Gold-Backed Crypto Currency

davefairtex
By davefairtex on Thu, Mar 15, 2018 - 3:09am

I've been noodling over the concept of gold-backed crypto for a while, and here are my thoughts; negative first, and then positive.

While I like the concept (insofar as I like a version of USDT that uses gold instead of USD, and that doesn't have such a cloud hanging over it, and allows little people like me to actually take delivery), when you pick apart the physics of it all, you are left wondering how a 100% gold-backed crypto could possibly differ from an ETF.

The issues are both storage fees and blockchain-mining costs.  If a "coin" starts out by being backed by 1 gram of gold, over time, the backing has to drop, in order to pay storage fees and mining costs.  Miners don't work for free and neither do vaults.  Effectively, the currency must "rust" over time, in some way, to pay for the costs of accounting and storage.  And - ultimately - that's all blockchain is: accounting.  10 years later, you probably have 4-5% less gold backing your "gold-backed crypto" than you did when you started.

Of course, you can always lend your gold-backed crypto coins out at interest, but then you have the risk of not being paid back.  Likewise, you can deposit your coins at a place where other people lend them out - but there is that risk element again.

From the accounting perspective, you can implement your gold-backed crypto on the omnicoin platform - exactly like USDT - which piggybacks right on top of bitcoin.  That way you pay for your transfers using bitcoin.

Fundamentally, all these coins must be ETFs that just have the word "ETF" scratched out and the word "Crypto" hastily scribbled over the top.  Either that, or they aren't 100% gold-backed.  And why would you put money into gold that didn't result in you actually owning gold, considering how many other options out there (I'm looking at you, PSLV) that actually do have gold in a vault somewhere that you can take delivery of.

At the core, even a 100% gold-backed crypto currency must still be a warehouse receipt scheme, with the form of the warehouse receipt changing over to this digital key that is stored in a crypto wallet (with all the issues of losing said wallet) instead of some older-style mechanism, such as shares of an ETF, or physical gold vaulted with some storage site into which you must pay every year.  "All the fun of an ETF, with all the terror of 'losing your wallet' that bitcoin brings you."

And why you'd buy into some of these ICOs at a discount - with the assumption that your $1000 would turn into $1300 of gold "later on" when the ICO actually ran out and bought the gold with the ICO proceeds - in what world could this perpetual motion machine actually work?  It relies on a bigger fool to come along and pay $2000 for $1000 in gold because it's "crypto gold" - much better than actual gold, you see.

And if the crypto-gold holdings don't "rust" over time to pay for vaulting, then there must be hidden risk in there somewhere.

Ok, so that's the negative view, from the "cranky goldbug" viewpoint.  However, there are some positives.

One big new positive would be the relative ease of starting a crypto currency (versus the regulatory hurdles and single-exchange listing you get with an ETF), and the easy convertibility with the rest of the crypto world, which may bring with it the hope that your 100% gold-backed crypto (that financial physics tells you must "rust" every year) will eventually move into a big premium if/when big problems hit, because of its liquidity advantage and global reach - global reach absolutely must not be be underestimated, because somewhere in the world, there will be panic, or hype - as well as some hoped-for level of clueless behavior of the mass of crypto "investors" out there.

Can you see a 30-40% premium during a big "gold hype" and/or "gold shortage" situation?  I sure can.  The 2017 bitcoin top showed us that anything is possible.  As did the $50 silver top in 2011.

There are two more things: money laundering, and evading capital controls.  Both groups of people will gladly pay a premium to use crypto as a mechanism to move their money out of the country and/or launder their proceeds.  Imagine if you have stolen hundreds of bitcoins from some site, and you now have the prospect of turning that into a bunch of gold bars.  Gold-backed crypto should do a lot better than USDT, which is still in relatively widespread use even though there is some very sketchy auditing behind USDT that makes the COMEX look good by comparison.

[That's a risk too; if gold-backed-crypto is too attractive to this group, that's a vulnerability - giving an excuse to the legacy financial organizations - banks, exchanges, etc - to prod their tame regulators into trying to regulate it out of existence]

There are other possibilities that I could imagine: allowing miners to issue special smart contracts that offer gold-crypto at a discount (that promise to turn into actual gold-crypto 6, or 12, or 18 months from now) that requires the miners to fulfill the contracts by delivering actual gold to the vaults.  This allows the miners a way of publicly funding their mining operations.  These can be defaulted upon, so there is risk, and presumably they too can be traded, at a discount, just like bonds, but with limited liquidity.  This would dis-intermediate the banksters, which of course brings up that regulatory risk once again.

