The Bitcoin system has the great virtue of securely sending value directly from stranger to stranger. It is open to anyone, anywhere in the world. The sender does not need to trust the recipient, nor any bank or other institution, to accurately record the transfer. The Bitcoin “blockchain” provides a readily consulted online public ledger with immutable records. Transfers are indelibly captured, like flies in amber, and made tamperproof by massive duplication and reconciliation of the ledger over thousands of nodes.
Bitcoin also has well-known limitations as a currency, however. First, it doesn’t scale well. The Bitcoin blockchain can process about four transactions per second, whereas Paypal does hundreds, Visa or Mastercard thousands. The blockchain has become congested as the number of transactions has grown. (Reducing the congestion was the motivation for the proposals to enlarge the block size that recently roiled the bitcoin world.) Validation takes at least ten minutes, longer for more secure validation, and even longer when the system is congested.
Cryptocurrency pioneer Nick Szabo has clearly explained that this tradeoff — high security at the cost of slow transaction speed and low capacity for transaction validations per second — is built into Bitcoin’s massive-duplication design:
Bitcoin’s automated integrity comes at high costs in its performance and resource usage. Nobody has discovered any way to greatly increase the computational scalability of the Bitcoin blockchain, for example its transaction throughput, and demonstrated that this improvement does not compromise Bitcoin’s security. … Compared to existing financial IT, Satoshi [Bitcoin’s pseudonymous designer] made radical tradeoffs in favor of security and against performance.
Thus a blockchain system like Bitcoin is not itself capable of quickly processing large numbers of retail payments.
Second, there is the network property of a monetary standard: each of us prefers to be paid in the currency accepted by the largest number of our potential trading partners. This property favors the incumbent standard (the fiat dollar in the US) over both bitcoin and gold. It reinforces the volatility drawback: when your rent and utility bills are denominated in dollars, it is risky to hold a bitcoin balance for the purpose of paying them.
Third, bitcoin’s purchasing power is for now highly volatile. Broader holding of bitcoin as a medium of exchange would reduce volatility, but all three problems impede that.
These drawbacks have inspired initiatives to combine the benefits of blockchain technology with the use of gold-denominated tokens in place of bitcoin. Gold as a potential medium of exchange arguably has fewer limitations than bitcoin on all three scores. First, its payment processes scale well. Second, its value (in dollars or in purchasing power) is somewhat less volatile over daily to monthly horizons, and is much less volatile over longer horizons. Third, its popularity as an asset in private hands is greater. As of 15 October 2017, total bitcoin balances are worth $92 billion, whereas worldwide private investment holdings of gold coins, bullion, and ETFs are estimated at $1.7 trillion. Gold holdings are more than 18 times larger; bitcoin holdings are less than 6% of gold in private hands.
Initial popularity matters for gaining widespread use in the face of an incumbent currency. Popular dollarization in Latin America and elsewhere gives us a model of how a non-incumbent currency gains a toehold and then spreads. Popular dollarization typically begins with the dollarization of savings, when the local peso becomes a less reliable long-term store of value than the dollar. Dollarization of pricing and payments spread when the peso inflation rate rises to double digits, requiring more frequent revision of peso prices, and imposing a high cost of holding pesos even from paycheck to paycheck.
A gold-backed account or digital token rests on a commitment to redemption at par.
Several about-to-launch new projects, described below, hope to create gold-based payment systems while using some form of blockchain technology to enhance the security of holdings and transfers. If gold-backed accounts or digital gold currency tokens with cryptographically secured transfers are successfully launched, users will be able to adopt a modern gold standard as easily as they can now adopt the bitcoin standard.
Gold holding is already widespread as an investment (a saving and tail-risk-hedging) vehicle, as noted, but convenient gold payment mechanisms have been lacking. The enterprise called E-gold was a prototype — a service for individuals to buy, hold, and easily transfer gold account balances — until it was shut down by US authorities in 2005 for nonconformity with US Treasury “anti-money-laundering” and “know your customer” rules. The upcoming new enterprises all promise to comply with AML and KYC requirements for money service businesses.
