A Research Primer on Gold-Backed Crypto Tokens
The investment case for gold, an analysis of gold-backed tokens compared to other ways of owning gold, and gold vs bitcoin.
The PDF version of this primer lives in Google Docs here.
With the current COVID-19 crisis, and unprecedented monetary and stimulus response, many investors have turned their attention towards hard assets such as bitcoin and gold. Over the last twelve months since April 2019 the price of gold is up approximately 35%. Given the current financial uncertainty many analysts are forecasting that gold will set a new all-time high.
Alongside growing demand for gold, interest in gold-backed digital tokens, which can be transacted and stored on cryptocurrency exchanges and wallets, has also grown of late. Since September 2019 a number of new gold-backed tokens have been issued from established crypto companies, such as Tether, Paxos and Blockchain.com, and the total value of gold-backed tokens has grown by over 16x in the past year to more than $160m in value.
The purpose of this research report is to provide a brief overview of the general investment case for gold, both as a standalone investment and alongside cryptoassets prized for their algorithmically governed scarcity, such as bitcoin (BTC). The report also provides an overview and comparison of the leading gold-backed digital tokens.
- Gold-backed tokens offer numerous advantages over traditional gold: 24/7 transaction availability, improved transferability, ease of usability (via internet), and low cost of ownership
- Size of gold-backed token market up more than 16x in last year: three new gold-backed tokens have led the combined sector value from less than $10m to >$160m; there are now at least eight gold-back tokens in circulation
- Three gold-backed tokens currently dominate: Tether Gold (XAUT) $87m market value, PAX Gold (PAYG) $44m market value, and DGLD¹ (DGLD) $25m market value together currently make up 94% of gold token total category market value
- Significant differences exist across gold-backed tokens such as measurement/peg to gold, cost of ownership and use, blockchain platform choice, storage location of gold backing the token, and options for converting the token into physical gold
- Overall, gold-backed tokens complement both traditional ways of owning gold and pure cryptoassets like bitcoin: gold-back tokens do not wholly replace reasons to own physical gold, and if an investor owns pure digital assets such as bitcoin (BTC) as a hard asset they should also in our view carefully consider gold
The ancient and eternal allure of gold
Gold has one of the longest, if not the longest, track records of use as a store of value and medium of exchange. The archaeological record is not entirely clear on when humans first discovered and began using gold as jewelry and for other purposes, but one of if not the first use of gold as a monetary instrument is known to have emerged in the Kingdom of Lydia (located in Turkey) around the sixth century BC.²
Much has been written through the centuries about the use of gold as a store of value, monetary asset, and general object of desire. Rather than recount this rich and interesting history, this report will focus on the modern investment case for owning gold in different forms, as well as how gold compares to pure cryptoassets like bitcoin.³
Beyond its wide global use in jewelry and other activities (e.g. dental work, electronics, as an industrial metal), much of the investment case today for gold revolves around its historical role as a hard asset and store of value. These properties are illustrated by how gold’s price often rises in times of economic, financial and political turbulence. For example, during recessions gold has tended to appreciate in value (Figure 1). During major wars gold’s price appreciation has often been even more dramatic. Gold is often referred to as the ultimate “safe haven” asset.
Figure 1: Hard assets like gold have often performed well during economic downturns and periods of financial instability.
Central banks and gold
In addition to its traditional role as a hard asset and safe haven, today gold is widely held in significant quantities as a reserve asset by many of the world’s governments, central banks and multilateral institutions (Table 1).
Of the estimated 190,000 tonnes of gold ever mined, approximately 35,000 tonnes (18%) is held today by public sector institutions.⁴ For some countries, such as the United States, this is simply a legacy of the gold standard and Bretton Woods era, where currencies were linked and convertible into gold, a practice which ended for the US dollar in 1971. Since US President Richard Nixon took the US off the gold standard in 1971 the US dollar has declined in value against gold by 98% (gold has appreciated from $38/oz to approximately $1,700 as of April 2020).
