How many SL’ers have been following the tale of Ginko Financial’s collapse? The short version: Ginko Financial was an investment bank in the unregulated economy of Second Life. Depositors could deposit money with Ginko and receive returns on their deposits that vastly outpaced returns in real life. On or about August 2, Linden Labs ordered a closing of all casinos that used Lindens as a currency for gambling, effectively outlawing gambling in world. This, combined with trading problems on the World Stock Exchange, led to a depositor run on Ginko Financial.

What’s exciting and fascinating about all of this is that it’s a real-time, present day example of stuff that’s normally relegated to dry, dusty financial history textbooks, and a validation of some of the financial institutions we have in present-day America that we take for granted, or worse, criticize without fully understanding.

Two institutions in present-day America could have saved, or at least helped Ginko Financial: the FDIC and the Federal Reserve.

The FDIC, or Federal Deposit Insurance Corporation, is a federal corporation set up in 1933 which offers a guarantee to depositors that up to $100,000 of their money in checking and savings accounts will be replaced by the government if the bank fails. The primary function of the FDIC is to provide confidence to consumers that their money is safe, thus reducing the risk and impact of bank runs.

The Federal Reserve System is a central banking system created in 1907 after the third major banking panic in the United States. One of the functions of the Federal Reserve is to act as a lender of last resort for commercial banks who face a liquidity (cash) crunch; banks that can’t borrow from other banks to cover a shortage of cash at market rates can borrow from the Federal Reserve at rates set by the Fed, which typically are higher than free market rates.

In the case of Ginko Financial, having the ability to borrow from a lender of last resort would have allowed them to cover their depositors’ money, and having depositor insurance would in turn reassure those who deposited money that their money was reasonably safe. Instead, a bank imploded and took its customers’ money with it.

Interestingly enough, the absence of an FDIC and FRB equivalent has real life consequences, too. One of the other roles of central banking is to contain inflation. Hyperinflation and currency devaluation sound dry until you realize they were responsible for millions of deaths in the 20th century - hyperinflation was one of the key factors involved in the implosion of the Weimar Republic, which in turn led to the rise of Adolf Hitler.

It’s important to point out that Linden Labs doesn’t need to create either an FDIC or FRB equivalent - a private consortium can do that just as well. Instead of acting as solely independent entities, the 20 or 30 so banks in SL could set up an interbank offering system similar to what banks in London did years ago (the LIBOR rate, on which many loan products are based, is the London Inter Bank Offering Rate, the rate at which banks in London will borrow from each other), and establish transaction fees on things like ATMs to fund a deposit insurance fund, just as the FDIC does today.

Welcome, Second Life, to real life economics. Thanks for being a fantastic, living example of the power of money and what the risks of an unregulated economy look like.