The Math Behind the LindeX

LindeX MathThe recent instability in the LindeX Exchange has caused a lot of people to begin questioning the reasons … and the solutions. But to really understand what is happening and why, first we must understand the Math behind the LindeX. Even though I’m not a trained economist, I do know math. Today’s post will hopefully explain things using math but in a basic manner that doesn’t require a sheepskin and a super-computer to comprehend.

LindeX Basics

The LindeX is a basic “Money Exchange”. That means it lets people exchange one type of money for another. The LindeX specializes in exchanging Linden Dollars for US Dollars. Just like many real-world exchanges, the rate of exchange is subject to many varied influences. Unlike real-world exchanges there is no regulatory agency or body of laws that oversee its operation. In other words, it can go nuts as a result of panic and misinformation, but there is no controlling agency to keep it from going too crazy.

From Investopedia:

The money that is traded on LindeX is constantly monitored and evaluated by Linden Lab to generate economic statistics of the virtual world. LindeX is essentially an exchange where users called residents can trade and exchange Linden dollars with other residents; users do not trade directly with Linden Lab. (underscore mine)

Buying and Selling on the LindeX

When you “Buy” on the LindeX, you are using real-world US Dollars to purchase some number of Linden Dollars. When you “Sell” on the LindeX, you are converting Linden Dollars into US Dollars. According to Linden Lab, the LindeX is a “User to User Exchange”. That means they are neither Seller nor Buyer; they are only the entity that runs the machinery.

The LindeX Buy / Sell Gap

There is always a difference (or “Gap”) between the best Sell Price and the best Buy Price. This Gap ensures that the LindeX cannot become a tool for fraud and illegal speculation. The Sell Price is always lower than the Buy Price. Thus anyone trying to “Buy low and sell high” … can’t. Even so, don’t let yourself believe this is done to protect people using the LindeX. The whole purpose behind the Gap is to protect Linden Lab from legal intervention and regulation. It gives the impression that the LindeX cannot be used for money laundering and thus keeps them off the government’s radar.

Basic LindeX Math – Fees and The Gap

The size of the Gap is usually around L$10 to L$15. With a center point of about L$266 per $1.00, the Buy and Sell prices are usually around $0.045 (4-1/2 cents) apart. That may not sound like much, but multiplied by an annual Sell and Cash Out volume of $60 Million, that’s a total Gap of $2.7 Million. That’s a pretty sizable amount.

Why does this matter? Remember that the LindeX is a “User to User” Exchange. That means that in order to stay in operation, the money out must equal the money in. Thus the two numbers must be roughly the same, only differing by the amount of the Gap. The Fees charged are based on the type of Transaction and the number of Transactions. A full list of applicable Fees is found at LindeX™ Exchange Fees.

(The Gap Value is calculated in US Dollars because that is the “Outside” currency. The “Central” currency is the Linden Dollar, and that’s the amount that must balance. The Gap Value is thus calculated by subtracting the US Dollars taken out from the US Dollars put in to purchase Linden Dollars.)

LindeX Income for Linden Lab – Fees and the Gap

So lets add them up. With $60 Million cashed out last year, the total Seller Fee at 3.5% is $2.1 Million. The Buyer Fee is harder to calculate because it is charged per transaction. But we can guesstimate that with $62.7 Million in L$ Buy orders and an average purchase of $100.00, there would be 627,000 times $0.40 per Buy Order for total Buyer Fees of about $250,000.00. The final totals then are: $2,700,000.00 (Gap) + $2,100,000.00 (Seller Fee) + $250,000.00 (Buyer Fee) or just over $5 Million.

The last set of fees that matter are the Transfer Fees. Just recently Linden Lab changed the fees for Cashing Out (Process Credit). They now range from a minimum of $3.00 to a maximum of $15.00 per transaction. Applying the law of averages, we can estimate the “Average Cash Out” at $600.00 (an average $9.00 fee at 1.5%). A total of $60 Million cashed out with an average transaction of $600.00 equates to 100,000 Process Credit transactions. At $9.00 each, that’s $900,000.00 in Process Credit Fees.

Caveat: I’m going to give the benefit of the doubt to Linden Lab on the Process Credit Fee. Most services like Linden Lab uses charge around 1.5% to 3.5%. Since Linden Lab is only charging 1.5% with a maximum limit imposed, I’m going to throw away the Process Credit Fee and not add it into the income equation we are building.

The Bottom Line for a Stable LindeX

Okay, let’s summarize and figure out just how much Linden Lab is earning from operation of the LindeX. As we calculated above, Every year they are taking in roughly $5 Million from the Gap and various Fees. Since they are paying out $60 Million to their customers every year, their total percentage of “The Take” is approximately 8.3%. That’s a pretty good chunk of change in anyone’s book. But apparently Linden Lab is not happy with this amount.