Here's one list of gold-backed crypto I ran into.  You can get the sense that some of them are real scam-coins, while others sound more reasonable.  The one from the Perth Mint sounds interesting.

http://www.goldscape.net/gold-blog/gold-backed-cryptocurrency/

13 Comments

charleshughsmith's picture
charleshughsmith
Status: Platinum Member (Offline)
Joined: Aug 15 2010
Posts: 705
thanks for exploring this topic

Dave, thanks for exploring this topic. The outline of negatives ("rust" a.k.a. storage costs/fees) applies equally well to any commodity-backed crypto (oil, bat guano, etc.)

From my perch, I see all fiat currencies being debauched/devalued as TINA--there is no alternative way to meet the promises made to generations when "growth" was organic and real (i.e. did not require borrowing $10 to add $1 of GDP). 

So if we're anticipating $10K/oz and up gold as fiats lose faith/purchasing power, then the crypto front-end is simply a convenient way to turn a "store of value" form of money into a "means of exchange" form of money, i.e. money that can be converted to other cryptos, fiat currencies or whatever goods and services can be purchased directly with cryptos.

So if the "rust" costs (say) 5% a year and you anticipate a 500% to 1000% rise in the purchasing power of gold, the "rust" is simply the cost of maintaining a store of value that's easily converted into means of exchange outside the fiat system--should that be desirable or valuable.

How is this different from BullionVault et al? Only in being convertible to other cryptos or goods and services directly, where with BullionVault et al., the gold must be converted to fiat.

Is this worth it? It may be too early to tell.

davefairtex's picture
davefairtex
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Posts: 5263
crypto gold

Ultimately, crypto is an accounting system with global reach - where the books are public, and anyone can execute a transaction for a fee.  The global reach thing is key, because it means that literally anyone, anywhere in the world can participate, 24/7.

This is the underlying utility in the coins.  But - honestly - nobody cares about that at the moment.  Everyone is just looking to get-rich-quick.  The current question is always, which coin do I pick so I can get a 10-bagger in the next 3 months?  Who would have thought there would be such a gold rush mentality around a public accounting system?  But, call it a "coin", add some manipulation, some great marketing, and presto, you get a gold rush.

USDT is a ... less than forthcoming implementation of what I see "real" coins looking like in the future.  Nobody is going to get rich owning something that looks like a USDT.  Likewise, people won't get rich buying gold-crypto.  It will be a safe haven and a medium of exchange.

But when a *coin represents ownership of a real-world object, there needs to be a linkage between the public accounting system/ledger and the real world object.  That's the missing piece - that's what USDT doesn't have.  Ideally, in the future, the bank where the USD is stored would make the account balance public and somehow attach it to the blockchain.  Changes in the bank balance would be instantly reflected on the blockchain, and vice versa.

Sprott could make a great coin backed by shares in their ETF.  They already have the real-world object linkage - now they need to just construct the public ledger for the fractional ownership and - who knows, it might even become popular, once the hype winds down and everyone stops trying to make 10-baggers off every new coin-type.  They just need that real-world linkage.

It could really drive gold into the Sprott vaults.

bronsuchecki's picture
bronsuchecki
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Posts: 71
crypto gold

Not sure I see the point of a decentralized ledger when you have a centralized vault of gold - I trust you to vault the metal but not to keep a database of owners?

The "its global, anyone can participate" benefit, which is only possible if the system does not enforce AML or any regulations on precious metal trading in each country. While that may be possible for a decentralized system, if a country doesn't like how it is being marketed and sold to it citizens, then it will just go after the centralized vault.

"you can always lend your gold-backed crypto coins out at interest, but then you have the risk of not being paid back" - I don't think individual holders need to lend out their coins, the better solution would be for the system operator to lend out just enough gold to cover operational expenses, and that can be done without taking on excessive risk. See https://quintric.com/ (disclosure: they are leasing some of their gold via Monetary Metals, who I work for https://monetary-metals.com/monetary-metals-partners-with-quintric/)

"allowing miners to issue special smart contracts that offer gold-crypto at a discount" - see https://metalicoin.com/

davefairtex's picture
davefairtex
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interoperation

Bron-

One key benefit of gold crypto is the interoperability with the other crypto coins out there.  The difference with this coin being, its actually backed by something real.  It is the equivalent of cash - but its gold-cash rather than USD cash.  A legitimate version of USDT.  From a marketing standpoint, its cashing in on the billions in demand that USDT has.

Certainly one implementation envisions a centralized vault, but there are plenty of players out there with vaults, and they could all agree to play - assuming they were able to charge a fee for storage, and open up their vaults to periodic inspection.  There are plenty of gold suppliers who have vaulting operations in several different jurisdictions, as you know.  Having multiple vaults wanting to participate doesn't seem beyond the pale.  What happens when a government 'goes after' a given vault?  That's a good question.

Hmm.

Maybe there's no way to have one "crypto-gold" token without tying it to an actual gold bar in some location.  I just talked myself out of the multiple vault scenario.