Since US President Richard Nixon took the US off the gold standard in 1971 the US dollar has declined in value against gold by 98%
Table 1: Reported Gold Holdings — Top 20 Countries and Institutions (April 2020)
However, in recent years, many governments and central banks have been increasing their gold holdings, including some of the largest and fastest growing countries like China, Russia, India, and Turkey.⁵ Countries do not always publicly disclose the reasons for why they add, dispose or move gold.⁶ However, some of the demand for gold from countries such as Russia appears to be driven by a desire to diversify reserves away from the US dollars and Treasuries, the world’s dominant reserve assets.
Gold’s wide ownership by central banks is one of its most important distinctions compared to bitcoin
The decline in dominance of the US dollar has been a subject of immense discussion and debate for some time amongst gold owners, macroeconomists, and others.⁷ While the likelihood and timing of such an event is beyond the scope of this research report, should such an event occur gold is viewed as one of the potential beneficiaries of a new monetary regime.
For an investor comparing bitcoin and gold, the wide and growing ownership of gold by central banks and governments marks a potentially crucial distinction. While gold gains added legitimacy from central bank ownership, it also arguably makes it much more likely that gold would be prioritized over bitcoin in any future new monetary system (e.g. Bretton Woods II) that required anchoring to a hard asset. Indeed, in 2010, during the early aftermath of the Great Financial Crisis, some policymakers such as World Bank President Robert Zoelick proposed a return to a gold-anchored monetary system.
History and market overview of gold-backed digital tokens
The effort to create an exchangeable electronic representation of physical gold dates back to at least 1995 to the infamous E-Gold network, which was shutdown by authorities over money laundering violations. While not intended to be backed by actual gold, the name of a proto-bitcoin cryptocurrency design published in 2005 by Nick Szabo called “Bit Gold” took some inspiration from the scarcity of gold. Following the launch of bitcoin in January 2009, Bitreserve (now Uphold) was perhaps the first cryptocurrency company to create a way to exchange bitcoin for gold in late-2014.⁸
One of the first relatively decentralized gold-backed tokens was conceived by Singapore-based Digix in 2014, which sought to put “gold on a blockchain”. The Digix gold-backed token (DGX) has served as a broad template for the many subsequent gold-backed tokens that have been launched:
- Token pegged to a specified quantity of gold: each cryptocurrency token represents some pre-defined quantity of gold (eg 1 fine troy oz of “London Good Delivery” gold) secured in a physical storage location
- Physical backing gold held by third-party custodian: gold reserve country location (and sometimes the specific vault location) are disclosed by the issuer; gold reserve storage locations often in the world’s major gold markets (eg Switzerland, London)
- Token linked to specific gold bars and redeemable for physical gold: individual crypto tokens can be tracked online against specific physical gold bars held in storage; tokens can be exchanged for physical gold in certain locations
- Leverage existing blockchains for security and network effects: the cryptocurrency token operates atop an existing blockchain network, most frequently Ethereum as an ERC-20 token, enabling crypto wallet storage, transfer and exchange support
- Micro-ownership of gold supported: the greater number of decimals places supported by by tokens (up to 18) allows for ownership of very small quantities of gold
- Token trades on cryptocurrency exchanges: allow for the trading of gold-backed tokens at exchange rates that closely follow gold’s spot price
- Fee-based business model: various fees are charged by the token issuer to help cover the costs associated with managing the gold-backed token and storing physical gold, including transaction, issuance, redemption, storage, etc.
It was only in the last year when the total value invested in gold-backed cryptoasset tokens grew substantially, up more than 16x in value, from less than $10m in combined value last year to over $160m as of April 2020. Some of the advantages of gold-backed tokens vs traditional financial instruments and physical gold are summarized below (Table 2).
Table 2: Gold Ownership — ETFs/Futures vs Physical vs Tokens
Some additional advantages of gold-backed tokens over the major traditional means financial market investors can gain exposure to gold are also summarized in Table 3.
Table 3: Gold Ownership Comparison
Today, three gold-backed tokens currently dominate: Tether Gold (XAUT), PAX Gold (PAYG) and DGLD (DGLD), which together currently make up 94% of total market value of all gold-backed tokens (Table 4).
