all. The third party exchangers may truck right along and be just fine. They may comply with the new regulations and continue forward. They may fail to comply and skate along without anyone noticing. BUT. They may fail to comply and get shut down and have all their assets seized. I don’t know.
Third party exchangers have always been a “use at your own risk” proposition. However, now the federal government is actively cracking down on administrators and exchangers of virtual currencies. It looks like Linden Lab is taking steps to make sure it’s in compliance. I don’t know if the others are.
So…you know. Use at your own risk. Really.
EDIT: Apparently, Linden Lab’s support team is telling people that LL is interpreting “not authorized” to mean “not permitted” rather than “not accredited.” I really wish LL would clarify this, because Section 5.3 of the Second Life Terms of Service pretty clearly states that other exchanges exist and that people exchange money there, and it only states that such transactions are “not authorized.” I draft terms of service pretty regularly, you guys, and if they’re intending “not authorized” in this section to mean “grounds for termination,” that’s some sloppy contract drafting. LL, you need to fix this. In the meantime, I strongly suggest that SL users stick to the Lindex exchange.
May 8: One last comment. First, Inara Pey drew my attention to a post she wrote in April about this very issue. It’s well-written and worth a look. Now, it may be that Linden Lab is doing something completely different, like just trying to get more revenue off Linden sales, or just trying to consolidate its control over the Linden dollar. These regulatory changes do affect LL, though, and it’s more likely than not that LL had to respond to them and chose to do it this way.
Regardless, I think LL has some big problems to deal with related to this move. As I see it, they announced this change yesterday, required users to re-establish agreement to the new Terms of Service yesterday, and implemented the changes yesterday (including revoking the third-party exchangers’ access to certain APIs that they needed to function). But as per LL’s own Terms of Service, material changes to the ToS aren’t effective until 30 days after users receive notice…and this is absolutely a material change. And that’s a problem. I’m not sure who’s sailing the ship right now, but they need to get it tightened down.