Lending is an interesting question.  Who pays for the inevitable failure?  Usually such a repayment issue happens when times are tough - just when you want your safe haven to be really safe.

In some sense, its either fully reserved or it isn't.  If it isn't fully reserved, then its basically an uninsured savings account, and you're just hoping for the best.  I guess that can be done on an individual token basis.  So how about this:

A crypto-gold token has both a location, as well as a yield, like a bond.  A fully reserved crypto-gold token has a location, but no yield - perhaps even a negative yield, while a partially-reserved crypto-gold token does have a yield, as well as a location.

And anyone with the private key can ask the vault to cough up the gold bar.

bronsuchecki's picture
bronsuchecki
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Posts: 71
Reservation & leasing risk

Not sure I agree that if it isn't fully reserved, it is the same as a savings account. Bank deposits are entirely "backed" by loans and are credit exposures to the bank.

The sort of leasing Monetary Metals engages in is legally a true lease, ie the lessors own the physical gold that is being used by the business and it isn't on the business' balance sheet. That is what I was thinking of for a crypto gold token. Not saying there is no risk, but that is significantly different to a bank deposit. Note we don't lease gold to people who are just going to sell it - there has to be a real productive use of the physical gold. In addition, with our leases paying circa 2-3% a crypto gold operator looking to cover costs might only need to lease out 10-15% leaving the token backed by 85-90% physical vaulted gold.

As to the repayment issue, if you then consider that only a fraction of conventional loans go bad, and with a true lease a liquidator can't touch leased property, the actual losses to a crypto gold operation would be fractions of a percent.

Finally, there is an argument that as we are leasing to business that use gold, their business would be booming when times are tough, so the risk profile may actually counter-cyclical and decrease in bad times.

A big impediment to mainstream use of gold and silver as money is that it incurs a holding cost, when they compare it to fiat. Eliminating this moves us closer to getting the precious metals to circulate, which is what systems like Quintric are aiming to do.

mrees999's picture
mrees999
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Posts: 386
Gold back crypto has been around for over two years already

One (if not the very first) DOA created on top of ethereum is Digix, it is backed by gold held in Singapor. Silly me didn't like the idea of a centralized authority keeping the store of gold which defetes the trustless nature of a blockchain. So I held out when it first hit the market at $10.00 each just two years ago.  Boy do I regret ignoring it now- has it is currently valued at $358.  Look into it further to see they are doing some very interesting things on this blockchain protocol.

 

https://coinmarketcap.com/currencies/digixdao/

 

Note, I don't own any...still regretting it.  Wondering if it's too late to take the plunge... As I've been telling myself each month since I originally passed on it.  I believe the intent is to make a stable coin with gold backing.

 

davefairtex's picture
davefairtex
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digix

Mark-

No.  Gold-backed crypto hasn't been around for years.

You should probably read what's actually going on at the site.

https://digix.global/

They have 2 coins.

coin 1) DGD (the lottery ticket; unclear what actual value it provides, other than simply a gambling opportunity - based probably on people just seeing the words "gold-backed token" and then buying without further thought)

coin 2) DGX (the coin backed by gold, 99%)

While they've had the coin-1 lottery ticket available for quite a while (yay team!  a $700 million valuation!) they haven't actually launched the underlying 99% gold-backed token yet.  It's freaking vaporware!!

Do people actually read the underlying detail?

Q1 2018 is here.  Let me know if they actually do something.  Or - my guess - they push off the release until Q3 due to "unforeseen circumstances" - after printing another 2M DGD tokens @ $350 each.

https://digix.groovehq.com/knowledge_base/topics/how-and-where-can-i-buy-dgx

How and where can I buy DGX?

Our primary product, DGX, the gold-backed token, has not been released to the public market yet. It is slated for release by end of Q1 2018, and we will update everyone on how/where it can be purchased once released.

 

davefairtex's picture
davefairtex
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leasing gold et al

Bron-

I'm not familiar enough with bankruptcy law to know where a "true lease" stands in line.  If fraud or theft is involved, and the gold is just gone (and let's assume insurance decides not to cover the loss), does the holder of a "true lease" stand in front of secured creditors?  Or does it only have title to the gold?  Which, if that gold is just gone...

I'd have to understand the historical cases where "true leases" went bad to assess what the risks are.  Great Depression type events are what I'm thinking about.  How did true leases fare during such times?

Certainly if you only have to lease out 10-15%, it would seem like a very reasonable alternative, if you trust the folks doing the leasing to vet the lessees properly.  Call it 85% reserved, with 15% leased to cover costs, so there is no decay.  Caveat emptor, but it sure sounds like a reasonable product.  Worst case loss is 15%.  Loss in a bank failure is vastly worse, assuming no FDIC.

