I wrote yesterday about virtual worlds, and the inevitability of government intervention in them. One objection to government intervention is that virtual worlds are only games; and it doesn’t make sense for government to intervene in games.

Indeed, many members of virtual worlds want the worlds to be games that operate at some remove from the real world. Games are more fun, they say, when what happens in the game doesn’t have real-world consequences. This was a common topic of discussion at State of Play.

The crux of this issue is the status of the in-world (i.e., in the virtual world) economy. Players can accumulate in-world stuff, including in-world currency, and they can trade in-world stuff for in-world currency. (A world might be designed without an identified currency, but it’s fairly certain that one in-world commodity would emerge as a consensus currency anyway.) Is in-world money just Monopoly money, or is it in some sense real money?

The only sensible answer is that it’s real money if it’s readily exchangeable for real-world currency. If you can trade in-world gold pieces for U.S. dollars (or Euros, etc.), and vice versa, then in-world gold is real money, and the in-world economy is a real economy.

If the world-designer wants to keep the world’s economy from becoming real, then, the designer must stop members from exchanging in-world currency for real currency. And this seems pretty much impossible, because there is no way to stop players from making side payments in the real world. Suppose Alice has gold pieces and Bob has dollars, and they want to trade. Bob transfers the dollars to Alice via a real-world channel (perhaps PayPal); virtual Alice gives virtual Bob the gold pieces. In-world, all that happens is a gift of gold from Alice to Bob. The dollar transfer isn’t visible to the world’s management. The world-designer can ban gifts of gold, but Alice and Bob can work around that ban by having Alice “lose” the gold in a private place where Bob will find it, or by cooking up a sham transaction where Alice buys a virtual toothpick from Bob at an inflated price.

Experience seems to show that any sufficiently popular in-world currency will become exchangeable for real money, whether the world-designer likes it or not.

There’s a useful lesson here about the limitations of code as a law-enforcement mechanism. One might think that code is law in a virtual world, in the sense that the world-designer writes the software code that defines what is possible in the world. It would be hard to think of a situation where code had more power to control behavior than in a virtual world. And yet the code can’t separate the virtual world from the real world. The reason it fails to do so is that the code doesn’t define the whole domain of human action; and people can defeat the code’s would-be restrictions by acting outside the code’s domain of control.

Once a virtual world gets big enough, and people value in-world stuff highly enough, it can no longer be just a game. The virtual world will touch the real world, along a sort of border through which money and communication flow.

Something remarkable is happening in virtual worlds. These are online virtual “spaces” where you can play a virtual character, and interact with countless other characters in a rich environment. It sounds like a harmless game, but there’s more to it than that. Much more.

When you put so many people into a place where they can talk to each other, where there are scarce but desirable objects, where they can create new “things” and share them, civilization grows. Complex social structures appear. Governance emerges. A sophisticated economy blooms. All of these things are happening in virtual worlds.

Consider the economy of Norrath, the virtual world of Sony Online Entertainment’s EverQuest service. Norrath has a currency, which trades on exchange markets against the U.S. dollar. So if you run a profitable business in Norrath, you can trade your Norrath profits for real dollars, and then use the dollars to pay your rent here in the terrestrial world. Indeed, a growing number of people are making their livings in virtual worlds. Some are barely paying their earth rent; but some are doing very well indeed. In 2003, Norrath was reportedly the 79th richest country in the world, as measured by GDP. Richer than Bulgaria.

(Want to try out a virtual world? SecondLife is a smaller but interesting world that offers free membership. They even have a promotional video made by members.)

Virtual worlds have businesses. They have stock markets where you can buy stock in virtual corporations. They have banks. People have jobs. And none of this is regulated by any terrestrial government.

This can’t last.

Last weekend at the State of Play conference, the “great debate” was over whether virtual worlds should be subject to terrestrial laws, or whether they are private domains that should determine their own laws. But regardless of whether terrestrial regulators should step in, they certainly will. Stock market regulators will object to the trading of virtual stocks worth real money. Employment regulators will object to the unconstrained labor markets, where people are paid virtual currency redeemable for dollars, in exchange for doing tasks specified by an employer. Banking regulators will object to unlicensed virtual banks that hold currency of significant value. Law enforcement will discover or suspect that virtual worlds are being used to launder money. And tax authorities will discover that things are being bought and sold, income is being earned, and wealth is being accumulated, all without taxation.

When terrestrial governments notice this, and decide to step in, things will get mighty interesting. If I ran a virtual world, or if I were a rich or powerful resident of one, I would start planning for this eventuality, right away.