A gold-denominated digital payment system will have to operate very differently from bitcoin (or any other cryptocurrency). For this reason, it is highly misleading to call it “Cryptocurrency backed by gold” as one promotional article has.
A gold-backed account or digital token rests on a commitment to redemption at par, or a price commitment, by contrast to bitcoin’s commitment to the quantity in circulation. The payment processing system will also be different. It cannot be purely peer-to-peer because it requires a gold vault-keeper or equivalent trusted intermediary to maintain the price commitment. But the use of a single trusted limited-access ledger, rather than Bitcoin’s distributed trustless open ledger with its massive duplication in record-keeping, brings a large advantage in the speed and cheapness of payment processing.
The first three projects I will describe do not aim at providing a payment system so much as a low-cost platform for investing in gold. Think of them as would-be competitors to gold ETFs or to bullion warehousing services with easy conversions from and into US dollars, like GoldMoney. I will then turn to projects with more potential to generate a sizable payment system.
1. Royal Mint Gold
On its website, Royal Mint Gold (RMG®) calls itself “The New Digital Gold Standard.” This is misleading because, unlike a gold standard in the usual sense, it isn’t a payment system. It elsewhere more accurately calls itself “an investment product” and “a new, cost-effective, convenient and secure way to trade physical gold” with online access and distributed-ledger transparency.
RMG, which promises to come online before the end of 2017, offers much to interest gold investors. It partners The Royal Mint (hereafter TRM), owned by the UK government, with the Chicago Mercantile Exchange (CME). Both are venerable and credible. (There was talk about privatizing TRM in 2011, but it didn’t happen. As a state-owned enterprise, does TRM enjoy sovereign immunity against lawsuits? I don’t know.) TRM will manage the gold vault, and the CME Group will provide the trading platform for electronic warehouse claims to allocated gold in the vault. The RMG system promises that “For every RMG that’s on the network, there’s one gram of gold that’s sitting in our vault.” A proprietary blockchain will be used to record and track whose gold is in the Royal Mint vault. There will be “live, transparent pricing” on the CME trading platform.
To attract gold investors, RMG promises zero “ongoing” management and storage costs. The RMG webpage compares how value grows with the price of gold under its 0% fees, “giving an investment in RMG a projected higher return than physical gold” held in “a traditional gold ETF [that] is assumed to charge an average 0.4% annual storage and management fee.” But where, you might cynically wonder, do the revenues come from to cover TRM’s vault costs?
Here: You buy in at a premium over the spot price of gold (how high is not yet revealed), so TRM gets some float. (They promise to maintain the premium by buying back unwanted RMG as necessary.) You sell out for a transaction fee. You can cash out, and take physical delivery of gold, only in the form of “physical gold bars and coins produced by The Royal Mint,” for which there is a “fabrication and delivery” fee that is presumably large (not yet specified, and it is not clear whether it will be contractually fixed in advance.)
A system that runs on transaction fees even for internal transfers among account-holders discourages using its accounts as checking accounts.
How big does RMG hope to be? “The initial amount of RMG at launch could be up to $1 billion worth of gold. It will be offered through investment providers. Further RMG will then be issued based on market demand.” For perspective, gold ETFs added $2.3 billion on net in the second quarter of 2017.
To summarize, RMG is not a payment system or a currency, much less a cryptocurrency. It is a warehouse claim to gold in a specific vault. It will be salable to the extent that there are many bidders for claims to gold in that vault, but you can’t transfer it to another RMG holder at a zero transaction fee, like writing a check, the way you could with E-gold.
Incidentally, there are two London wholesale payment systems marrying gold to the blockchain. A Bloomberg Markets article explains the business case:
About $27 billion of gold changes hands every day in over-the-counter markets where settlements can sometimes take days, leaving price risk for buyers and sellers. Using blockchain promises more transparency, security and speedier deals.
