From bullion to blockchain: an introduction to gold-based cryptocurrencies and tokens. With examples. Once upon a time, gold was a primary backing for several major world currencies. It was considered a safe-haven asset and an intuitive symbol of unchanging value, which instilled a sense of trust among investors and led to certain currencies dominating the global markets.
From bullion to blockchain: an introduction to gold-based cryptocurrencies and tokens. With examples
Once upon a time, gold was a primary backing for several major world currencies. It was considered a safe-haven asset and an intuitive symbol of unchanging value, which instilled a sense of trust among investors and led to certain currencies dominating the global markets. With such a long history of backing traditional currencies, it’s no surprise that the idea of gold-backed digital currencies was floated fairly early in the life of the internet. In fact, the first experiment in online gold, G&SR’s ill-fated ‘e-Gold’, was launched in 1996, pre-dating the first cryptocurrency by 13 years.
Since then, cryptocurrencies have become a popular investment option for many investors, with Bitcoin leading the charge in 2009. However, while most cryptocurrencies are not backed by any tangible or real-world asset, some have emerged that are backed by fiat money or precious metals such as gold. These gold-pegged cryptocurrencies and tokens are designed to offer investors a way to invest in gold without physically owning the asset. But what are gold-pegged cryptocurrencies and tokens? How do they work? And what are the benefits and risks associated with them?
What are gold-pegged cryptocurrencies and tokens?
Put simply, gold-pegged cryptocurrencies and tokens are digital currencies that are pegged to the price of gold. They are a so-called ‘derivative’ asset class, because they derive their value from a ‘tangible’ asset – in this case, physical gold. This allows individuals to invest in gold without physically owning it. These cryptocurrencies and tokens are usually issued by a third party, usually a bank or third-party custodian, who holds the equivalent amount of real gold in reserve to back the value of the cryptocurrency. Different assets are also pegged in different ratios to the gold. For example, some are backed 1:1 with 1 token equalling 1 troy ounce of gold, while others may be backed by a fraction of an ounce.
Gold-pegged cryptocurrencies and tokens are created using blockchain technology, which allows for transparent and secure transactions. Recent data from Goldscape states there are currently over 150 gold-pegged cryptocurrencies in circulation, with two of the most prominent, PAX Gold (PAXG) and Tether Gold (XAUt), together surpassing a market capitalization of $1 billion in Q1 of 2022 – a significant increase of around 60% on the same period the previous year.
It’s clear the demand for gold-backed cryptocurrencies is on the rise.
How do gold-pegged cryptocurrencies and tokens work?
The process of creating gold-pegged cryptocurrencies and tokens involves two steps. The first is the creation of the cryptocurrency or token, which is usually done using blockchain technology. The second step involves backing the cryptocurrency or token with physical gold held in reserve.
To create a gold-pegged cryptocurrency or token, a third-party issuer will first create a digital asset that represents a unit of the cryptocurrency or token. This digital asset is then made available for purchase on a cryptocurrency exchange or through a third-party issuer. Buyers receive a unique serial number, stored on the blockchain.
Once a unit of the cryptocurrency or token is purchased, the third-party issuer will hold an amount of physical gold equal to the value of the cryptocurrency or token purchased in reserve. In some cases, a token or tokens may be traded directly for the physical gold.
As a derivative, the value of the cryptocurrency or token is tied to the price of gold on the open market. So it’s important to note that if the price of gold fluctuates, the value of the cryptocurrency or token will also fluctuate, influenced by various factors such as market demand, investor mood, and regulatory changes.
Benefits of gold-pegged cryptocurrencies and tokens
There are several benefits to investing in gold-pegged cryptocurrencies and tokens. One of the main benefits is that they offer investors a way to invest in gold without physically owning the asset. This means that investors can benefit from the price of gold without having to store and protect physical gold. The majority of gold-backed tokens are built using the ERC-20 token standard, making them highly transferable and easily tradeable on both centralized and decentralized exchanges, depending on the token.
The liquidity of gold-pegged crypto confers a number of benefits. It can be split and fractionalized easily, which creates a lower bar to entry and allows more people to invest. And transaction costs are also reduced as the gold no longer needs to be traded physically.
Meanwhile, gold-backed cryptocurrencies and tokens offer access for unbanked individuals who cannot access tradition financial instruments like ETFs, as they can often be bought via decentralized exchanges with no need for KYC (Know Your Customer) checks. This makes them a promising investment instrument for emerging markets in the developing world.
Another benefit of gold-pegged cryptocurrencies and tokens is the actual and reputational value that comes from them being backed by physical gold. When it comes to tangible assets, gold is one of the most stable. Long seen as a ‘risk-off’ asset, gold typically has a lower correlation with the broader financial markets and tend to hold its value or appreciate in value when other asset classes, such as stocks or high-yield bonds, experience a decline. All this means gold is perceived as a more reliable hedge against periods of turmoil, such as market volatility, financial collapse, or war. Gold-pegged crypto derives both market stability and reputational value from the time-tested reliability of gold, making it easier to market.
Gold-pegged cryptocurrencies and tokens are also transparent and secure thanks to the decentralized nature of blockchain, as this technology operates without a central authority controlling the network. Each block of data on the blockchain is linked together through a cryptographic hash function, which makes it tamper-resistant. Additionally, the use of consensus algorithms, such as proof of work (PoW) or proof of stake (PoS), ensures that no single entity can control the network, making it highly secure. Blockchain apps offer a host of other benefits alongside security, from data sharing and storage to streamlining complex processes, reducing costs, and improving trust and accountability.
