'Virtual currencies' power social networks, online games

(CNN) -- When Santiago Martinez wants to give his friends birthday presents, he buys a cake or flowers or sometimes a teddy bear.

'Virtual currencies,' like the hi5 Coin, shown here, are becoming more important on the Internet.

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But the
41-year-old, who lives on Mexico's Yucatan Peninsula, doesn't spend
pesos or dollars. He buys the gifts with an online-only currency called
hi5 Coins.

He also doesn't deliver the gifts in the physical
world. They appear digitally on his friends' online profiles on a site
called hi5, which is a social network like Facebook or MySpace.

"They can't eat the cake. It is an image -- the thing that it
represents," said Martinez, an accountant with a wife and two kids.
"You can send the feeling of that [cake] that you want to send."

In any given month, he spends the equivalent of $40 in this manner.

But Martinez is hardly alone.

As our identities migrate further onto the Internet, currencies that
exist only online are becoming a more significant part of commerce on
the Web and in the real world. Some, like the hi5 Coin, operate almost
like tokens in an arcade or tickets at a fair: They're a stand-in for
real-world currency.

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Other "virtual currencies," like Second Life's
Linden Dollars, however, are traded on markets. The currencies also
fuel online gaming communities and are becoming an important part of
social networks.

Several online currencies are competing to be the economic engines for MySpace and Facebook, which don't have their own unified currencies. Other social networking sites, like hi5 and myYearbook, have created their own units of money for their users to spend.

All of this movement leads some experts to see a future in which
virtual currencies enter the same trading space as their real-world
counterparts.

The online monies are not robust enough to trade
competitively against real-world currencies, but people underestimate
the large amount of cash that is transferred from the real world into
virtual currencies, said Edward Castronova, a professor of
telecommunications at Indiana University.

Castronova says people
transfer at least $1 billion into the virtual currencies each year,
with most of that money going into online games. The actual amount
could be much higher, he said, but the market is hard to quantify.

"The question is really one of scale," he said. "Is this big enough for
someone to take their 401(k) [out of real-world currency] and start
looking into this? No, absolutely not."

Sometimes, people collect online money simply by purchasing it.

In "World of Warcraft,"
players earn WoW Gold as they advance through the game. The currency
has become so sought-after that it is bought and sold on a black
market, experts said.

Low-wage workers in China are known to
play the game for a living and then sell the virtual currency they earn
to avid "World of Warcraft" players in the West. This despite the fact
that the game's maker prohibits such activities.

As the market
for online-only currency grows, problems that plague real-world
economies start leaking in, said Charles Hudson, who runs the Virtual
Goods Summit, an annual conference.

"Once you get a virtual
economy that's functioning, you run into all the problems that we have
with the real economy: taxation, interest rates, inflation. All of the
same problems that cause headaches for the Federal Reserve come up in
the virtual economy -- and the stakes are the same," he said.

The solution has been for each social network or game that uses its own
currency to appoint a money manager. Hi5, for instance, employs a staff
economist for this purpose.

The site soon hopes to make as
much money through its virtual currency exchange as it does from
advertising, which is the primary revenue source for many social
networks.

Mark Methenitis, a Dallas attorney who writes a blog
called "Law of the Game," said online currencies are "completely
unregulated," which will make trading them against each other dangerous.

"There is huge potential for fraud, for what would be the equivalent of
insider trading," he said. "Also, since these economies are completely
under the control of the virtual world owner, it's pretty easy to cause
massive hyperinflation."

Social networks and virtual worlds are currently trying to find ways to manage or capitalize on their developing economies.

These networks' successes may hinge on how they are able to manage their economies and currencies may, experts said.

Facebook is researching the idea of creating a unified currency but is
"very early" in the process and has not committed to it, the site said
in a statement to CNN.

Currently, applications on the site --
which allow users to play games with each other and trade gifts -- are
powered by currencies made by the application's developers, not by
Facebook.

These developers are making good money on the system,
and Facebook is missing out on profits in that area, said Hudson, of
the Virtual Goods Summit.

Joey Seiler, who writes about virtual
worlds, said virtual goods are becoming more popular because people are
taking their online identities more seriously.

At first, it may
seem ridiculous that someone would pay for virtual currency in order to
buy a T-shirt icon to put on a social-network profile. But Seiler said
more or his friends see the virtual T-shirts on his Facebook page than
see any T-shirt he wears in real life.

So being able to spice up his online identity has real value, he said.

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