Gold-backed crypto is a derivative-based digital asset and type of stablecoin whose value is matched to and supposedly backed by a certain value in gold measured in grams or troy ounces.
- We are to this day undoubtedly experiencing a gold rush in the world of crypto, no pun intended! It's still very wild, huge fluctuations are the norm and well almost anything goes at this point in time. This is quite a contrast to the traditional financial world where there is of course fluctuation but it's generally nowhere near as volatile. This volatility and extreme unpredictability gave rise to stable coins which are as you would guess, stable coins. Typically stable coins are linked to and/or backed by fiat currencies or indeed valuable commodities such as gold or silver.
So why gold?
Gold as a value of exchange and valuable commodity goes back way more than the fiat currencies that we use every day. Gold really has stood the test of time in terms of value and universal acceptance. Our fiat currencies such as the USD or the GBP were even historically backed by physical gold until not that long ago. Actual gold bullion sitting in vaults matching every pound or dollar.
As a very crude measure, it has been said that historically 1 ounce of gold would purchase 10 loaves of bread and throughout time this has been more or less the case to this day. We can trust gold as a reliable holder of value and also as a commodity that sees respectable long-term growth and stability. With some of these things in mind, it made sense to create gold-backed crypto tokens to hedge against the extreme volatility of crypto coins such as Bitcoin for example.
How do gold-backed crypto coins work?
A crypto backed by gold should generally be supported by actual gold sitting in a physical vault somewhere. So, one gold-backed crypto coin could be equivalent to say 1 gram or troy ounce of gold. As mentioned above, a gold-backed crypto coin will typically be pegged to the price of say 1 gram or troy ounce of gold. As the price of gold rises or falls the gold-backed crypto coin will fluctuate with it. As gold is generally pretty stable the volatility is not extreme. Typically the issuer of the gold-backed crypto coin will be holding actual reserves of gold to back up the coin just as was the case with our paper money in the past. On some of these coin issuers' websites, you can even get a live view of the safe vault and the physical gold at any time.
The benefits of gold-backed cryptocurrencies
If we think in terms of investing in companies, the gold-backed crypto could be the equivalent of buying shares in a very well-established and stable blue-chip organisation such as a bank or maybe a corporation like IBM, Apple, or Microsoft. They will have decent levels of liquidity, will be considered well established, not be very risky, and will tend to go up in value over time. Now compare this to investing in a hot new startup company with no track record and little to no liquidity. The risk parameters are totally different. Investors come in all shapes and sizes and invest in all sorts of things, some have high appetites for risk and may well back that startup, others are more conservative and would prefer to put their money into Apple or Microsoft stock or perhaps an index fund like the S&P 500 that tracks the performance of 500 large listed companies in the USA. In much the same way in crypto land, those with higher appetites for risk can put their money into higher-risk coins and tokens and those that may want to play it a bit safer and perhaps enjoy the best of the worlds can instead put their money into something like gold-backed crypto. There is also of course a middle ground where a shrewd investor can put money into both and thus have the possibility to enjoy huge gains but at the same time hedge some of the risk. Stablecoins such as gold-backed crypto can also be used for business transactions where a certain level of price stability is required. For example in imports and exports, the common currency being used in the trade simply cannot fluctuate outside an acceptable range otherwise one of the parties will no doubt suffer.
The excitement and inherent volatility of the crypto market have undoubtedly made many people extremely rich but by the same token, many have no doubt had their livelihoods destroyed or at least dented. During this same time, gold has grown by around 25%, a very respectable level of growth and hence a relatively safe investment commodity for the masses. Gold has historically also beaten inflation by a fair margin so all in all, there is a pretty good case for a crypto that is backed by gold.
The downsides of crypto-backed by gold
What about the downsides? Gold-backed cryptocurrencies have historically struggled with certain issues such as:
- Not really decentralised - gold-backed cryptocurrencies tend to be dependent on central parties for collateral safekeeping and auditing which kind of defeats their purpose as cryptocurrencies, with decentralisation generally being one of the core properties of cryptocurrencies
- Irrefutable proof of actual gold reserves - it's not easy to ascertain the proof of gold reserves as claimed by the coin provider. With crypto still being largely unregulated, there is no government body ready to step in if things go south. Investors are very much on their own with little to no recourse if the gold-backed crypto collapses for example.
- Lower levels of liquidity - gold-backed cryptocurrencies tend to have lower levels of liquidity compared to other coins mainly due to not being traded across as many exchanges
A few examples of crypto-backed by gold
Below are a few examples of gold-backed cryptocurrencies:
- Goldcoin (GLC)
- Paxos Gold (PAXG)
- Perth Mint Gold Token (PMGT)
- Digix Global (DGX)
- Tether Gold (XAUT)
- Meld Gold by Algorand
Why buy a gold-backed cryptocurrency when you could simply buy and hold physical gold?
It's true, very little can beat the security of holding physical gold. It doesn't rely on technology, holds its value very well, and is pretty liquid. Even in urgent situations, there will always be people out there who will buy your gold and turn it into hard cash. What are then the benefits then of holding gold-backed crypto?
Below are some of the benefits of holding crypto backed by gold
- A global market that can facilitate almost instant transactions - selling and transferring gold would be an expensive and time-consuming process. As gold is valuable, insurance would no doubt be wise and would add extra costs on top of physical shipments. By contrast, gold-backed crypto coins can be transferred worldwide via blockchains relatively inexpensively, fast, and securely.
- Highly fractional - it's way easier to purchase and transfer small amounts of gold using gold-backed crypto tokens.
- A secure audit trail - transactions conducted on blockchains can be easily audited and traced. There is no risk of gold going missing in the post!
- Backed by smart contracts - one of the inherent beauties of smart contracts is their absoluteness, there is no space for misunderstandings, mistakes, or prejudice. A transaction does or does not take place based on very specific rules and once it's done it's done.
- No need for banks - there is no need for banks or other intermediaries to carry out transactions due to the decentralisation of crypto and this should result in lower costs.
In summary, gold-backed crypto is very useful as a stable cryptocurrency, either to hedge against the volatility in the crypto market or trade-in gold using the security and speed of blockchain technology or for use as a stablecoin for transactional purposes where volatility can be a problem. Investors looking for alternative, stable long-term crypto investments can certainly consider digital assets such as gold-backed crypto as safe long-term bets