Domain Speculation

From Zanecorpwiki

Complete, but 1st draft

Is domain speculation an appropriate action? Should it be allowed? Restrictions of this sort should always be approached with the utmost caution. To this end, we should consider the strongest argument for domain speculation: it turns a profit--estimated as high as $700 million in 2006[1]--and history has shown time and time again that market success is the best indicator of doing things right. History (and logic) also conclude that there is ample basis for questioning the market. We must simply be cautious as we do so.

Contents 1 The Question 2 The Cost 3 The Value 4 Theories of Ownership 5 Conclusion 6 Further Reading

The Question

In our case, we want to ask this question: is there transactional value created by domain speculation? All free market activities must have the potential to benefit all parties involved: buyer, seller, and society. In practice, specific transactions may of course fail to meet this test because real transactions do not occur in an ideal market. Actors have imperfect information. Yet, if a transaction cannot by its nature benefit the buyer, seller, and society then any one of these parties, which all have proper veto power, would in a true free market veto the transaction.

To put it another way, transactions must be free standing. They cannot rely on the loss of the participating for if they did, they would be inherently non-viable in the long run.

The Cost

$700 million is the estimated revenue taken by domain traders in 2006. Revenue is always someone else's cost, s the monetary cost of domain speculation in 2006 was also $700 million dollars. As a the cost of domain names in the primary market is negligible, we know that at the very least domain speculation cost companies $700 million dollars that they would not have otherwise have needed to spend.

This is, however, a case where the actual cost is far greater than the direct cost. How much greater is impossible to say. To understand this cost, we first divide domain speculation into two sub-categories: domain squatting and typo squatting.

Domain squatting means registering a domain without intent to use it in any real sense, but to simply hold it till someone else makes it valuable and then extract some of the value the buyer themselves created. Typo squatting mean registering a domain that is close to a real domain and which might accidentally be typed into a URL. This is a type of speculating because the purchaser of the domain is betting on how common a mistake will be (though domain kiting makes the actual risk of speculation quite low).

Some typo squatting is done with the intent of selling the domain to the owner of the real domain under the theory that if the typo is common enough, then the typo domain becomes a significant embarrassment to the owner of the actual domain who will then pay to make the problem go away.

More insidiously, typo squatters use their domains to trick visitors who think they are visiting a legitimate company into sharing email, personal information, and sometimes even bank and credit card numbers. Typo squatting is commonly tied to phishing attacks. The most sophisticated typo squatters will replicate substantial portions of real sites, all with the aim of capturing sensitive personal information.

The cost of typo squatting is more-or-less the fraud loss people suffer after having divulged sensitive information to the typo squatter. While comprehensive estimates are understandably hard to come by, CADNA estimates that a particular kind of typo squatting costs consumers over $100 million per year.[2]

In the same report, CADNA estimated the total cost of domain speculation to brand owners at $1 billion annually. This estimated includes the cost of lost consumer confidence, diverted sales, fraud loss, and the cost of enforcement and policing trademarks and squatted domains (they use the term cyber squatting to refer to the two types used here).

There is another, potentially larger cost to domain name squatting: the lost opportunity for new and growing businesses. The high cost of resold domains puts them out of reach of the small business. Furthermore, even when the cost of a domain is justified by the perceived value, many refuse to participate in what they consider to be extortion.

The heart of the Web 2.0 movement is small, quick applications. In such cases, the inability to grab a suitable domain can often decide against developing an application. In my own business experience, I have seen two applications that did not launch for want of a decent domain.

Of course bigger move ahead anyway, but one has to wonder about the cost of being forced to use lesser names. Nonsense names seem to be all the rage... maybe because domain squatters are sitting on all the reasonable names. Rather than spend dollars towards improving their service, companies are forced to move to increasingly obscure names and spend money telling customers that fibazoo.com is really a nanny finding service. Why? Because at the time of writing findananny.com, nannyfinder.com, and thenannyagency.com were all squatted. (nannyagency.com appears to be a legit site for a Philadelphia company.)

The Value

For the speculators, the value of domain name speculation is clear enough. A legitimate economic transaction, however, must have at least the potential of transactional value. Transactions that have the potential to benefit only one party stink of market perversion and extortion.

When domain name traders (also domain name speculators) talk about what they do, they talk about drawing attention [3] to names wherein the domain becomes its own advertising [4]. This is a specious argument as far as transactional value is concerned. Consider this quote:

blockquote When domain name speculators buy a domain name, they generally put up a page indicating that the domain is for sale. This becomes a sort of free advertising, whereby someone interested in that domain name will naturally check out the site to see if it is a competitor, or if the domain can be purchased. /blockquote

With a domain trader in the mix, the interested party finds a domain is indeed for sale, but rather than paying between $7-20, they find they must now pay anywhere from hundreds to millions of dollars. The domain trader has not provided the purchaser with any information they would not have otherwise gotten without their involvement. It is in fact much easier to find if a domain is for sale if it is not squatted since a free domain can be checked with a registrar, allowing interested parties to search many domains quickly from one place rather than visiting domains individually. To make it even worse, those who start at the natural place, their registrar, may not even check non-free domains and so will never realize that a domain is free. The domain trader ends up obscuring the availability of the domain and increasing the cost at the same time.