Risks and drawbacks of gold-pegged cryptocurrencies and tokens
While there are benefits to investing in gold-pegged cryptocurrencies and tokens, there are also drawbacks. One of the main risks is that the value of the cryptocurrency or token is tied to the price of gold. If the price of gold decreases, the value of the cryptocurrency or token will also decrease. While gold has historically been relatively immune to wild drops in value, it also doesn’t tend to rise much either. This means highly risk-tolerant investors looking for spectacular returns will not be well-served by investments in gold-pegged cryptocurrencies and tokens. Gold also tends to perform best in challenging financial environments, which may or may not be a disadvantage depending on your view of national and global political and economic trends.
Gold-pegged cryptocurrencies and tokens are subject to the same risks as other cryptocurrencies. These include high volatility and market fluctuations, hacking and cybersecurity threats, and potential scams and fraudulent activities. The absence of centralized regulatory control or oversight can lead to a lack of transparency and accountability in the crypto market, making it more difficult for investors to make informed decisions. More seriously, it means that there is no protection for investors if something goes wrong.
As with all derivatives, investors in this form of crypto don’t own the asset directly, and are reliant on centralized service providers to manage the storage of the physical gold that backs the tokens. This means the security of the gold itself is completely out of the investors’ hands. Accounting for the actual gold may not be as transparent and clear-cut as accounting for digital currencies, which blockchain technology inherently protects. As such, ascertaining whether or not the physical gold exists and if its storage is secure can be a matter of trust for some investors. Audit frauds and gold heists are not common, but they’re not impossible either. To mitigate the risk, investors should research the issuer and the amount of gold held in reserve extremely carefully before purchasing gold-pegged cryptocurrencies or tokens.
Finally, for some investors, the nature of a ‘pegged’ cryptocurrency undermines the very purpose and ideals of blockchain technology, as it reintroduces a centralized point of control and creates a single point of failure. Decentralisation is held as an article of faith by many crypto investors, who are unlikely to opt for any instrument that does not uphold this central ideological tenant of cryptocurrency.
Examples of gold-pegged cryptocurrencies and tokens
There are many gold-pegged cryptocurrencies and tokens in the market. To better understand their similarities and differences, let’s take a look at six of the most prominent…
Tether Gold (XAUT)
Tether Gold, founded in 2014, is a digital asset offered by TG Commodities Ltd. It’s backed 1:1 by physical gold held in reserve in a Swiss vault, which means each token of Tether Gold represents undivided ownership of one troy ounce of gold. These bars can be identified through a unique serial number, purity, and weight, and token holders can verify their ownership and the amount of gold they possess per bar through the website. Tether Gold is available for purchase on several cryptocurrency exchanges. The tokens are issued by TG Commodities Limited, a new entity created by the Tether team. To purchase these tokens, users need to open an account at app.tether.to, verify it, and the buy the tokens using US dollars. XAUT tokens are ERC-20 tokens held on an Ethereum-based wallet and TRC20 tokens on the TRON blockchain, and they can be transferred from one on-chain Tether wallet to another. To make a redemption request in the form of physical gold, users need to have completed the TG Commodities Limited’s verification process. Then users can exchange their tokens for physical gold, which will be delivered to any location in Switzerland. They can also request to sell their gold and receive cash minus fees.
Minimum purchase: 50 XAUT
Website: Tether Gold
Paxos Gold (PAXG)
Paxos Gold was launched by Paxos, the company behind Singapore cryptocurrency exchange itBit, in September 2019. Operating under a charter issued by the New York State Department of Financial Services, the company aims to allow people to own, transfer, store, and bet on gold without the limitations of owning the physical product, and also allows investors to trade it as futures on exchanges like Kraken, Binance, etc. Together with Tether, Paxos is considered one of the most reliable gold-pegged cryptocurrencies on the market.
The protocol was created entirely on the Ethereum blockchain and is secured by the proof of work (PoW) model. However, PAXG is not exclusively tied to Ethereum and can be launched on other blockchains as well. Backed 1:1 by gold stored at Brinks Bank in London, PAXG is tradable on Kraken, itBit exchange, Alpha Bullion, Binance, and other exchanges. No custody fee is charged for tokens and instant settlement is available.
Minimum purchase: $20/0.01 PAXG. For Major Gold ETF futures, 1 share. For LBMA 400 t oz gold bar, $800.
Website: Paxos Gold
Conclusions on the future of gold-pegged cryptocurrency
Gold-pegged cryptocurrencies and tokens are a relatively new investment option, but they are gaining popularity among investors worldwide at a rapid pace. These digital assets boast a simple concept, to provide a way for investors to invest in gold without having to physically own the asset. And they achieve this through a simple mechanism, by pegging the value of the cryptocurrency or token to the value of gold, which is backed by physical gold held in reserve.
Investing in gold-pegged cryptocurrencies and tokens can be an attractive option for many investors, particularly those who are looking for a more stable investment option than traditional cryptocurrencies, which can be subject to significant volatility. Equally, gold-pegged cryptocurrencies and tokens can provide investors with a hedge against the inherent volatility of crypto, as well as a protection against the potential risks associated with fiat money or regulated stable coins.
However, it is important to note that like all investments, gold-pegged cryptocurrencies and tokens have their risks and drawbacks. For example, market volatility can impact the value of these digital assets, and investors need to be aware of the potential for fraud.
As such, it is crucial for investors to conduct their own research on the issuer and the amount of gold held in reserve before investing in a gold-pegged cryptocurrency or token.
Despite the risks involved, gold-pegged cryptocurrencies and tokens hold incredible potential. By bringing together the ancient value of gold and the futuristic potential of crypto, these digital assets offer investors a unique opportunity to diversify their portfolios and potentially achieve significant returns. As the world becomes increasingly digital, it is likely that gold-pegged cryptocurrencies and tokens will continue to gain popularity and become an essential component of any well-diversified investment portfolio.