One project to provide this service is called Tradewind, supposed to launch in early 2018. Another is Bankchain Precious Metals. Tradewind promises to provide “a distributed ledger that will handle trade settlement, account management and record-keeping.” Bankchain Precious Metals promises “the instantaneous transfer of payments and ownership of the bullion stored in various vaults in London.”
Launched in Dubai, OneGram offers a gold-backed (and Sharia-compliant) cryptoasset with blockchain features. Investors in OneGram will be shareholders in a vault full of gold and will profit as and when the vault accumulates more gold per share.
OneGram aims [at] using blockchain technology to create a new kind of cryptocurrency, where each coin is backed by one gram of gold at launch. In addition, each transaction of OneGram Coin (OGC) generates a small transaction fee which is reinvested in more gold (net of admin costs), thus increasing the amount of gold that backs each OneGram. Therefore, each OGC increases in real value over time, making OneGram unique among cryptocurrencies.
The vault will be located in the Dubai Airport Free Zone. OneGram promises that it will be audited by PricewaterhouseCoopers.
OneGram promotes its cryptoasset as a payment medium, declaring that the “payment institution license is already in place.” But transfers of OGC will be subject to a transaction fee of 1%. The promoters call the fee “small,” but it is high enough compared to ordinary deposit transfer to discourage using OGC as a payment medium.
How the price of gold will be continuously transmitted to the OGC cryptocoin is unclear, because it isn’t clear how the cryptocoin can be converted into the quantity of gold that it is supposed to represent. OneGram promises to have a “payment gateway” for OGC in Dubai and Abu Dhabi, “with fiat conversion.” But how the conversion to fiat will be priced is not specified.
OneGram’s ICO (initial coin offering) ran from May 21 through September 4, 2017. It offered 12,400,786 coins, priced at the spot price of one gram of gold (which averaged around $41 during the period) plus 10%, for total revenue of about $550 million if all the coins sold. A September 6 press release, which announced that the initial coin sale had ended, curiously omitted mention of the quantity of coins actually sold. It also announced that launch of the cryptocoin has been pushed back from October 2017 to “the first quarter of 2018 to ensure that we launch a solid and secure technology solution.”
Critically limiting the potential of OGC to become an important medium of exchange is the feature that no more OGC will be created even if new adopters want in: “100% of total coin supply is pre-mined.” This means that the size of the OneGram payment community in value terms will at most grow only slowly with transaction fees, assuming that the price of OGC remains tied to the value of the gold in the vault.
Much like OneGram, the Australian/American project OzCoinGold promises a limited issue (in this case 100,000 troy ounces maximum, giving a potential market cap of only $128 million at the recent gold price of $1280 per ounce). As with OneGram, the quantity limit prevents widespread use as a medium of exchange. Each cryptoasset token, labelled OzGLD, will be “100% backed” by gold, but with two catches: only one-third of the gold reserves will be above ground as bullion (the other two-thirds will be the proven reserves of a gold mining company), and the tokens can be redeemed for gold only after five years. Audit reports will be uploaded to a blockchain. Accordingly, the main sales pitch is as an investment vehicle: it hopes to be “the easiest, most effective and cheapest way to own or invest in gold.”
Moving on to gold-blockchain combinations better designed to be payment services, I consider four, beginning with those farthest from launch.
1. Digix Gold Tokens
Although its software is not yet fully coded, the developers of Digix gold tokens have at least spelled out their concept in detail. Digix is headquartered in London. As explained in a press release on Medium, Digix aims at “tokenizing valuable real-world assets” on the Ethereum blockchain. It “intends to be the first to launch a fully trackable and auditable crypto gold token.” A DGX 1 token “contains the right to 1 gram of gold that is stored in an audited vault.” As a claim to gold, like a transferable warehouse receipt, the token “can be easily traded or pledged against a loan without moving the physical gold” from its vault. The validity of ownership is certified through a “Proof of Asset protocol.”
