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Regardless of the services offered in the virtual world, it is apparent that introducing a virtual currency and exchange is simply the most cost efficient way of handling a high volume of low-value transactions. However, this will only work if the critical user mass is achieved and if the exchange rate remains stable. Alternatively, the payment mechanism within the virtual world can be designed as a closed-loop environment that allows purchasing virtual money but does not allow to covert it back to the real world currency anymore.
Paying Up

Payments within Second Life are made by exchanging virtual currency from one user to another user. These virtual transactions are supported by the innate programming logic of Second Life, which is administered by Linden Lab. Thus, users do not have to use credits cards or other real world payment instruments. However, some companies plan to issue virtual loyalty cards that would grant the users discounts when shopping at certain places within Second Life.

Before Linden Lab announced a policy change at the beginning of the year, users had also been able to bring their money to virtual banks to gain interest. Money could be paid in and paid out by using virtual ATMs.

Some banks offered annual interest rates of up to 60 percent per year. Since some in-world banks failed paying funds to customers -- and the virtual bank Ginko Financial even went bankrupt in August 2007 -- complaints of residents accumulated. As a consequence of these developments and in order to protect its subscribers, Linden Lab banned in-world banks from the community. Effectively, a virtual world also needs certain regulations and banking rules to stabilize its economy and to avoid enormous risks caused by unregulated institutions. Linden Lab's recent decision is a reasonable step to regain the trust of numerous Second Life residents and potential subscribers.
Cashing In

Other virtual worlds often do not try to imitate the real world by installing ATM machines and banks. However, the payment mechanism is usually supported by the service provider's own platform. For instance, in "World of Warcraft," virtual gold is exchanged to pay for goods and services.

In order to derive revenue from a business in a virtual world, such as Second Life, real world production factors have to be applied. A financial investment is initially required to establish a budget in the virtual world. Know-how and time have to be invested to buy and design property/products, which in return can be sold for a profit. The below depicts a simplified illustration.

Illustration: Funding and extracting money into and from virtual worlds
 
(click on image to enlarge)

From a payment point of view, money should be fundable and extractable from the virtual world at any point in time. Credit cards are usually used to convert real money into the virtual currency in order to fund the account. In addition, increasingly more Internet wallet type of payment instruments are used to fund virtual accounts. The exchange rate generally depends on the demand and supply of the virtual currency -- although certain arbitrary seller aspects exist.

In Second Life, virtual money can be extracted through the official currency exchange or independent providers. In these cases, Internet wallet type of payment instruments are suited to receive the credit in real world currency. Real world payment instruments are thus only used for entry and exit transactions, which greatly reduces fraud risks and fees which would otherwise be charged for many small micropayments.

However, some variations to this model exist. For instance, "World of Warcraft" gold is not officially sold through the platform provider but it's sold on eBay (Nasdaq: EBAY) . Some companies have specialized in generating gold within the virtual world and then to sell it for real world currency. However, an official exchange rate mechanism does not exist and is not intended by the game provider.

Other worlds, such as Cyworld, allow for exchanging real money into virtual money but not vice versa. Thus, only the platform provider and its affiliated partners sell virtual products. Participants are not drawn to this world to make a profit but for the community aspect.

The future will show how the business models will develop in the virtual arena. From a payment and legal perspective, the situation is certainly more complex when money can once more be extracted from the virtual world. As the virtual money has a certain value in the real world, it has to be determined if a bank license is necessary to safeguard and exchange the money. Furthermore, restrictions have to be in place with regard to the maximum exchange amount in order to fight money laundery transactions -- or certain businesses types such as casinos have to be banned from the virtual world due to local laws that do not permit that profit is derived from that.
Critical Business Factors

Businesses who intend to derive profit from a virtual world have to have a successful business model and give consideration to the payment mechanism adapted in the virtual world. Here's a summary of what companies need to know:
A multitude of virtual worlds exist and correspondingly different revenue and payment methods.
The platform provider of the virtual world should allow for extracting the virtual currency.
Payment transactions within the virtual world are predominantly low value (micropayments). It may thus take time before a considerable amount is accumulated to exchange it to a real world currency.
An efficient and secure payment mechanism has to exist within the virtual world.
Real payment instruments have to be used to fund money to the virtual bank account or to extract money. These payments instruments are often restricted to credit cards and Internet wallet type of payment instruments.
Virtual currencies are subject to exchange rate fluctuations. In principle a demand/supply principles determines the exchange rate, however, certain arbitrary aspects also exist. The risk to invest money in a virtual currency is less foreseeable than investing in a real currency.
Regulations and laws such as money laundering laws restrict the conversion amount from virtual money into real money. In some countries local laws do not allow to profit from gambling activities.

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