While domain traders seem unable to provide an economic justification for what they do, I can suggest a better alternative. Free domains sell for very little money, between $7 and $20. At this low cost, less serious interested parties may purchase and hold domains, developing them for less significant sites or failing entirely to develop the domain. By raising the price of the domain, domain traders lock out casual players.

The value of this activity is directly offset by the locking out of serious, but small interested parties who cannot afford the inflation of the purchase price. Still, the domain traders do effectively generate useful information regarding the value of a domain which is masked by the free domain market where prices are set. Stock trading in the secondary market perform a similar function.

There is one other possible source of value created by domain speculation: the ads commonly put up on squatted domains. Since I have not been able to find any speculators referring to this potential value themselves, and because the larger market picture for internet ads makes it unlikely that this practice generates any significant revenue and can therefore be assumed to be of little value. The practice is more likely used to satisfy the use it or lose it requirement to hold a domain. In this sense, there is value for the squatter, but the practice fails to generate transactional value.

Theories of Ownership

Domain speculation is predicated on a fee simple theory of ownership. While it is true that domain ownership must renewed on a periodic basis this is a tax and simply means that owners lack allodial title to the domain (allodial title is a kind of absolute ownership generally reserved to governments).

There are a number of historical lessons that apply to domain names. Free domains have parallels to unclaimed land and the public spectrum. (Of course unclaimed land was usually claimed by someone or some group that the new claimants simply don't recognize, but the development of the legal and economic theory is still illuminating.) The question is: when something which had no value--really no economic existence at all--what do you do when it suddenly does?

From the economic perspective, the invention of radio and TV created the broadcast spectrum. Something which had effectively never existed before was suddenly worth trillions of dollars. But without a pre-existing owner, how to dole out control of this new commodity? As is often the case, ownership was deemed to reside with the public. The government, acting on the publics behalf, holds actions for the spectrum. (The government has also at times engaged in economic planning, and this has uniformly resulted in worse results, delayed technology, and lost opportunity. The auction system has in practice been much better at allocating the resource.)

The auction is in fact a mechanism to try and determine who will best develop the spectrum. The proceeds from the auction, while significant, are secondary. This idea of developing the property has a long tradition in real estate as well. During the colonization of North America by Europe, the expansion of the US west, and the closing of the commons in Europe public land was most often transfered to private hands based on who could best develop the land. Most colonial settlements adopted laws that said an individual could claim as much land as they could fence and till (or ranch, mine, etc.)

This idea of tying ownership to development is not limited to the European culture. Many Native American cultures (as well as others) relied primarily on a usufruct system in those that need or can utilize a commodity acquire usage rights that transfer independent of ownership. Ownership may be retained by the public or superseded by usufruct rights.

Like the public spectrum and unclaimed land, domains are properly a public good and yet almost completely fails to incorporate the traditional concepts of allocation based on development. (With trademarks and in the language of domain name arbitration, we do see these concepts, but domain traders tend to stay away from trademarked domains and the arbitration rules are interpreted in a way that favors squatters.) Domains were originally free because no one much cared about them. As the web develop and the value of domains increased a small fee was tacked onto the domain name registration to cover the growing cost of operating the registration system and to prevent the casual acquisition of domains.

The system never developed a proper theory of ownership or determined it's relation to the public interest. Obviously some sort of auction system in the primary (rather than secondary) market would have been better. Alternatively, a reasonable implementation about the use it or lose it rule that excluded I'm using it to sell it bullshit and funding of the system through higher registration fees would also be sensible.

Conclusion

Domain names are a public good, but the system for distribution lacks any recognition or respect for the public good. The current system costs businesses around a billion dollars more than it needs. Billions mare are lost to fraud and in lost business opportunity. All these billions of dollars are wasted so that domain traders can make a few million dollars while not only failing to add value, but actually diminishing the value of the product they sell in a system that has all the hallmarks of extortion except for the fact that it's legal.

The solution, however, is not easy. Fixing the primary market so that domain names are allocated on a sensible basis would certainly introduce complexity into the system. ICANN (the ultimate authority on domain names) has a vested interest in the current situation. They can make a few bucks off every domain name sold and they don't have to do anything because they've decided not to enforce their own rules in any meaningful way. They could charge higher, but still reasonable fees, to fund more effective enforcement, but why bother? If the secondary market disappeared, not nearly so many domain names would be registered and from their point of view it is preferable to make one tenth as much on ten times as many domain names and do nothing for it than to make ten times as much on a tenth as many names but have to do their job.

All in all, forcing ICANN to adopt better rules and actually enforce those rules looks to be the best way to go. Keep the purchase of domain names easy, but charge a higher, though still reasonable, initial price to fund increased enforcement. Give a discount on renewal fees. Force them to open their books to public inspection so we know we're getting what we pay for. As ICANN makes it's money off a public good, the public has the absolute right to demand these changes.

Further Reading

• Google, typo-squatters, and AdSense
• Bush buys back domain for $35K; the GWB Library forgot to renew georgewbushlibrary.com and ended up paying some random guy on the Internet $35K for... well, for fucking with them. A clear case of extortion.