Money Supply Impacts on an Online Economy

The following is a brief discussion of money supplies, hyperinflation and depression and how this theory relates to online games.

What is cash?

Cash is the grease that lubricates transactions. It does not have to be a commodity in itself, though most early economies used a currency that was based on some high value commodity, such as gold.

Hyperinflation/Depression

Any cash based economy, whether a real country or an online game, is subject to Hyperinflation and Deflation. In its most simplistic form, the general price level is affected by the amount of currency in the economy as well as the amount of goods being produced. This is best described by a simple formula.

P= MV/Q

Where

¨       P = the price level

¨       M = the amount of cash in circulation

¨       V= the velocity of money (who fast it changes hands)

¨       Q = quantity of goods

As the formula shows, when the money supply is doubled, but the quantity of goods stays the same then prices naturally double. If the money supply is halved then the general price level falls by half. If production increases but the amount of available currency stays the same then the price level decrease and visa versa. A healthy economy is one where the available currency is in relative balance with the amount of goods being produced.  This is a classic, and well proven model.

Figure  1 – Hyperinflation, Depression and a Healthy economy

In unhealthy economies either the cash supply’s growth vastly outstrips the increase in goods production or the cash supply shrinks to such an extent that the production of goods and services cannot be reduced fast enough and it over produces unwanted goods. In either case market structures caused an imbalance (i.e. the government did not want to take action and increase or decrease the money supply until it was too late).  This imbalance causes things to spiral out of control such as it did in Germany’s hyperinflation in the 1920s or the worldwide Depression in the 1930s.

Simple growth of the money supply or a steady increase in prices is not bad. It is when the available cash gets out of balance with the amount of goods in the marketplace that economies fail.

Such failures in the real world impact real people, causing unemployment, starvation, and political unrest in the worst cases. Economic failures in the online world are not as dramatic. At its worst, the “business game” is destroyed, professions or skill sets are “useless” and we are only left with the combat treadmill.

However, given the rise of Real Money Transactions and the new play for free /buy in-game items, this is no longer the case. Having an economy fail in this manner, now means a massive financial lose to the company. Thus we as game designers have to understand how money is created, destroyed and managed in an online game.

Controlling Agents in Online Economies

In a real world economy individuals control the goods and services available and the prices that they ask for them. Millions of people make decisions that determine how much of any good or service is available and what price will be asked for it. The government controls the money supply, and increases or decreases it as it sees fit.

In an online game economy, the players control both the flow of cash into the economy and the amount of goods and services that are produced. If players decide that they need more cash they take their characters out and do cash creating activities, such as running missions for NPCs or selling items to NPCs (buying and selling between players is not a cash creating activity).  Cash is removed from the economy by activities that permanently remove it from circulation, (transportation and maintenance fees for example). Simple conversion of cash into an item does not destroy the cash, since the item can be sold again. Typically the only real control that the game (government) has is the ability to manipulate the maximum rate that players can create cash and the maximum rate at which it is destroyed, players are in control of the actual flows in and out.

Matching the rate of inflow of cash to its outflow is the key dynamic that must be achieved in order to insure that a viable “business game” is created. This is not a trivial task. If the inflows of cash exceed the outflows, and an equivalent increase of goods or services is not called forth then hyperinflation sets in. If outflows exceed maximum inflows then deflation sets in and no one can sell anything because there is not enough cash in the economy.

The easiest way control this system is through dynamically matching the inputs and outputs of cash into the system. There are two methods to achieve this objective. The first is to have the game attempt to match the inflows of cash, either programmatically or manually. This method would require an incredibly sophisticated program moderating the various prices for all items in the economy, as well as the size of the money supply. Alternatively the game could have its own version of the Federal Reserve board, meeting once a month to set the “prime decay rate”. Both methods have a high probability of failure.

The alternative is to allow traditional market forces to go to work. Since the players ultimately controls the flow of cash into the game they should be given incentives to reduce the cash inflows when there is too much money in circulation and increase it when there is not enough. If this control is created using traditional market forces then a reasonable balance should be achievable.