Table 4: Overview of Leading Gold-Backed Digital Tokens: XAUT, PAXG, DGLD
The leading gold-backed tokens are similar in that they all allow for exchange of the token for physical gold, although the manner and cost of doing so differs substantially. Other differences include regulatory status, technology platform, cost of ownership, exchange/redemption requirements, and other factors summarized in each token’s respective full data profile contained at the end of this report. The different token issuer fee structures are particularly important to examine closely to ensure that the way you intend to use the token (eg long-term hold vs. frequently transact) is in alignment with the token’s fee structure.⁹
While tokenized gold holds a number of advantages, as we discuss next there are scenarios where owning physical gold may be preferable to tokenized gold (eg cyber security risk).
Gold vs bitcoin
From an investment perspective, gold shares a number of attractive attributes with bitcoin and other hard cryptoassets (Table 5). Indeed, these similarities have led to many referring to bitcoin as “digital gold”, and recently a number of prominent crypto fund managers and investors have mentioned significant gold holdings alongside their bitcoin, including Ari Paul and Arthur Hayes.
Table 5: Similarities between Gold and Bitcoin
Like bitcoin, gold can be owned entirely outside of banks and the traditional financial system. While financial products such as gold ETFs have grown in popularity in recent years, there is also a large market and range of institutions, including government run mints, that supports physical gold ownership. Physical gold ownership can in some ways be likened to holding cryptoassets in non-custodial wallets. Both gold and bitcoin can be owned outside of any intermediary or third party, residing in the sole possession and control of the actual owner.
The physical and virtual nature of gold and bitcoin, respectively, makes them more complimentary
The most fundamental difference between bitcoin and gold is their virtual and physical nature, respectively.
Bitcoin is entirely digital. It is created using computer code and only exists “on computers and the internet”, so to speak. In contrast, gold is one of the just over one hundred fundamental chemical elements that form the primary constituents of matter and cannot be broken down into simpler substances. From this fundamental physical-digital difference springs a number important distinctions, potential advantages and trade-offs, between gold and bitcoin (Table 6).
Table 6: Gold vs Bitcoin — Advantages/trade-offs arising from Physical vs. Virtual nature
While the above table attempts to highlight advantageous characteristics for bitcoin and gold, particularly from a use and store of value perspective, it is important to note a number of limitations with this exercise.
First, any generalization of advantages across different people and institutions is inherently problematic given differences in circumstances and preferences. For example, crime and risk of theft varies across geographies and personal circumstances, making any physical security generalization problematic. We have therefore chosen not to indicate an advantage for either bitcoin or gold for physical security.
If an investor owns pure digital assets such as bitcoin (BTC) as a hard asset they should also carefully consider gold
Second, this table does not weigh the relative importance of different advantages, and the importance of some advantages may vary over different geographies and periods of time. For example, some countries have shown a willingness to shut-off internet access, an act which effectively renders cryptocurrency impossible to use and thereby negates bitcoin’s transferability advantage.
Looking at total supply, at first glance this characteristic might appear to favor bitcoin given its finite and knowable supply. However, because bitcoin has only been in existence for just over 11-years some would argue that the social consensus and technology that secure bitcoin’s finite supply have not received a sufficient test of time compared to something like gold, which has proven immune to efforts by alchemists, etc. to inflate its natural supply.¹⁰
Finally, a number of gold vs bitcoin dimensions are not included in this comparison, such as environmental impact, a heavily debated topic. Concerns over both have been raised, but we are not aware of any authoritative analysis comparing the respective environmental impact of gold and bitcoin.
Gold vs bitcoin: other differences and characteristics
Bitcoin and gold can both be traded and accessed via different financial instruments and markets, and we compare the two across a number of financial market dimensions in Table 7.
