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Cryptocurrencies and Precious Metals: Complementary or Contenders?

Estimated reading: 5 mins

Cryptocurrencies and Precious Metals: Complements or Contenders?

Recently, there has been a massive surge in interest in the concept of asset-backed cryptocurrencies. The basic idea of asset-backed cryptos is undoubtedly appealing; a token or coin represented by the real-world value of a particular physical asset. For example, a gold-backed token could have one gram of gold equaling one token of a cryptocurrency. A trusted custodian stores the gram of gold represented by the token. It is also tradeable with other token holders.

In the perfect system, the price of the token will always be linked to the underlying asset. If the cryptocurrency increases in popularity, the value of the token can potentially grow higher than the value of the asset itself. If the cryptocurrency doesn’t become sought-after, the token value remains the same as the current value of the asset.


Are Gold-Backed, or Other Asset-backed, Cryptocurrencies Safe?

There are, naturally, risks associated with this idea as well. Whereas the blockchain accounts for the tokens, accounting for the physically stored asset is another matter entirely. When deciding to purchase asset-backed tokens, it is imperative to research who owns the asset (you or them), how securely it is stored, and if it is regularly audited by a reputable third party.


Storing Bullion Versus Cryptocurrencies

When buying bullion, it is crucial to weigh up the pros and cons of the different storage methods available. Three options exist: store it yourself, use a bank's safety deposit box or store in a third parties vault.

If you store bullion yourself, you have the advantage of immediate access and increased anonymity. However, you also need to store your bullion securely to guard against theft, and it is improbable you will be able to insure more than a small portion, which is very risky.

If you use a safety deposit box or a third-party vault, your bullion is stored in a high-security facility and you can arrange insurance. You won't have immediate access to it but, in the instance of vault storage through a bullion dealer, it will be easier to trade.

In the case of most asset-backed cryptos, the asset is stored in a secure vault system. The nature of a decentralised distributed ledger system addresses the issue of anonymity. You store your tokens in a wallet, as per other cryptocurrencies.


Cryptocurrencies and Gold

The price of Bitcoin, the most well-known cryptocurrency, reached parity with gold in 2017 (1BTC equalling one ounce of gold) which piqued the interest of gold investors globally. This event even prompted the release of a physical Bitcoin made by Denarium from pure gold, and able to act as a paper wallet.

There are several similarities between gold and cryptocurrencies. Both finite limits and relative scarcity make each deflationary. Neither gold nor cryptocurrencies (minus a few exceptions) are government-issued units of exchange. A consumers desire to trace gold from mining to processing to an end-user product is the same as tracing transactions on a blockchain. Variables such as supply and demand, market volatility, media impact and geopolitical events have similar impacts on both gold and cryptocurrencies.


The Stock Market's Effect on Gold

History shows that during a stock market crash, more often than not the price of gold rises due to it being sought out as a safe-haven, or hedge against crises. For example, during six out of eight of the S&P 500s most significant crashes in the past four decades, the price of gold rose regardless of whether the market lull lasted a couple of months or for a couple of years. During the global financial crises of 2007/2008 the price of gold initially fell but, by the end of the 18-month crash, it's price was up over 25%.


How do Modern Banks Work?

To end the financial crises banks across the US, and ultimately the world, lowered interest rates to encourage spending as opposed to saving. When this didn't work, they turned to quantitative easing. Quantitative easing is where central banks buy assets, such as government bonds, using the money it has "printed" or, more accurately, electronically created. This money is then used to purchase bonds from financial institutions, further encouraging borrowing and spending to boost the economy. One of the problems with quantitative easing is that it can lead to inflation.

The modern banking system typically relies on fractional-reserve banking. A system whereby banks only hold reserves that are equal to a fraction of their liabilities. On the flip side, full-reserve banking (aka 100% reserve banking) requires the bank to keep the full amount of reserves on hand. Investment in a physical asset-backed cryptocurrency would be an example of full-reserve type "banking."


Case Studies:

  1. E-Gold

    The first digital currency backed entirely by gold and silver was E-Gold. At its peak, there were millions of users around the world and E-Gold was backed by 3.8 metric tons of gold. E-Gold was a private, international currency that circulated independently of government controls. It was second only to PayPal in the online payment industry. Unfortunately, E-Gold became the preferred method of money transfer for cyber-criminals. This eventually led to the FBI and Secret Service shutting the company down in 2007.


  2. National Gold-Based Cryptos

    Several countries are looking to issue national gold-backed/asset-backed cryptocurrencies; two examples are Krygystan and Venezuela. The Prime Minister of Kyrgyzstan announced development plans for a gold-backed sovereign cryptocurrency, Golden Rock, on June 14, 2017. Venezuela launched oil-backed crypto, Petro (PTR), on Feb 20, 2018, to aid their failing economy; one Petro backed by one barrel of oil. Nicolás Maduro, President of Venezuela, stated that Petro would improve "issues of monetary sovereignty, to make financial transactions and overcome the financial blockade”. Following the release of Petro, Venezuela proposed Petro Oro as the country's second cryptocurrency, this time backed by gold. Rumours speculate the development of further cryptocurrencies backed by the countries gas and diamond reserves.


  3. Bullion Star

    Bullion Star, Singapore's leading bullion dealer, started accepting payment in Bitcoin for gold and silver in May 2014. AMPEX, an American bullion dealer, also accept Bitcoin.


  4. Royal Mint Gold

    The UK's Royal Mint has launched gold-backed cryptocurrency, Royal Mint Gold (RMG). The token digitally represents the actual gold stored in their vault. One RMG is equal to one gram of gold.


  5. Perth Mint

    Perth Mint, owned by the Australian government, is looking to introduce a token backed by precious metals. They see it as another platform for trading gold. It will be a means by which to make it easy for everyone to invest in gold. The Perth Mint plans to release the gold-backed token in 2019.


Are Cryptocurrencies a Threat to Gold, or an Asset?

Despite comments from a few well-regarded financial commentators over the last year that the price of gold is suffering due to increased interest in cryptocurrencies, there isn’t any quantifiable evidence to support this statement. The gold price in 2017 was consistent with the past few years and as such, is showing no signs of suffering from "competition" with cryptocurrencies.

Blockchain technology is innovative and could have wide-ranging applications across various financial sectors. Several companies are exploring how blockchain technology can transform gold and other precious metals into a ‘digital asset,’ tracking the metals origin across the supply chain and making the post-trade settlement processes more efficient. Other benefits the blockchain can provide include high-speed transactions and ease of trade. Also, a virtually incorruptible ledger system (meaning increased security and privacy), and increased accessibility of gold to consumers.


Disclaimer: The above references an opinion and is for informational purposes only. It is not intended as personalised financial or investment advice. The opinions expressed by the author do not represent the opinion of BitPrime.

Last updated: 01/08/2018


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