1                   Money Supply Dynamics

Most online games have some fixed drains for destroying cash, while letting the players control the flow of cash into the game. It is difficult to design a system that allows for player control of cash creation while using fixed drains to destroy that cash. The game has either an inflationary trend which ends eventually in a hyper-inflated state because the players create more cash than the economy can use, or the game removes cash from circulation faster than the players can replace it, causing a deflationary spiral that forces the game’s economy into a depression. In the end the game admin’s have to tweak, change or modify the economic variables to fix the problem, causing numerous customer satisfaction issues or they destroy the Business game.

Players have various activities that allow them to add new cash to an economy (see Money Creation below).  To keep this economic system in balance, (insuring sufficient liquidity while avoiding hyperinflation), we should use two methods.

First is a traditional method. This is a mix of traditional fixed drains and variable drains. Fixed drains destroy money at a constant rate regardless of the size of the overall money supply.  The viable drains take more or less cash out of the economy based on the general level price level.  Commissions or taxes on sales can be our primary method of doing this. For example if players sell crafted arrows for $1 today, and next week the money supply is doubled then the player offered price of arrows will naturally raise to $2. If the sales commission or tax is 25% then 25 cents is removed from the money supply in the first week and 50 cent the second week, effectively doubling the size of the drain when the money supply doubles. (see Money Destruction).

The second method is to remove the incentive of the players to engage in cash creation missions by reducing the profitability any of those missions. This is our non-traditional approach. We can accomplishes this by having cash creation missions require the use of purchased consumables (bullets, bandages, etc.) and having the players set the prices for those consumables. (see Controlling Hyperinflation).

1.1           Money Creation

In most MMO games,  new cash is introduced through character activities, thus increasing the money supply. These activities include:

¨       NPC Missions – Missions given to the character. Successful completion gives the character a cash reward.

¨       NPC Purchases – Money given to the character by an NPC Vendor in exchange for a good or resource.

¨       Cash Loot – Cash loot the character takes off of a corpse.

¨       New Character Arrival –Money that the character has on him when he arrives in the game. Important to boot strap the initial game economy, but loses importance as the money supply and prices begin to naturally inflate.

By manipulating the risk/reward ratios for the missions, as well as the cost in time and components to succeed in those mission, we will be able to heavily incent one character activity over another (as SWG does). The prime means for introducing new cash is the NPC Mission.

1.2           Money Destruction

The money supply is also destroyed by character activities or fees charged by the game for a particular service. Note that activities that transfer cash directly or indirectly from one player to another are not reducing or increasing the money supply. The major activities can reduce the money supply are:

·         NPC Consumables – Items that are purchased from NPCs and then destroyed through game play. For example basic arrows, bandages, medicines, food, and water. Consumables should play an important roll in moderating the flow of cash into the game (See Controlling Hyperinflation). 

·         Housing and Facility Maintenance – The maintenance cost on a house or facility. This is typically a fixed drain.

·         Transportation –  If the transportation system is in the hands of the NPCs this can be another set of direct fixed drains.

·         Special Rentals – Hiring of special event items and NPCs. For example having a parson to perform an in-game marriage, or buying fireworks, flowers or other perishable decorations and items from an NPC.

·         Character Deletion – When the character is deleted the cash on him is removed from the game. This is a very minor effect since players normally transfer most of their items before they cancel their account.

·         Taxes – A good viable drain is having some type of percentage tax. This can be a sales commission for any NPC vendor selling a player object, or charging a percentage tax for sales on a trading hall list.

Note that using Player created consumables, or paying a character to do some activity does not destroy the cash used to purchase it. The cash is just simply exchanged from one character to another.

1.3           Controlling Hyper-inflation

Almost all games tend toward a hyper inflated state, because drains are traditionally designed to be smaller than the maximum inflow of cash possible in the game, to insure that sufficient cash is in the game to support a business game.  Thus the issue is not if the game will get hyper-inflated, but rather when will it get there. This is because there are no strong incentives for a character not to get as much cash as he needs to purchase things. Typically a steady raise in general price levels, due to an ever-increasing money supply, is an incentive for most players to generate more and more cash to stay ahead of the inflationary curve. This becomes a vicious cycle, which eventually results in a hyper-inflated state.

