The Valley is small, and the Web 2.0 community can feel even smaller.  Sometimes it’s easy to forget that there are people in the Bay Area who don’t work in technology and, as a result, don’t follow emerging trends as closely as I do.

Trends like virtual currency are a growing – and incredibly lucrative – element of social networks like Facebook and MySpace.  But that doesn’t mean that virtual currency is well understood outside the confines of Silicon Valley.

I was reminded of this fact at a picnic over the holiday weekend, where a close friend asked, “Tell me again exactly what your company does.”

It’s a question that I’ve heard time and time again, since joining Social Gold back in March.  I often respond by asking, “Do you have kids?”

Luckily, this particular friend has a young son who is potty training.  Children that age do not understand the value of money, but they understand incentives.  When my son was that age, my wife and I tracked his potty successes – and accidents – with the help of a chart, where successes were marked with a star.  After he earned enough stars, we rewarded him with a small toy or a treat.  In other words, children understand the value of virtual currency long before they understand the more abstract value of a dollar.

My son, Cooper, is almost 5 now, and we still use stars as currency.  Most recently, my wife created a chart in anticipation of the Memorial Day release of the latest Pixar film, “UP.”  Cooper loves Pixar movies and eagerly earned stars by listening well, using good manners, and not running or climbing in the house.  He understood the star as a tangible instrument of value, where 100 stars earned him one ticket to “UP.”  To Cooper, stars just make more sense than dollars.

So much for virtual currency.  But what about virtual goods?  That’s actually pretty easy to explain:  virtual goods = entertainment.  Just as Cooper redeemed his stars for a ticket to “UP,” people redeem virtual currency for enhanced experiences or advanced play in social games and applications, all in the pursuit of entertainment.  It’s really no different than entering a physical arcade and pouring quarters into your favorite video game.

There are basically 3 types of virtual goods:

Gifts. Giving gifts is an inherently social activity, which lends itself well to social applications on Facebook.  I recently celebrated a birthday and received real gifts and snail-mail cards from the usual suspects – mostly older relatives.  My friends on Facebook, however, posted well wishes on my wall with a host of virtual gifts, ranging from beers to baseballs (side note: I am a huge baseball fan).  And these virtual baseballs add up quickly.  Even the lightly-promoted Facebook Gift Shop drives, depending on your source, between $50-150M in annual revenue for the company.

Decorative Goods. Most often found in applications where your virtual persona, avatar, pet, etc. is the focus, decorative goods allow you to express your own personal tastes much as you would in the physical world.  The possibilities are limited only by your imagination, although hairstyles, clothes, accessories and room decorations are among the most popular decorative goods.  In fact, as the U.S. economy has forced many to forego buying that new pair of designer jeans, the virtual world presents a low-cost alternative for self expression.

Sebastien de Halleux, co-founder and COO of social game company Playfish, provided perhaps the best example I’ve heard at last month’s Social Gaming Summit.  De Halleux reported that, within its wildly-popular Pet Society application, Playfish sold 20 million virtual Christmas trees last holiday season at a value of $2 each.  He went on to explain the users’ rationale for investing in a virtual tree: “Previously, Christmas trees, we’d put in our flats and it’d be something to share,” explained de Halleux.  Now, “we’ve become disconnected, and maybe three or four friends would see the real Christmas tree – on Facebook, all of their friends would see it.”

Functional Goods. As the name suggests, functional goods provide enhanced functionality within an application.  If you’ve ever played poker on either Facebook or MySpace, you’ve likely purchased a functional good:  poker chips.  More often, an application offers a base level of play but allows users to “level up” – to advance more quickly – by purchasing functional goods.  So, in one of the many mafia-related role-playing applications, you can try to advance from street thug to mafia don using only a baseball bat, or you can purchase an arsenal of mercenaries and weapons to accelerate your ascent up the ranks.

Once I explain virtual currency and virtual goods in those terms, whether it’s at a Fourth of July picnic or a cocktail party, I can usually sit back and watch the “aha!” moment as people suddenly understand what we do.  Then, it’s just a matter of warding off the investment/ employment requests.

-Mike

P.S. For the uninitiated, Social Gold is a platform that – among other things – enables developers to sell virtual goods to users within social games and applications.  If you’d like to learn more, feel free to contact me directly at mike [at] jambool [dot] com.