Last point.  When times are tough, that's when the fraud & theft will come out of the woodwork.

I'd also bet that gold will tank hard during any deflationary event.  Gold isn't money like it was during the 30s, so it won't act the same.  It will act more like silver.  You should look at how silver did during 29-32...

bronsuchecki's picture
bronsuchecki
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Posts: 71
True Leases

Your point about fraud & theft is correct, and that would happen when times are tough. "True lease" is a legal term which distinguishes between a lease where the property is returned versus a financing type lease where ultimately the lessee ends up with the property.

As to the creditor situation, I should note that Monetary Metals leases are real leases and not how "leasing" is used in the bullion banking game, which is really a loan. The leasing agreement we use has the same wording as if a business leases a property or a vehicle - title remains with the lessor and lessee just has use. The gold is therefore treated the same in bankruptcy as would be a factory building that a business was leasing - a liquidator would not just sell the property, it is clear it isn't owned by the business. The upshot of that is that if the business or owner sold or took the gold, then that is theft, not just a "oh sorry, business is bankrupt, stand in the creditors line". The criminal nature of selling/taking leased property means it is unlikely to happen. Gold is a lot more mobile, that is true, but a business owner looking to take it would have to leave the country. We do require the business to have insurance covering theft and other losses.

For that reason we would consider a worst case to be a lot less than 15% for a system that looked to recover storage costs via a Monetary Metals lease.

davefairtex's picture
davefairtex
Status: Diamond Member (Online)
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Posts: 5263
thanks bron

That's some excellent commentary.  No surprise you guys have thought it through since its your business.  I can see how this could be a very reasonable way to hold gold and not have to pay storage, while keeping the risk to a minimum.  I like the insurance - assuming the insurance companies don't go tits up, of course - but you can only do so much, and I agree with your point about it being a criminal act does mean it would be less likely to happen.

However, as you say, the portability of gold makes it look more like jewelry or diamonds or other easily-stolen inventory rather than buildings.  Presumably there are historical loss numbers on that sort of thing.  Who steals a building?

And with crypto on the top as a medium of exchange, that would act to funnel large amounts of money into the coin...that would seem to hold promise.  It's not a ... gold rush ... or anything, but I imagine you guys getting access to some percentage of those $500 billion in crypto capital flows - replacing USDT with something that actually has real value behind it.  That would seem like a few billion dollars right there.  You could be the "cash coin" for the crypto space.

The problem of course will be about all the regulatory stuff.  The more you comply, the fewer people will be able to actually cash the coin in (due to AML, etc).  If I am a US citizen, and I receive an MM crypto-gold coin from someone in North Korea - unbeknownst to me - and you have to follow all the KYC/AML laws, would I be able to take delivery of my gold bar?

But - presumably - few people would actually cash the thing in.  And you could charge 1% for a cash-in fee.

So get to it already!  I want to hold my "cash" in MM gold crypto, not in these filthy US dollars sitting in some shifty exchange... :)

mrees999's picture
mrees999
Status: Gold Member (Offline)
Joined: Aug 16 2013
Posts: 386
Digx backing

I did a cursory review when it first came out and I passed. Were I actually to invest, i would study it further. Looks like you saved me the trouble. Thanks!

bronsuchecki's picture
bronsuchecki
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Joined: Apr 22 2012
Posts: 71
Crypto gold AML

We haven't got any plans for a crypto gold coin, https://quintric.com/ is the only option I'm aware of at this time. The issue as you identify is the AML but also once you have a platform where buy/sell or transfers occur, then it becomes a money transmission business and more intensive transaction monitoring is required. All that adds to the cost. But the incentive is to access the money that wants to be into something with the word "crypto" in front of it, as well as all the existing wealth (if that is the right word for it) that is in the main and alt coins looking for a more stable and solid alternative.

In the meantime there is nothing stopping people from doing their own personal gold standard - we are currently offering leases directly to investors, so people could deposit 15% (or whatever) of their current gold holdings (or convert fiat earning zero into additional gold) with Monetary Metals and then choose which leases they want to invest in based on their risk profile. This suits those that want to be in control.

bronsuchecki's picture
bronsuchecki
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Joined: Apr 22 2012
Posts: 71
81% of ICOs are scams

The gold miner crypto I follow just had an email out https://mailchi.mp/06b12be4a9cb/social-metl-update-25-march-2018?e=9f2f2... saying that the crypto-currency "market itself has gone a fair bit quieter. Valuations are down" as "regulators around the world are taking a very close look at ICOs". The result is they "will not be running our ICO out of Malta and that we will be going to market with a security token offering".

Having to comply with securities rules sort of defeats the main benefit of ICOs but it will reduce the scams, which if this is right https://medium.com/satis-group/ico-quality-development-trading-e4fef28df04f account for 81% of ICOs.

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