New Growth Frontier: Why Banks Need to Start Investing in the Virtual Economy Now

By John Egan, CEO of L’Atelier, a foresight subsidiary of BNP Paribas Group

For years now, digital transformation has been one of the biggest opportunities—and headaches—for banks and other financial-services firms. Banks are constantly racing to meet ever-changing customer expectations around digital services and striving to keep up with challenger brands that were built to be digital-first.

It will always be difficult for traditional players to keep pace with these digitally native players. However, one way that bigger players can carve out a competitive advantage is by looking further ahead, beyond the one-to-two-year timeframe upon which most digital strategies focus. Once you do that and look at the emerging trends likely to define the next decade or more, one largely unexplored area of opportunity stands out: the virtual economy.

The virtual economy is an emerging system of online jobs, virtual assets and exchanges. It is made up of gaming worlds such as World of Warcraft and Minecraft and non-gaming virtual platforms such as Second Life and Decentraland. It is already big business. The economic activity in these virtual worlds is worth well over $100 billion annually and is growing rapidly.

Virtual assets represent a real opportunity.

Whilst the opportunities for banking and other financial-services firms within the virtual economy are rich and diverse, the most immediate revenue opportunities lie in a new breed of virtual assets.

Virtual assets come in all shapes and sizes—including weapons, cars, real estate, “skins”, clothing, characters, accessories, currencies and more. The most expensive virtual asset sale was “Club Neverdie”, a popular nightclub in the game Entropia Universe, which was sold in separate lots for a total value of $635,000 in 2010. ^[i] More recent examples include a virtual F1 car that sold for more than $113,000 and a “battlecruiser” in the game Crypto Space Commander, which sold for $45,250.^[ii]

The bulk of the virtual assets traded online currently are in-game items created by publishers and players, which are sold through microtransactions. To take Fortnite as an example, the average player spends $20 a month on items such as skins and weapons. However, there is a growing market for virtual assets that are “tokenised” on a blockchain—a system in which a record of transactions is maintained across several computers linked in a peer-to-peer network. This latter category, of which the F1 car and battlecruiser are prime examples, is where the biggest opportunities lie.

The most promising of these tokenised assets are non-fungible tokens (NFTs) because they enable the creation of unique, non-interchangeable virtual items with clear provenance. Since they are standardised in their programming, they can easily be exchanged on decentralised open markets. Unlike a lot of virtual goods on centralised virtual market platforms, NFTs can also be liquidated for real-world currency without breaching the terms of service or the law.

Collectables such as CryptoKitties^[iii] are a straightforward early application of NFTs, but users are starting to gravitate towards more complex assets that have genuine utility.

Examples include virtual real estate such as Cryptovoxels^[iv] and visual art such as Josie Bellin^[v], as well as social-network handles, event tickets and even ownership records for physical assets.

The NFT market remains volatile; it is sensitive to fluctuations in cryptocurrencies and the actions of a small number of powerful users. But it is showing signals of a maturing market ready for growth. As the user base for NFTs grows over time to include a larger number of significant actors, it will dilute the impact of cartel or speculative behaviour. And, with the emergence of new exchanges such as OpenSea^[vi], it’s now possible to establish a live market value and historical price data for virtual assets.

Investors and brands are starting to find commercial uses for NFTs. For example, virtual cities complete with virtual real estate and virtual designer goods have sprung up and attracted significant investment. One investor, “Matty”, made $60,000 speculating on virtual land.^[vii] Investments in NFTs also surged as lockdowns took effect in late March and April (when compared with the previous months), generating more than $2.20 million in transaction volume between March 29 and April 22.^[viii] Meanwhile, total NFT sales have just surpassed $100 million.^[ix] Brands such as Nike, Formula 1, Louis Vuitton and Samsung are also examples of big names investing in the trade of NFTs.^[x] However, while there is clearly growing demand for virtual assets, they remain uninsured and unsecuritised.

Creating financial products for virtual assets

Whether it’s options, forwards, futures, swaps, asset-backed securities and so on, the financial-services industry has always insured, collateralised and securitised anything with an income stream. The new legitimacy and transparency afforded by decentralised open marketplaces mean virtual assets are ready for the same treatment.

The ability to insure virtual assets would create more certainty and stability within these growing markets and would open up lucrative new revenue streams for those firms that can successfully develop policies. And, as more stability enters the market, so will more legitimate operators. This will increase the demand for virtual assets and create a virtuous cycle in which the firms that establish themselves in this market first can build their profiles as the trusted providers to a growing community. Once virtual assets have definable value, they could also be used to collateralise loans, just as “real” assets have been for decades. Additionally, users would be able to lease their NFTs if they don’t use them often.

So what are the best assets for banks to start with? Real-estate NFTs provide the most stability and value right now and are good entry points. The most established platforms are Decentraland^[xi]—on which land transactions totalling $50 million have taken place since the platform launched in 2017^[xii]—as well as Somnium Space^[xiii] and the aforementioned Cryptovoxels. Additionally, the works of crypto-artists who have a significant following can provide added transparency: the popularity of the artist can be assessed via their social following, and the purchase price and secondary-market sales can be seen publicly on the exchanges, making them easy to measure. Finally, another good place to explore would be the market for fractional ownership of tokenised physical assets, an example being people buying NFTs that represent pieces of a painting.

Invest in understanding the virtual world.

Entering any new market presents unique risks, and if banks are serious about establishing revenue streams within the virtual economy, they should start by ensuring they fully understand this new world and its users.

Besides the current volatility in the NFT market, the lack of proper regulation and relative brand anonymity will be big challenges for the early entrants to this space. It will also be difficult not to be exposed to crime on certain platforms and even more difficult to manage authentication and authorisation in some cases. Getting a thorough understanding of these virtual worlds will be the only way for banks to ensure that they know which pools to dip their toes into without unacceptable risk.

The ability to know and understand the potential customers will also be critical. The emergence of the virtual economy has given rise to new career paths totally unfamiliar to traditional finance. Our own research found that there are hundreds of thousands of people earning full-time or supplemental income in the virtual economy. To successfully serve this new environment and audience, financial institutions need to immerse themselves in the virtual worlds and online platforms from which their potential customers derive their income.

Banks can start by hiring digital natives with firsthand experience and expertise in navigating the virtual economy—for example, modders and virtual asset creators—to advise on and shape virtual strategies. They should look within the emerging NFT community and also explore partnerships with existing NFT brands, while also ensuring that those leading these efforts internally are also investing time and developing their understanding of the virtual economy for themselves.

Looking ahead

The pandemic has significantly boosted activity in the virtual economy as people have migrated to spending more time online. And the virtual economy’s capacity to generate revenue largely unaffected by outside events means it is well placed to thrive post-lockdown. Even as physical businesses reopen, it will take time for consumer confidence to return, and real-world mass gatherings will be unlikely for a while. This means that many of the virtual behaviours adopted during lockdown are set to continue and evolve, accelerating the growth of the virtual economy.

The immediate pressures of digital transformation are not going away, and banks need to continue working to build the mobile and digital offerings that customers want here and now. However, those firms that can also look further ahead will have a great opportunity to carve out a real leadership position in the long term. By investing now in building their institutional knowledge of the virtual economy, and in developing ways to insure and collateralise virtual assets, banks can tap into lucrative new revenue streams in the next decade and beyond. Virtual assets may exist only in the digital world, but the value they command is real, and their numbers are growing.

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