What exactly does it mean to “tokenize” gold? Consider a universal open shared ledger, running on top of the Ethereum blockchain, that records ownership, and transfers of ownership, of a numbered 10g gold bar stored in a known vault. The gold bar has been “tokenized.” As with a unit of bitcoin, once I record a transfer of ownership to you on the blockchain, you can now further pass on the token, or redeem it, and I no longer can.
Digix promises to tie the price of DGX to the price of gold the old-fashioned way.
In other words, DGX is a spendable digital warehouse claim for gold, with ownership validation on the Ethereum blockchain. Of course, payment by transferring claims to vault gold without moving the gold is pretty old hat. Italian banks were doing it around 1200 AD. What’s new is that these claims are warehouse rather than debt claims, and transfers take place in currency-like fashion on the blockchain rather than by use of named account balances on the books of the depository.
The Digix sales pitch is both to gold investors, and to transactors who want to hold purchasing power in spendable cryptoasset form at least temporarily. Unlike unbacked IOU-nothing cryptocurrencies, DGX tokens are claims to physical gold expected to trade at a price tied to the price of physical gold. Gold exhibits less purchasing power volatility than BTC or ETH.
But if reduced volatility of purchasing power is what you want, why not hold the cryptoasset Tether, the price of which has been held fairly steady (so far) at $1? Some people don’t trust Tether. Tether claims to have 100% dollar reserves parked in audited accounts in licensed banks, but it lacks full transparency and there has been controversy over its terms of service. Digix promises greater transparency: warehousing of gold in vaults that are certified members of LMBA, the London Metal Bullion Association, with “Realtime Transparency; immutable on-chain auditing records for your viewing from Inspectorate and PWC; accessible at anytime, anywhere.”
To warehouse your gold, whether purely for storage or (combined with a transfer mechanism) for use as a payment medium, requires you to pay a fee to cover the cost of storage. A typical arrangement is for the warehouse to deduct a percentage storage fee periodically from each account. Gold ETFs typically charge around 0.4% per year. If there is a transfer mechanism, the warehouse may also charge a transaction fee when fulfilling a transfer request. The planned Digix fees appear to be similar to ETF fees. Storage fees will be 0.4% per year to the vault owner. In addition, an Administration fee of 0.2% per year will be charged by the Digix organization, making total annual fees 0.6%. Transaction fees will be 0.1% of the transacted amount.
The medieval Italian banks already mentioned introduced the option of accounts with lower fees for customers who wanted not pure storage but rather transaction services, a way to pay people without lugging gold coins around. Such customers brought in loose rather than bagged coins, and consented to fractional reserves, allowing the bank to cover its (reduced) storage costs by interest earned in lending out most of the gold. The advantage for the bank was, of course, the interest income on the coins lent out. The advantage to the customer was lower storage and transaction fees. Competition among fractional-reserve banks soon reduced storage fees to zero and even led banks to pay interest on transaction accounts.
Digix promises to tie the price of DGX to the price of gold the old-fashioned way, by redeemability: “Physical Gold Redeemable at any time at our partnering custodial vaults.” The holder of DGX can “Redeem 100 DGX tokens for 100g of physical gold” in person or by mail. However, it has not yet specified whether redemption will be at a zero or a positive price. In traditional banking, the redemption fee is zero, but it can be zero in this warehousing system only if storage fees are high enough.
The most impressive evidence that Digix intends to promote DGX as a widely used medium of exchange is that they have partnered with a payment card provider (Monolith Studio, whose platform is called TokenCard) to provide an “Ethereum powered” gold-backed debit card. The announced aim is “to ensure gold tokens can be spent efficiently at minimal cost.”