Table 7: Gold vs Bitcoin — Financial Market Dimensions
As with the previous comparative table, no attempt has been made to weight any of the above financial market characteristics as their respective importance will vary across individuals and institutions. For example, all cryptoassets are combined ~$200 billion whereas the size of the gold market is at least an order of magnitude greater, meaning than many institutional investors simply see cryptoassets as too small to invest in at present. Gold is also a more mature asset with regulatory clarity compared to bitcoin, meaning that investing in bitcoin may simply not be an option for many institutional investors at this stage.
One of the main concerns often expressed around bitcoin is its extraordinary volatility relative to gold and other financial assets (Figure 2). While it is true that bitcoin is substantially more volatile than gold and most other currencies and financial assets, outsized volatility is not always a disadvantage. Overall, outsized volatility has played a positive role to date in the growth of cryptocurrency use and adoption. Volatility helps boost liquidity and fund development of critical infrastructure, such as cryptocurrency exchange “on-ramps”.
Figure 2: Volatility — Gold vs Bitcoin vs Fiat Currency
There are numerous other points worth considering when comparing bitcoin to gold including:
- bitcoin arguably faces more direct replacement competition than gold faces as a reserve asset
- gold is owned for “legitimate” purposes that would be socially and politically difficult to justify complete confiscation (eg wedding jewelry), but restrictions on gold ownership have been implemented by governments in the past in countries such as the US
- investment preferences expressed by younger generations would appear to bode well for cryptoassets as compared to some traditional asset classes
Hard assets have historically performed well during times of crisis and periods of financial instability, and both gold and bitcoin offer a number of compelling and complementary characteristics.
Gold’s historical track record, physical nature, and wide ownership amongst central banks and governments are its standout characteristics. Tokenized gold is attractive for a number of reasons, including 24/7 access, ease of transferability, cost, and overall convenience of use compared to traditional gold ownership options. Rather than completely replacing other traditional means of gaining exposure to gold, tokenized gold offers a complementary and exciting new way to access and transact with the world’s ultimate safe haven asset.
 The launch of DGLD was announced in October 2019 by a commercial consortium comprising CoinShares, Blockchain.com and MKS (Switzerland) SA. Blockchain.com maintains an ongoing commercial interest in the distribution of DGLD.
 While today many countries are either growing or maintaining their gold holdings, this was not the case in the 1990s. For example, the United Kingdom showed disastrous timing when at the turn of the century Gordon Browne sold half the UK’s gold holdings at the bottom of a two-decade bear market (~$200/oz.). Other countries including Canada, Belgium, Argentina, Australia, the Netherlands and Switzerland also reduced gold holdings around this time.
 Questions about motives arose when Germany repatriatiated 583 tonnes of its gold stored at the Banque de France and the Federal Reserve Bank of New York.
 See for example Barry Eichengreen on the US dollar’s “Exorbitant Privilege” (video)
 Other early gold-backed token efforts include a high-profile aborted collaboration between CME, the UK Royal Mint, Bitgo and other partners
 See for example this analysis from last year of PAXG’s fee structure under different use and position size scenarios https://sci.smithandcrown.com/research/understanding-paxos-gold-stablecoin
 In addition, the seeming advantage of finite supply could work against bitcoin in certain scenarios, such as consideration by monetary authorities as an anchor hard asset for a new monetary system (Bretton Woods II). Gold’s potential growth of supply into perpetuity could make it more attractive as a base monetary asset to economic policymakers than something like bitcoin with a fixed supply as it would be relatively less deflationary. We therefore chose to rate both bitcoin and gold equally on total supply, although our forecast is that over time bitcoin may show a more clear advantage in this category from a store of value perspective.
Disclaimer and Disclosures
Notice: This document is intended for high-level information purposes only. The views expressed in
this document are not investment advice nor recommendations. The facts contained herein are not necessarily complete and recipients of this document should do their own due diligence, including seeking independent financial advice, before investing. This document is not an offer, nor the solicitation of an offer, to buy or sell any of the assets mentioned herein. This document contains forward-looking statements, which Blockchain may not update publicly and may not prove accurate. They are provided solely as indications of portions of Blockchain’s internal strategic planning. The individuals contributing to the report have positions in some of the assets discussed.
