The Viability of Virtual Currency on Social Networking sites

I recently received an Internet Media report from some investment bankers at a boutique investment bank.  It discussed how virtual currency systems may supplant advertising as the main revenue source for social networking sites.  This is a very interesting thesis.  At Community Connect, we were originally 100% ad supported.  When the previous recession hit in 2001, we needed to diversify our revenue streams to survive.  One of the few successful B2C business models was online personals with its subscription model.

We realized that people were coming to our sites to make friends and flirt.  However, there was not an area on the site where you could easily identify people actually seeking romantic relationships.  So we built an online personals area on our site and it saved the business.  People were willing to pay for the ability to communicate with someone that they have identified as single and of interest to them.  The money was pouring in and I started to believe that our business was going to be much more subscription based.  The problem though was that the subscription model was based on limiting communication between users.  As Friendster and MySpace emerged, we realized that if we restricted communication users would quickly leave for these unrestricted alternatives.  And this soon came true of our online personals area.  PlentyofFish.com exploited that issue and has been the fastest growing online dating site in terms of size of audience.

So why now will a paid model work for social networking sites.? Well, the emergence of 3d worlds such as Second Life, Habbo, IMVU and Meez as well as casual game app publishers such as Zynga who provide apps on Facebook such as Texas Hold’Em, YoVille and Mafia Wars have shed a light that folks in Asia have known for quite some time now (See TenCent and CyWorld).  That by providing a virtual economy does it not only provide a strong monetization engine but actually provides a better user experience.

So how does making people pay for something, create a better user experience?  By creating scarcity for something, it allows those that obtain it to have a higher level of status within the community.  Isn’t this true for our real lives?  Of course!  And I have always believed that the more a social networking site reflects what occurs in the real world, the more successful it will be.  So what type of products or services should be scarce in a social networking site:

1. Gifts – the more scarce, the greater the appreciation and recognition of your gift giving.

2. Self Expression Enhancements – Having special layouts and templates for things like your profile and the messages that you send gives you status.

3. Compliments or Elevating Someone’s Reputation – the reason why having a strong reputation on Ebay is hard is because it has scarcity.  Social networking sites generally lack a good reputation system so you know those members that are appreciated by other members.  By not creating any meaningful hurdle to give someone a compliment then the system will be gamed by those that truly don’t deserve that elevated status.  So there should be a price to it in order to make it effective.

So do I think that a virtual currency system will be a bigger monetization engine as advertising for social networking sites.  No.  I stlll think the advertising platform for social networking sites is completely under monetized (more to come on that topic) and that advertising should be able to monetize every single visitor to your site.  Virtual currency space has limitations and are very dependent on a subset of your most enthusiast users and probably will be limited because of that.  However, it could be a very meaningful revenue stream in addition to advertising for most social networking sites.