August 24, 2011 | 2
On April 22nd, 1889, large areas of what is now Oklahoma were officially opened up for homestead settlement. At high noon, thousands of pioneers raced from the territory’s borders into pristine land, claiming lots on a first come, first serve basis. Within hours (!), first cities emerged around railroad stations or at other well connected spots, quickly establishing local governments, basic infrastructure and property rights. Despite opposing laws, land claims were directly sold off in secondary markets.
The initial registration process for internet domain names is organized in exactly the same land rush way. Early birds creamed off the finest names year after year, paying just a low nominal fee. With currently more than 200 million registered domains, the internet landscape looks like the United States in the 20th century: almost all the nice spots are taken. Late-comers have to buy their way in when looking for a catchy name for a new online venture.
Exclusive domains oftentimes trade for 5 or 6 figure dollar amounts, and some for even more. The current record in reported sales prices is the $13 million dollar transaction of sex.com (NSFW) in 2010. Trading of and investing in domains has quickly evolved from a geeky pastime of a few to the serious bread and butter industry, feeding hundreds of professional traders today.
In contrast to Oklahoma’s settlers, however, domain name investors could not rely on any experience in pricing this new asset. There were no comparable markets elsewhere that could guide traders, making buyers and sellers real pioneers.
Internet domain markets offer incredible research opportunities for real estate scholars
Being a housing economist by training and an internet entrepreneur at heart, I was missing answers to basic questions like: How did the value of domain names change in the last year? Are domains a good investment asset? How big are risks and returns? Which factors determine the value of a domain?
I started applying real estate methodology to data on domain sales. The key result is that domain markets are not just a fantasy land where esoteric goods are traded at imaginary prices. On the contrary, domain name prices have an economic foundation, and they are not detached from the general economy. My research shows that domain price changes are very similar to changes in the NASDAQ 100 index, the stock prices of internet giant Google or total revenues from online marketing (US). A practical result of my work is the first academically sound Internet Domain Name Index, dubbed IDNX.
As seen in the graph above, Internet domain names rapidly gained in value from 2006 through 2007, with prices peaking in November 2007 (+72 percent relative to Jan 2006) before falling by 34 percent in the subsequent five quarters. Since then, domain prices have regained their strength, climbing to an all-time high in May 2011. The current mayhem at the stock markets left its mark at domain values as well.
Both NASDAQ 100 and IDNX substantially lost value in July 2011, heading down in close lockstep. The strong correlation with other economic indices shows that domain name buyers and sellers make economically motivated price decisions.
Before discussing the nuts and bolts of the index estimation, let’s first turn to the core analogy of domains being nothing but virtual land.
Internet domain names bring back the location to the otherwise location-less Internet economy. A domain name provides a virtual street address for any website or service on the internet. It is comparable to a tract of land on which a business or just a private home (page) can be built on.
Understanding the World Wide Web as an agglomeration of interlinked network locations is not uncommon. This is visualized by many terms related to the internet exhibiting a spatial connotation. Labels for technical network addresses, for instance, are called domains, users are visitors, internet browsers have been baptized Navigator or Explorer, websites are home pages – the list can be easily extended.
Understanding domains as a novel form of land offers the opportunity to transfer established theoretical and empirical frameworks for the pricing of land into virtual space. Theoretically, textbook models of urban layouts explain differences in the rents and prices of land by differences in the distance to jobs or amenities. Applying this reasoning to domains, the price of a domain is hypothesized to depend on its ‘proximity’ to potential users. Since a voyage on the world wide web usually begins with the user entering the domain name of the desired website into her web browser, distance to the user can be seen as the effort a user is required to make to correctly remember and type a domain name. An appealing domain name like weather.com is easy to recall and quickly entered. In this sense, an intuitive domain name is like a convenient down-town address linked to excellent transportation systems.
The IDNX Methodology
Two general methodologies are commonly used to price non-standardized assets like real estate or art. The first one, known as hedonic regression analysis, explains the price of an asset by a set of quality variables that describe the characteristics (hedonics) of that asset. Alternatively, the repeat sales methodology traces individual domains over time, comparing each transaction to previous transactions of the very same asset. While this is generally regarded as the most direct form of making an “apples to apples” comparison, it disregards all information on transactions that are sold only once. IDNX combines the advantages of both methodologies and relies on a so-called Hedonic Repeat Sales methodology, using a hedonic classification of the top level domain (the “last name” of a domain like .COM, .NET, .ORG, …) and, otherwise, a repeat sales approach.
Thanks to the largest secondary domain name marketplace Sedo, IDNX has a strong empirical base of more than 200,000 real domain transactions over a six year period.
In summary, domain markets have matured. The strong correlations of aggregate domain prices with the high tech economy and online advertisement revenues show that buyers and sellers are clearly evaluating the business potential of domains before trading. Domains are not yet another fad, but real business.
The domain name index put forward in my research can serve as a benchmark for domain name traders and investors looking for information on price trends, returns and fundamental risk of internet domain names. It thereby increases transparency in the market for this newly emerged asset class.
Furthermore, IDNX serves as a fever curve for the internet economy in general, covering small enterprises that are currently excluded from stock-price based indices, which by definition focus only on large corporations.
In domain markets, the times of iconic pioneers and virtual Daniel Boones are over. Domains have become a more mainstream investment asset with economically sound prices – at least at the aggregate level. Vibrant secondary markets replaced the rush, and the “last frontier” is tamed, again.
Interested in learning more? You can download the index numbers here, and review a more detailed description found here. If you find this information interesting and valuable, please feel free to reach out to me directly for more details.
Images: ‘Oklahoma Land Rush‘; and ‘IDNX_vs_NASDAQ’ by author.
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