The intriguing vision of Digix and TokenCard is that people will put themselves on a new digital gold standard. A news account quotes Monolith’s co-founder as saying: “Together with Digix, we will be able to offer one of the only true commodity backed debit cards, and bring back the gold standard in a meaningful way.”
The Glint webpage describes its project as a “new global currency, account and app.” Although it says that the project is “Launching in Q4 2017,” no specific roll-out date is offered. Headquartered in London, Glint Pay Services Ltd claims “permission to issue electronic money and provide payment services” from the Financial Conduct Authority under the Bank of England. Its co-founder is CEO of GoldMadeSimple.com, an online bullion dealer.
The project has curiously little press coverage online, only a single article which reads like a paid press-release placement. It is very sketchy on details. “Glint is a stealthy London fintech startup that promises to turn gold into a ‘new global currency’. … Glint will offer a frictionless way to both store and spend your money in gold, including at the point of sale, just like a regular local currency. The bigger picture is that gold historically has been a better storage of value than any government-created currency, and therefore — with the aid of technology — is (arguably) a good candidate for an alternative global currency.”
Obviously, more details are needed.
3. DinarCoin (DNC)
Despite “dinar” being the Arabic name for a gold coin (derived from the Roman denarius), DinarCoin (DNC) is not linked to Islamic finance. The parent firm DinarDirham is registered in Hong Kong, with offices in Singapore and Kuala Lumpur. It describes the DNC as a “unique digital currency created … on the Ethereum blockchain. The value of each DNC is based on the worldwide gold spot price. DNC can be used for trading, investment and also to make payments.”
Here’s the sales pitch:
If you’re a person that’s interested in precious metals, but are concerned with storage, security, and actually being able to use your metals as cash for purchases, then DinarDirham is for you. You can actually store, secure, and use your gold on the blockchain, and have the ease and convenience of not needing to have it on your person, and accessing it worldwide in minutes.
It will be
a simpler way to transfer gold, as akin to PayPal with dollars. The aim of the DinarDirham is not only to provide additional value and stability to the coin but also to perpetuate the use of bullion as an accepted form of digital currency.
Of course, physical gold isn’t stored on the blockchain. But the record of a contractual claim to gold can be. The promoters promise that “For the lifetime of a DNC a corresponding value of XAU [physical gold] will be held in escrow. … [W]hen DNC is created it is registered on the Ethereum Blockchain and the Bitcoin Blockchain. The total amount of DNC in circulation can be verified on either Blockchain, and audited against the total XAU held in escrow … by DinarDirham.” Of course, the accuracy of such a comparison is only as great as the accuracy of the reports of the “total XAU held in escrow.” Unlike consensus-validated bitcoin ledger changes, the accuracy of unilaterally altered ledger entries relating to external facts, like the volume of vaulted gold held by DinarDirham, is not ensured by the blockchain.
Unlike OneGram, the volume of DNC payments has the capacity to grow should it catch on as a medium of exchange. If demand growth begins to push the bid price of DNC slightly above the spot price of gold, either the parent firm or one of its “liquidity providers” stands to make an arbitrage profit by buying physical gold, putting it in an escrow vault, and selling additional DNC into the market, until the premium subsides. The vaults are associated with Associated Bullion Exchange, an electronic exchange for allocated precious metals in storage.
The “redemption” mechanism is not straightforward. DNC “can be redeemed for physical gold,” the website says, via a DinarDirham blockchain-recorded digital asset called a Gold Smart Contract (GSC). Unless 1 DNC can always procure 1 GSC, however, “used to purchase” would be more accurate than “redeemed for.” Another account does say that a DNC holder can “purchase” a GSC and then use it “to collect gold from one of many available vaults.” If in fact 1 DNC trades at a variable price for 1 GSC, which is redeemable for 1 gram of gold, it isn’t clear how the price of DNC is supposed to be pegged to the price of gold.