Chinese state-endorsed public chain to act as a global DeFi bridge, says Conflux CEO
Conflux Network, a permissionless blockchain project which is endorsed by the Chinese state, told Cointelegraph on Sept. 22 that the project has officially launched its Tree Graph Research Institute with the Shanghai government.
According to Fan Long, CEO of Conflux, the Tree-Graph Blockchain Research Institute will experiment with local states to build a regulatory compliance platform that can bridge global DeFi applications and government regulations. He added that:
“DeFi is a new world and while it appears as though it may pose a challenge for regulators, they appear willing to listen. At this stage, the most important thing is to maintain a reliable communication channel between two sides— the DeFi innovators and the regulators.”
When it comes to new techniques and innovations, the Chinese government has shown signs of tolerance for experimentation in the past. Fan indicated that the complexity surrounding DeFi and other relevant distributed innovations will make open communication crucial for continued legislative acceptance. He stated that:
“Regulators need a reliable way to learn what the new technique is about and where it might lead us to. Innovators need a way to understand the concerns and red lines of regulators.”
At the moment, Conflux is working with the Shanghai government on several sandbox projects. Fan told Cointelegraph that these projects include integrating blockchain borrowing and lending services into Shanghai’s Pudong Development Bank, and leveraging the Shanghai free trade zone’s unique regulatory framework to devise a unique stablecoin for the region, The CEO explained:
“Shanghai Free Trade Zone is outside of capital control of China where RMB is offshore with its own set of rules, so we are trying to come up with some regulation breakthroughs with experimenting under the free zone framework.”
Compared with the central bank’s digital currency, or CBDC, Fan pointed out that although a CBDC will allow the central government to maintain control of the financial activities, it would be hard for such a centralized form of digital currency to be accepted outside of China.
Conflux is trying to either create a free zone stablecoin or build a public permissionless cross chain for the CBDC.
The project, which began its life as a research project at Tsinghua University, has been working to provide a robust and cheap framework for developers to build decentralized finance applications. Fan explained that:
“Conflux Network seeks to provide a POW network with transaction speeds an order of magnitude faster. The key enabler technique is a novel DAG-based ledger structure together with an optimistic concurrency control to achieve a consistent order of transactions among all the nodes in the network.”
Fan believes that DeFi projects will only be able to go mainstream through willfully enacted compliance measures which evolve alongside government regulations. Blockchain and DeFi are new areas for regulators. Although he cannot speak to how regulators will go about this, his predicts that:
“Decentralization will make it more difficult for regulators to control DeFi products, but there are still possibilities to exercise controls at the boundary between the decentralized world and the centralized world.”
The Shanghai Municipal Government, one of the states endorsing the project, is interested in exploring how the city can leverage blockchain techniques to integrate traditional finance with decentralized financial services, says Fan.
In order to connect global DeFi projects and regulations, the company also created the Conflux Open Defi initiative.
Members include: Sequoia Capital, Blockpower Capital, Antelope Holdings, dForce, DeBank, and MCDEX along with Chinese state support through the Shanghai Science and Technology Committee. Fan says Open DeFi aims to unite Eastern and Western DeFi markets through three globally focused program tracks: risk management, new liquidity strategies, and incubation & innovation.
Inside the Mysterious World of Bitcoin’s Mempool
Blocknative’s Mempool Explorer lets you explore the transient space where Bitcoin transactions are suspended in limbo.
- Blocknative has launched its Mempool Explorer to help understand mempool data.
- Transactions pass through the mempool before they reach the Bitcoin blockchain.
- The Mempool Explorer promises to democratize access to mempool data.
But what is the mempool? It’s the gateway to Bitcoin’s blockchain and many others. Before any transaction is written on a blockchain, the information first enters the mempool. There it sits, almost in purgatory, waiting for a Godly miner to select it and inscribe it into a block—or discard it forever. But the very nature of this in-between world, which differs for each miner, has always made it challenging to analyse. And it is often exploited by bad actors with the expertise to see things the rest of us can’t.
