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Friday, January 14, 2011

Will Facebook Virtual Currency Credits Derail Their IPO?

In an act of desperation or genius ,depending on how you perceive Facebook, the company's adoption of  a virtual currency economy may very well propel them to a much sought after IPO. Despite their creation of a "proprietary" Internet world (a topic for another blog) where they control the applications and content that a user sees or participates in they have struggled with how best to monetize their exclusive Facebook community and the applications that serve the community. Generating revenue exclusively from Ad impressions clearly was not an adequate revenue source even for a  large community of 500 million plus users.  This conundrum has been a head wind that the company has faced since their inception stalling its IPO aspirations. It appears virtual currency and virtual goods are coming to the rescue.

To date Facebook has not revealed any numbers relative to revenue generated by virtual currency transactions. However, if you look at the Facebook credits being issued to companies such as Zynga and RockYou and the 30% haircut they take and give back to Facebook for these transactions the numbers are very good indeed.

Despite this much needed revenue boost there is a significant problem associated with this new found revenue source. Virtual currency inflation is already rampant in the Facebook economy devaluing the virtual currency bought to date and paid for by people playing games in Facebook applications.

The inflation issue is growing for a number of reasons. Facebook is arbitrarily issuing large blocks of currency to Facebook application providers without any consideration for the total amount of currency in the system.  Another contributing factor for Facebook credit inflation is the lack of another currency to peg the value of the currency against. With Zynga and RockYou discarding their own currencies and exclusively using Facebook credits Facebook credits lack a reference point to control their valuation. Of course the biggest issue is that there is no exchange or trading with traditional virtual currencies like the Euro, Dollar, Pound Sterling, etc.

So how could this inflation impact the Facebook IPO? Well if purchasers of Facebook credits realize that they bought a bunch of credits and now they want to buy something with them and the purchase price of that item continues to go up relative to the currency the holder of the currency will be less than happy.  On the flip side, if the virtual good they did buy with the credits decreases in value over time the desire to transact with Facebook credits will also diminish. Essentially the faith and trust in the currency will wane and cease to have value for consumers.

Certainly demand for a product also impacts the price of a commodity impacting  pricing. However, this could create a more serious problem with high demand products going stratospheric making sought after virtual products difficult to buy.

This phenomena could easily result in consumers and application developers abandoning Facebook credits and the transaction medium thus removing Facebook credit as meaningful source of revenue for Facebook.

Regulatory scrutiny by the SEC will also be a problem. They are not going to be keen on floating a company on the NYSE with an unregulated currency exchange system propping up their revenue numbers.

This is all very solvable if Facebook begins to let its currency float in relationship to some other viable currency. Unfortunately, the close association of Facebook game play and Facebook credit accumulations by gamers will squarely put Facebook in the online gambling penalty box if they peg Facebook credits against the Dollar or Euro. This is certainly something Facebook is  very aware of.

This situation leaves Facebook in a bit of a jam. They have only two virtual currency management alternatives that could save their virtual currency revenue stream and IPO. They could begin to control virtual currency issuing based on overall valuation of the currency within their system. This would require them to monitor all Facebook credit transactions in their closed economy to determine the true value of the currency at any given time. If they see inflation occurring they could buy back virtual currency from application providers to keep the currency stable. They could also peg their virtual currency against another virtual currency. This is a bit more complex and requires them to create a virtual currency trading system that let's institutions, companies and individuals trade other virtual currencies with Facebook credits.

Clearly the scrutiny associated with IPO preparation will reveal Facebook's weak virtual currency revenue management and cause the company to deal with this issue. If they do not it is unlikely that Facebook will be going public anytime soon. 

Kevin Flood is the CEO of Gameinlane, Inc. Kevin writes extensively about online games and their impact and integration into iGaming and E-commerce environments. Kevin is a frequent speaker at online game events and conferences in Asia, Europe and the US. Kevin and his Gameinlane team are currently working with online gambling, social gaming and e-commerce companies integrating social gaming with online gaming operations and integrate game mechanics into e-commerce applications. 


Anonymous said...

I don't think virtual currency inflation is an issue at all since most VC is being purchased by HARD CURRENCY. Yes, FB is giving away free currency like there is no tomorrow, but at the end of the day, it will still be raking in 30% of all future virtual currency purchases (which will be purchased using hard currency, ie. PayPal, CC, etc). Also FB can, at any time, stop giving away "free" currency, stopping one of the major factors of it's inflation too.

Loyalty Expert (@loyalty_expert) said...

Virtual currency, like Facebook Credits, have been around since green stamps from S&H. They morphed into points which are used in loyalty programs used by many large corporations on the TSX like American Airlines and Tesco. Points have value and can be purchased with actual money. It's true that points are inflated through bonus points giveaways, but I don't think it will impact the Facebook IPO (if they even will have one). In fact, loyalty programs are sometimes more profitable than the company's core business.