The announced payment-system plans are ambitious. The CEO says:
We are building an entire ecosystem around DinarCoin — exchange, DinarCoin ATM, merchant gateway and debit cards to allow our users to use their digital assets anywhere in the world. Also, physical Dinar Gold Coin (4.25 grams) is already available to order in South East Asia.
How far along is the project right now? Unclear. It hasn’t posted much lately. DNC isn’t listed on CoinMarketCap. I could not find any report on the value of DNC coins currently in circulation.
GoldMint is based in Russia. Surf to its webpage from a US location, and you are immediately confronted by a black drop-down box that declares that you may not invest in its ICO if you are domiciled in the US, Canada, China, or Singapore. Its first phase is an ICO ending this month (hoped-for sales, $49 million) for a token called MNTP. A “prelaunch” coin running on the Ethereum blockchain, MNTP will migrate in Q2 2018 to become MNT — the “stake” in the proof-of-stake GoldMint blockchain — which will process transactions in a gold-backed cryptoasset confusingly named GOLD (all caps).
The most important questions about the potential of GoldMint as an important gold-backed currency are about the trustworthiness of its buyback promise.
What is most novel and remarkable about GoldMint is that the parent firm claims to be developing hardware called “Custody Bot automated storage facilities,” which it plans to deploy at pawn shops and shopping centers worldwide. Custody Bots will be “programmed to automatically identify and store gold jewelry, small ingots (up to 100 grams) and coins, without human intervention,” taking escrow custody of them for people who want to take out loans collateralized by the gold. (Loans collateralized by gold jewelry are already popular in India, by the way.) Through the spread of Custody Bot automated storage facilities, according to the GoldMint white paper, the firm hopes eventually to handle the storage of gold reserves worth, in US dollars, tens of billions.
More importantly for currency purposes, Bot-stored gold can alternatively be tokenized and traded as the cryptoasset GOLD, which “will become the trading unit for these operations.” GoldMint promises that units of GOLD will always be “100% backed by physical gold and ETF” that the firm holds.
Because the price of gold is less volatile than the price of bitcoin, the firm’s pitch goes, “Crypto traders and enthusiasts can hedge the risks of storing their assets in [a] highly volatile crypto market environment by transferring their savings to cryptoassets GOLD. [Also:] Low volatile GOLD cryptoassets can be used as a payment unit both for companies and individuals.”
GoldMint will not redeem GOLD for gold at par, but it promises to sell you 1 GOLD cryptoasset for a 5% premium over the London spot price of one ounce of gold, and to buy it back at a 3% premium. Thus the total fee for making the round-trip fiat-GOLD-fiat will be 2%. In addition, it will assess an “On-Chain transaction fee” of 0.3%, three-fourths of which will go to the miners on the GoldMint blockchain. These seem like fairly competitive fees.
The most important questions about the potential of GoldMint as an important gold-backed currency are about the trustworthiness of its buyback promise, and the reliability of its blockchain for payment validation.
I am not endorsing or recommending investment in any of these projects. Caveat emptor. But I think the last three listed warrant our attention as attempts, in the spirit of E-gold, to provide modern gold-based payment systems with online access. All three explicitly promise not to hold fractional reserves, and say that you can track the volume of cryptoassets on their ledger to see that it matches the number of gold grams or ounces held in their vaults. But if one of them becomes popular as a one-hundred-percent-reserved gold payment system, perhaps a subsequent innovator will offer zero storage fees and interest on account balances by re-introducing gold-denominated fractional reserve banking. Such a bank, supposing that it surmounts legal obstacles but lacks government deposit insurance, would have to provide as much transparency as potential clients demand to show that it has enough gold and other liquid assets available to redeem promptly all claims that are likely to be presented.
Reprinted from Cato at Liberty
Lawrence H. White is Professor of Economics at George Mason University and The Freeman contributor. He previously taught at New York University, the University of Georgia, and the University of Missouri – St. Louis. He is a member of the FEE Faculty Network.
This article was originally published on FEE.org. Read the original article.