“At a minimum, our platform represents sunrise in the Dark Forest. The alpha predators are still operating, but now everyone can monitor their actions,” Matt Cutler, CEO and co-founder of Blocknative, told Decrypt.
The main problem is that the Bitcoin mempool is built upon the shifting sands of pending Bitcoin transactions. As there is no one central source of mempool data—each miner has their own version of events—it is difficult to gather and utilize this data. This, in turn, makes it hard to take a reliable snapshot of events, and present them to developers.
“It is pre-consensus by definition. It is constantly changing—literally at a sub-second level,” said Cutler.
How the Mempool Explorer works
The Mempool Explorer tries to make sense of the pre-consensus data found in the mempool, making it accessible and easy to analyze.
In the mempool, pending transactions are ordered, fees are prioritized, and new blocks are sent to the blockchain. The Mempool Explorer examines this data and makes it available to developers. Using the Mempool Explorer, users can track pending transactions, monitor exchanges, and share mempool data with others. In other words, it is a purpose-built environment for crunching data before it hits the blockchain.
The Mempool Explorer works as a global network of nodes, all enabling the Explorer to detect and record data on the mempool in real time. The Mempool Explorer can record more than 7 billion Ethereum mempool events in just one month. That is over 2,000 events per second on a 24/7 basis.
How mempool data fights frontrunning
While mempool data is tricky to get hold of, it’s very useful for several different purposes.
One of its main, albeit shady, uses is for frontrunning. Frontrunning is a way of making trading decisions based on knowledge of future events, similar to insider trading. And traders use frontrunning to get ahead of people on decentralized exchanges, typically on the Ethereum blockchain.
Alex Svanevik, CEO at Nansen, told Decrypt, “There’s certainly demand for mempool data. Trading in traditional finance is often a latency game, and crypto is no different,”
Here’s how frontrunning works when blockchain is involved. Since blockchain data is public, someone watching the mempool can see a trade being made and then make the same trade, offering a higher transaction fee. Since miners tend to pick transactions from the mempool that have higher fees (so they make more money), this means the later transaction is more likely to get included in the block—and the person gets ahead of the trade.
Until now, only some individuals use such techniques. “Today, these techniques are the domain of a well-equipped, and well-financed, elite few. Everyone else is at best a spectator to their actions – at worse, unaware,” said Cutler. This means general people using decentralized exchanges are often subject to frontrunning—but may have no idea.
Now anyone who uses the Explorer will now be able to fight back.
“Any adversarial action that goes on chain must—just like everything else—first traverse the mempool. So our platform can give concerned parties advanced warning that adversarial actions are underway,” Cutler added.
It’s time to embrace the mempool.
Congress sees two new bills looking to chart CFTC and SEC regulatory turf in crypto
Two major crypto bills were introduced in the U.S. House of Representatives on Thursday. One aims to establish which cryptocurrencies are securities. The other looks to put regulation of exchanges in the hands of the country’s commodities regulator.
The securities bill
The Securities Clarity Act, from the office of Representative Tom Emmer (R-MN) establishes a new distinction in securities law between an investment contract and the “an asset sold pursuant to an investment 22 contract, whether tangible or intangible (including an 23 asset in digital form).”
The new bill is basically a direct response to recent controversy over the Simple Agreement for Future Tokens framework under which currencies like EOS were distributed and which caused immense controversy in the case of Telegram. If passed, the act would restrict the Securities and Exchange Commission from pursuing digital assets on the basis of the initial contracts under which they were sold.
…and the commodities
Conaway may be less familiar to Cointelegraph’s readers than Emmer, but his position on the Agriculture Committee is critical. Today’s bill would put crypto exchanges under the jurisdiction of the CFTC, which answers to the Agriculture Committee. That registration would save exchanges from the patchwork of state-by-state licensing required of money service providers.
Though the new bill would seem to put retail crypto under the same rules as commodities exchanges, it is careful to leave space for the SEC for sales involving “a securities offering or transaction associated with a digital commodity presale.”
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