We should break this cycle by letting the players set the prices for combat consumables. As the money supply increases the price of these player-controlled consumables naturally increases. As long as the reward for cash generating activities is fixed and requires the expenditures of consumables purchased from other characters then there will be a natural brake on hyperinflation. Tying the creation of the consumable to an item that has to be purchased from an NPC adds a nice fixed cost to the consumable, buyt as seen in the example below not necessary. 

A simple simulation of a two-person (Adventurer and Crafter) economy illustrates this point. The simulation makes the following assumptions and was done in Excel.

We have an Adventurer who goes out into the world to finish a cash creation mission that is worth $100. He operates under the following restrictions -

o        He must fire 100 bullets from his gun to get the newly created $100.

o        He will not go out to kill the beast if he loses money in the process.

o        As a new character he starts with $300.

The second actor is a Crafter who can make bullets and sells them to the Adventurer. He operates under the following restrictions -

o        The Crafter sets his prices as he will and at the start will sell 100 bullets for $75.

o        The crafter will adjust the price based on the general money supply in circulation and whether or not he made a sale last period.

o        The Crafter also has to pay a sales commission tax on each (variable drain) transaction and a fixed license fee for doing business (fixed drain). Conceptually this can be a Vendor who makes a salary and gets a sales commission, but can also be charges for posting on an auction site.  

o        The Crafter sells everything through his Vendor or this auction site.

o        The crafter does not pay any NPC for components needed to make the bullets, and for this simulation makes the bullets on demand.

In this case the simulation indicates that the money supply naturally stabilizes as shown by the chart below.

Figure 2 – Money Supply Growth of a Two Person Economy, where both care about profit

This is a robust model that tends towards stability. Changing the variables in how fast the Crafter drops or raises his prices does not change the general trend to stability. Assuming the Adventurer tries to get cash faster based on the general price level does not significantly change the trend toward stability. Adding either a component cost for bullet making, changes the curves as well, but does not change the trend toward stability.

Even assuming that the Adventure is not driven by profit still results in stability of the money supply, though the crafter ends up with most of the money in the system.

Figure 3 – Money Supply Growth with Adventurer not caring about profit

A crafter who does not care about profit soon goes out of business, as long as he has a regular fee that he has to pay, either in the form of a salary to an NPC or for access to a an auction house. If the crafter becomes economically irrational he will go out of business and economically rational individuals take over as long as there is a profit to be made. Again this is time proven, economic theory.

The take away from this exercise is to insure that the following structures are in place to drive the money supply to stability.

·         Consumables are important in creating new Cash – If large amounts of new cash can be created without consumables, then there is no economic brake on cash creation.  

·         Players set the prices of Consumable – This is the other side of the coin, since only player set prices can legitimately respond to changes in the money supply. Attempting to do this programmatically in such a diverse economy as a typical MMO is to invite failure. National governments have not been able to do this.

·         Fixed drains need to be in place – This provides a mechanism to remove a Crafter who is economically irrational from the business game, as well as to provide equilibrium in prices and money supply. Thus a regular fixed cash fee for doing business is required, and set by the game.

·         Variable Drains via percentage commission of the sale need to be in place – This provides a damper that mitigates wild swings in the money supply. Fictionally Sales commissions provide this damper. The percentage is set by the game, on Facility Type basis.

1.4           Deflationary Controls

Deflation is another major risk in any online game. At its extreme a market is flooded with goods that no one can consume or use at any price, or there is just not enough cash to allow people to efficiently trade. While barter and gifting economies come out of such an event, it makes any Business game so difficult to play that only a few players will attempt it.

Item and facility decay helps to remove equipment from the economy over time. However this is not sufficient. These goods take weeks if not months to decay.  The major cause of deflation in many online games is over production of goods. A non-economic incentive for players to produce goods causes this, i.e. the characters get advancement experience for the act of creating a sellable item, allowing them to advance the skill. Thus markets are full of low value items that have no real customers. MMOs should mitigate this problem by disassociating crafting skill improvement with creation of goods that can be sold.