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Note: I'm leaving this article in the plural despite Xanth's being the only god currently active.

Karma is an out-of-character representation of how much the gods like you. Each offering you make, whether it be a prayer or an item or even participation in a quest, can earn you karma points [KP]. When you reach a certain number of karma points, you can trade them in (through the Prize Shop) for special items or favours.

Note: You can get karma from any god (just know they each have different values so making an offering to one may not work as well as it would on another). However, if you annoy one of them, you may not receive any rewards from that god no matter how many karma points you have.

Gaining Karma

You can gain karma in many different ways, both in-character and out (though mostly in). Some are easier than others but will not earn you much in the way of karma points; others are dangerous but more rewarding. It's up to you which you choose. :)

If you gain karma out of character, it should be assumed that your character has done something in character to gain favour from a god (such as donating money (or better yet, their time) to a charity or helping someone). It's up to you to figure out what actions would make sense for your character.

Humans gain twice as much karma as the other races, as long as they do so in-character (which is to say they cannot purchas double karma through the Prize Shop, only by their in-character deeds).

Offerings

The easiest - and least dangerous - in-character method of earning karma is for your character to leave money or items at their chosen god's shrine. Each god is different and will be more or less receptive to certain types of items but it's up to you to figure out which.

Monetary Offerings
The return on your money varies depending on the deity you're making the offering to, their current mood and what they already think of you. Gods don't value money all that much and will swiftly become bored of monetary offerings, so you may find the number of karma points you receive reducing with each offering.
Sentimental Offerings
If an item you offer holds sentimental value, you could earn up to double its monetary value in karma points.

Questing

Participating in official plots and quests is the most dangerous in-character method of earning karma. They usually involve other rewards as well as karma, though, including special weapons, trophies and potions, so they're definitely worth the effort.

Divine Service

Some gods look for individuals willing to serve them. This service can be as simple as maintaining a shrine or encouraging more people to worship them, or it might include dangerous or diplomatic missions. Often, they include 'payment' in karma (see Occupations).

There are other methods, too, but it's up to you to find them. ;)

Spending Karma

For a list of what you can buy with your karma points, please visit the Prize Shop.