Friday, March 11, 2011

The rise of Credits

Facebook recently announced that the only payments mechanism on the Facebook platform will be Facebook Credits starting from July 1. As with anything related with Facebook, hard numbers are difficult to come by, but by all accounts Facebook Credits is growing rapidly, and forcing through this change will only help that.

Credits could be revolutionary

Credits are essentially a private currency. The US has a long history of private currencies. Private currencies usually function as replacements for the US dollar in a particular geography, where they can help to keep money in the community and drive business to local stores. In that way. The fact that Credits is "virtual" doesn't change its fundamental nature; it's a private currency usable within a specific community.

What makes Credits exciting is the size and reach of that community. At 500 million users and growing, the Facebook userbase is already larger than the population of the US. In fact, Facebook's population is exceeded only by that of India and China. Comparing population growth in China with Facebook's growth, Credits could easily become the most widely accessible currency in the world by the end of this decade.

Of course, the fundamental purpose of any currency is to act as a means of exchange*, and Credits won't really be useful until more people, especially merchants, accept it as a form of payment. That's where the Facebook API comes in. For the thousands of app developers on Facebook, Credits is now the only way to get paid for their efforts. This guarantees a rapidly growing base of merchant acceptance for Credits. Given how addictive many of the games built on Facebook's API have proven to be, this move by Facebook guarantees a steadily growing demand for Credits.

Of course, comparison's with earlier virtual currencies such as World of Warcraft's Gold, and Second Life's Linden dollars is inevitable. And in the early stages, Facebook Credits certainly resembled these earlier virtual currencies. But the twin factors of Facebook's massive userbase and rapidly growing acceptance through the Facebook API guarantee that Credits will be much more revolutionary than anything that has come before.

Facebook Credits is not PayPal

Another comparison that I've heard made is between Facebook Credits and Paypal. Paypal was a revolutionary p-2-p transfer mechanism when it launched 12 years ago. Since then it has evolved into a money transfer behemoth, processing over $60 billion in payments volume in 2008. Its primary revenue stream is from helping merchants process payments online. Paypal is definitely the premier online money transfer mechanism today, but it's a very different from Credits in many ways -

  1. Despite being seven years older, Paypal doesn't have nearly as many users as Facebook. The size and engagement of Facebook's userbase gives Credits a gigantic advantage.
  2. The Facebook API is another huge advantage; Paypal's X API is no comparison.
  3. Paypal doesn't have a virtual currency. Any money in your Paypal account is denominated in dollars. Credits is a virtual currency, and because of its convertibility into multiple currencies, it's like a private version of the IMF's SDR.

Credits needs work

Credits still has a long way to go to reach its full potential. Facebook needs to do a few things -

  1. Mandate Credits for everything on Facebook. Not just third party apps, but accept Credits for stuff like buying ads.
  2. Make Credits freely transferrable between users. This will immediately increase the utility of Credits for users; Credits will immediately become a money transfer mechanism reaching 500 million people at one stroke.
  3. Reduce the effective interchange rate, currently an eye-watering 30%. There is no way that Credits will be usable as a real world payment mechanism until this comes down to <5%.
  4. Get ahead of the regulatory curve. In the US, apply for money transmitter licenses in the required 48 states, and in other countries get a banking license or partner with an existing in-country bank. Paypal did it; so can Facebook.

Facebook would be smart to do all the above in a carefully phased manner. Start by pushing the use of Credits on the platform and allowing users to transfer Credits between themselves at par. This will create an incentive to hold Credits and use them as a payment mechanism rather than convert them immediately into dollars**. Then start reducing the interchange rate to convert Credits into real currencies. Do this at a steady rate, say 1% a month. Again, people will be incentivized to hold on to Credits for as long as possible, rather than convert into other currencies. All of this should be sequenced with the appropriate state, federal, and international licensing. Done carefully, this should ensure that any revenue lost from reduced interchange is more than made up through massively increased volume and seigniorage.

A Facebook Bank anybody?

Building a currency** has always been a Catch-22. People don't want to use it until lots of merchant's accept it, and merchants' don't want to accept it till lots of people use it. Unable to force usage by writing a law, private currencies have always solved this problem by persuading a small group of merchants and users to use it in a particular geography.

The flip-side of the Catch-22 is strong network effects***. Once enough merchants and users start using it, there is tremendous value for additional users and merchants to join in, and the system can grow very rapidly. The only limiting factor becomes the total population size and the scaling speed of the underlying technology. If Facebook plays its cards right, Credits will grow exponentially; much faster than Paypal ever did. I even have a bet going on LongBets about it.

Essentially, Facebook could become a private central bank, issuing a widely distributed and accepted currency. They could build a leveraged balance sheet, just like any other central bank, and with a degree of control and flexibility over their 'economy' that central banks can only dream of. Of course, they would have to develop expertise in managing a multi-currency balance sheet and hedging risks, but those skills can be imported into the organization fairly easily.

Another intriguing possibility that the combination of a virtual currency opens up is a virtual bank. A bank within Facebook, that takes deposits in Credits, and lends to anybody who needs it****. So will we see a Facebank sometime this decade?

* and a store of value, and a unit of account, and a standard of deferred payment.

** or Ringgit, or Euros, or whatever

*** same goes for building a payments network

**** initially, probably startup gold-farms and poker players looking for an ante

1 comment:

  1. The future is never predictable, because unexpected ideas arise. Like Facebook Credits. Will there be an uproar about "world currency" and loss of sovereignty? I doubt it. Nevertheless, Facebook Credits could turn out to be the means by which exactly that comes about. Meanwhile, can I borrow some Credits? What's the rate? And then -- would you like to borrow some Credits from me?