In a recent Lab Chat, Ebbe Linden commented that they are looking at various ways to increase their piece of the pie. Specifically he said:

…we’ve also taken some actions to pick-up some of the revenue elsewhere; on the exchange and on the redemption side of the equation to compensate a little bit…

An Unstable LindeX

As we’ve all seen, recently the LindeX has been anything BUT stable. Linden Dollars purchased to spend in Second Life are usually “held” for about a week before they are sold and cashed out again. If the LindeX Exchange Rate goes up, it has the most impact on Sell Orders. And this is where the math gets a little tricky, so hang on tight.

The average Sell Price was about L$252 per $1.00 US. Just recently it climbed to L$262 per $1.00 US. What that means is that at the lower rate, there must have been around 15.1 Billion Linden Dollars sold. ($60 Million × L$252 per $1.00) But at the higher Exchange Rate, that same 15.1 Billion Linden Dollars will only result in $57.7 Million. That’s another $2.3 Million into Linden Lab’s pocket.

Take from Column A and Add to Column B

And there’s the real bottom line. In a stable LindeX market, Linden Lab stood to make around $5 Million. But because the LindeX has gone wonky, they now are looking to take in an extra $2.3 Million, or a grand total of $7.3 Million. That’s pretty darn close to a 50% increase in projected income … just for “destabilizing” the LindeX. Of course that also means that Sellers will take out $2.3 Million less this year. With our projected 100,000 Process Credit transactions, that yields a total LOSS of about $23.00 per transaction. If the average Seller cashes out once per week, their total losses add up to just under $1200.00 per year.


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Comments

6 Comments on The Math Behind the LindeX

  1. Dix on Thu, 26th May 2016 5:31 PM
  2. In your article you rightfully state that the market is unstable and that this is profitable for LL, but what I’m missing is how this happened and if this is done on purpose. I still don’t understand how this is happening and how this is LL’s fault.

    Isn’t it a simple matter of supply and demand? Are people maybe not buying L$ anymore while sellers keep taking out? Or is every seller taking out their reserves? Or were there tech issues with payment processing? Could it have been that it’s a temporary glitch because LL has finally started processing takeouts much faster, which they have promised for a long time? Although it would also show in volume. Tbh, I don’t see how LL can influence this, other than through changing the fees. And they haven’t, not that dramatically.

    I’m sure you have to be Lindex team within LL to be in on the finer details and actually know why this is happening, but I’m curious about your best guess.

    Of course I am very happy that I’m following your blog and it’s pretty much always a very good read. If I hadn’t read this post, I wouldn’t have noticed until our next take out. Now I’m gonna watch the market like a hawk to see how far this destabilization is going to go. Or maybe it’ll repair itself. I sure hope so.

  3. Darrius Gothly on Thu, 26th May 2016 8:46 PM
  4. Thank you Dix. Forgive me for leaving this out .. I sometimes forget that people can’t read my mind. *smile*

    In my post on the SL Forums I made mention of the way giant Blocks of L$ for sale are used to “coerce” people to sell at higher and higher rates. Those Linden Dollars add up to so much real-world money that they simply cannot come from SL customers; they must be placed by Supply Linden. Since most people want their money out fast, and even very patient people are only willing to wait a week or so, those Blocks convince people to limit their Sell Orders at the next higher rate.

    It’s a common technique that LL has used for years to keep the LindeX in control. They appear to be using it again to gently nudge the LindeX upward. You are right though, I am only speculating as to their reasons. But if my suspicions are correct, they are using the technique to get a temporary bump in their income. What troubles me is .. it’s a technique that speaks of desperation at best, flat out stupidity at worst.

  5. Dix on Sat, 28th May 2016 1:58 AM
  6. Well noted Darrius, I didn’t realize they did such blatant influencing of the market. That could explain the spike on the market. And apparently they certainly have the motivation to get a quick money influx.

    I vaguely remember reading something that LL made grandfathered tiers available to sim owners, for a one-time fee. That reeks of a sudden need for fast money as well. Putting one and one together, you might be on the right track with your idea about this.

    Anyway, the L$ rate spike seems to be back on the decline already. Hopefully it restores back to normal fast so sellers (including myself) can get back to normal life.

    Thanks again for the great article and your extra note. Well put and as I said, the more I think about it, the more I think you are completely right. 🙂

  7. Dix on Sat, 28th May 2016 2:01 AM
  8. Ps. I just now realized that I missed your blog post about the Lindex rollercoaster. Mwuah! It all comes together for me now. If I had read that article before this one, I would have understood where you’re coming from better. 🙂 My apologies!

  9. Darrius Gothly on Sat, 28th May 2016 2:07 AM
  10. *grins* NEVER be afraid to challenge me or flat out bust my chops. Even though I am totally perceft and neevr meak a mitsake (LOL) I have been known to be wrong. Push-back is sometimes the thing I need most to work through the fog and arrive at an even better answer. Thank you for the thoughtful comments and the compliments. I look forward to hearing from you again. Well-reasoned thinkers are always welcome.

  11. Dix on Sat, 28th May 2016 12:38 PM
  12. Whoah, he called me well-reasoned! 🙂
    Either way, last 3 days seem to be all about restoring order on the Lindex. It’s gradually returning to normal it seems. Let’s hope it will stay there for a while. Whether it’s LL or any other influence, an unstable Lindex is never good.