RV Blog Are There Gold-Backed Cryptocurrencies?

Are There Gold-Backed Cryptocurrencies?

Gold-Backed Crypto

There was a time when national currencies were backed by gold. Today, this is an almost forgotten fact. More than 50 years ago, the U.S. dollar was pegged to ounces of gold. President Nixon closed the gold window in August 1971 by unpegging the U.S. dollar from its previous gold anchor.

Back in the days when government-issued money was still pegged to gold, the state currencies were actually backed by a real commodity. Although fiat money without any backing in the form of gold is widely and frequently used today, the case for a currency-backing in the form of a real value like precious metal is still intuitively understood.

As a matter of fact, when cryptocurrencies like Bitcoin came along, it was only natural for some people to propose and advocate for cryptos backed by gold. According to their view, as an entirely new phenomenon, cryptocurrencies would need to initially earn the trust of the general public. And only if one backs a cryptocurrency with gold, which has proven itself as money over centuries, will it earn the necessary trust to function as a proper currency, so their argument goes.

Prominent Gold-Backed Cryptocurrencies

Consequently, several people went on to launch a gold-backed cryptocurrency. Over the last few years, a multitude of gold cryptocurrencies has come and gone. According to Goldscape, there are currently well over 150 gold-pegged cryptocurrencies. Among these, the most prominent gold-pegged cryptos are PAX Gold (PAXG) and Tether Gold (XAUT). Combined, these two gold-backed cryptocurrencies surpassed $1 billion in market capitalization during Q1 of 2022. This marks an increase of about 60% from the same period last year, which goes to show that the popularity of gold-backed cryptocurrencies has been growing.

Other high-volume gold cryptos are Perth Mint Gold Token (PMGT), CACHE Gold Token (CGT), and Goldcoin (GLC). One of the first gold cryptocurrencies that got wider attention in the crypto sphere is Digix Global (DGX). The project is Ethereum-based and has originally done an Initial Coin Offering (ICO) out of Singapore, collecting funds to build their gold-backed crypto. However, as of January 2022, the gold-pegged cryptocurrency has suspended operations because it is currently reviewing license requirements under the Singapore Payment Services Act.

Understand the Future of Everything

Join the Crypto Revolution
Start Your Free Membership Now

100% Free. Yep, You Heard Us

What Is a Cryptocurrency Backed by Gold?

As mentioned, gold-backed cryptocurrencies are cryptocurrencies with an underlying physical asset, in this case, gold. As such, a gold cryptocurrency is tied to the precious yellow metal and functions as a derivative, tracking the price of gold. This means that a gold-backed cryptocurrency should always move with the price of gold.

The reason for this is the fact that each gold-backed cryptocurrency unit is promised to be backed by a predefined number of grams or troy ounces of gold. How much actual gold is backing each cryptocurrency unit or token can be defined arbitrarily. Thus, theoretically a cryptocurrency backed by gold should never deviate from the price of gold.

Gold-backed cryptocurrencies can also be referred to as gold-backed stablecoins. As such, they are similar to gold ETFs. The most prominent gold ETF, SPDR Gold Shares (GLD), is an exchange-traded fund that holds physical gold and divides its ownership thereof into shares that can be bought by investors.

How Do Gold-Backed Cryptocurrencies Work?

Just like a gold ETF has an issuer and relies on a trusted custodian to store the physical gold, a gold cryptocurrency is also operated by a centralized issuer. Whether it be physical gold in the form of coins or bullions, gold certificates, or gold-related securities, these assets need to be held with a custodian in “meatspace.” This fact makes gold-backed cryptocurrencies into centralized “off-chain-backed cryptocurrencies” as they are bound to a counterparty.

While some gold-pegged cryptocurrencies are merely pegged to gold, other gold-backed coins or tokens allow for redemption back into gold. If the latter is the case, the holder of gold-backed cryptos can redeem their gold cryptocurrency for a definite amount of the underlying gold by presenting the gold tokens to its issuer. Once a gold-backed cryptocurrency is redeemed for its underlying gold, the cryptocurrency backed by gold is burned and removed from circulation.

Technically speaking, the gold-backed cryptocurrency exists as a token on a public blockchain. Most contemporary gold cryptocurrencies have been issued on Ethereum through the blockchain’s ERC-20 token standard. Besides Ethereum, there are also some gold-backed crypto tokens on other blockchains, such as Algorand.

Typical Cryptocurrency Versus Gold-Backed Cryptocurrency

Bitcoin, the most prominent cryptocurrency, is not backed by any physical commodity. This fact has not resonated well with all investors. One of the most popular arguments against Bitcoin is that its value is intangible and not backed by anything of real, physical value. Gold-backed cryptocurrencies on the other hand are associated with a tangible value because of their connection to physical gold.

Because of their physical underlying in gold, some investors feel more comfortable investing in a cryptocurrency backed by gold. After all, gold has a longer history than cryptocurrencies, which is why some investors believe that a gold-backed cryptocurrency’s price fluctuations can more easily be understood than that of a cryptocurrency without gold backing.

While this might be true, it’s also important to point out: A cryptocurrency backed by gold is ultimately tracking the price of gold. As long as gold’s price does not go through the roof, a gold-backed cryptocurrency won’t either. So, investing in gold cryptocurrency with the expectation to reap returns that are peculiar to cryptocurrency, is not a very promising approach.

What’s the Point of Gold-Backed Crypto?

As previously mentioned, gold-backed cryptocurrencies are in fact tokenized ETFs. But how is a centralized gold-backed crypto token any more desirable than a gold ETF? If at all, the gold cryptocurrency seems inferior as crypto investors have to worry about the protection of their private keys and be familiar with the handling of blockchain-based assets.

Considering this argument, two broad points can be put forward. For one, gold-backed cryptocurrencies can potentially be purchased by investors, who generally do not have access to traditional financial instruments like ETFs. The so-called “unbanked” come to mind. Because gold-pegged cryptocurrencies are issued on open, public, and permissionless blockchains, everyone with a cryptocurrency wallet and some funds in it can potentially invest in them. Although hardly any cryptocurrency exchange is currently licensed to trade tokenized ETFs, there have emerged many decentralized exchanges (DEXs) like Uniswap that offer the trading of such gold-backed crypto tokens.

The second reason is that gold-backed cryptocurrencies help gold to be more prominently used as a means of payment. Because of their digital nature, cryptocurrencies can be easily traded on a global scale. Physical gold on the other hand has high transaction costs due to its physicality. Gold-backed cryptocurrencies can be conveniently traded over blockchain networks all around the world.

Gold-backed cryptocurrencies represent an interesting mixture between gold — an ancient store hold of value — and cryptocurrency that potentially represent new-age money. While many investors like cryptocurrencies backed by gold for their more tangible characters, it remains to be seen whether they will be able to catch on. After all, gold cryptocurrencies have counterparty risk and are more centralized than true cryptocurrencies.