Gold-Backed Cryptocurrencies: Innovative or Redundant?

The debate between Bitcoin and gold is often waged by two opposing sides: those who believe that Bitcoin is the future currency of the world, and those who think gold is the only alternative to fiat. However, there is a third-party in this discussion — although they are a minority in the cryptocurrency community.

Also read: Gold Takes a Backsesat to Bitcoin During Greek Debt Crisis

Disclosure: this author is a paid blogger at Anthem Vault, a company that has recently launched the Hayek, a gold-backed cryptocurrency.

This third group believes that a combination of gold and Bitcoin would result in a currency that takes advantage of the best of both worlds. Essentially, these people envision a cryptocurrency that represents ownership over an amount of gold in the physical world. The digital coin would act as a gold certificate, working as a perfect money substitute. The only time the tokens would need to be redeemed for gold is if the owner simply wishes to increase his or her physical store of gold.

Thus, by using a gold-backed cryptocurrency, we get the “intrinsic” value of gold as well as the speed and portability of Bitcoin. According to its supporters, this kind of cryptocurrency is capable of reaching a much broader market than a purely digital currency. Those who are reluctant to trust a computer program with their wealth, or people who doubt the reliability of Bitcoin’s digital scarcity can find solace in the token’s gold value.

Commodity-backed digital currencies have received support from people who tout sound money reform, but are not exactly familiar with Bitcoin’s technology. To them, cryptocurrency is a promising idea, but its lack of tangibility either intimidates them or rouses doubt. One of the most prominent people to get behind the concept of a commodity-backed cryptocurrency is Rand Paul, a Republican candidate for US President in 2016. In May of 2014, Paul stated that he would like to see a digital currency backed by a basket of stocks:

“I was looking more at it until that recent thing [sic]. And actually my theory, if I were setting it up, I’d make it exchangeable for stock. And then it’d have real value. And I’d have it pegged, and I’d have a basket of 10 big retailers… I think it would work, but I think, because I’m sort of a believer in currency having value, if you’re going to create a currency, have it backed up by — you know, Hayek used to talk about a basket of commodities? You could have a basket of stocks, and have some exchangeability, because it’s hard for people like me who are a bit tangible. But you could have an average of stocks, I’m wondering if that’s the next permutation.”

While gold-backed cryptocurrencies may sound like a best of both worlds scenario, there are a couple things that could make them redundant. These redundancies could make commodity-based digital tokens unnecessary, since their purely digital counterparts would be less bulky.

Having a digital currency tied to gold drives up transaction costs. When a digital transaction takes place, and the ownership of physical gold changes hands, the gold storage facility will have to alter its records. Managing the records requires labor; even automated processes would have high capital and maintenance costs. These expenses would be reflected in transaction fees, meaning that the gold-crypto hybrids are not as “cheap” as pure digital currencies.

As far as a gold token’s protocol is proprietary, its users must trust the issuing firm. Since the tokens represent ownership over a physical supply of gold, they will most likely be premined to match the amount of gold owned by the issuing company — and later to match the amount of gold deposited by customers. Therefore, the issuer will have the ability to create tokens in excess of its gold reserves, allowing it to operate with fractional reserves for its own benefit. Aside from devising a decentralized gold token, the only choice users have is to trust that the issuer will not engage in questionable activities.

An issuing firm can also use its gold reserves without the knowledge of its depositors. Since gold is not linked to a decentralized protocol that automatically logs all transactions — like Bitcoin’s blockchain — a customer will have a hard time knowing whether or not the firm is using his or her gold for personal gain. This practice also qualifies as running fractional reserves which, depending on the stipulations of the deposit contract, betrays the trust of the depositors.

The higher transaction costs and trust requirements associated with gold-backed digital currencies puts them at a disadvantage to purely digital currencies, but that doesn’t mean that they are totally useless. Having a token that acts as a hybrid between tangible and digital media of exchange builds a useful psychological bridge for gold bugs initially being exposed to cryptocurrency. This hybrid could ease newcomers into the digital currency world, making the learning curve seem smoother. Whether or not the users of such currencies complete the transition to totally digital coins, though, depends on whether or not they value decentralization and affordability over familiarity.

Are gold-backed cryptocurrencies a good idea? Let us know in the comments below!

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