Gold-backed tokens: A secure route to invest in digital currencies

Since its unveiling in 2009, cryptocurrencies have been a mystery and a rage at the same time. Mystery because no one is 100% certain how or why cryptocurrencies came into existence or why some gained prominence over others. Nor does anyone have a clue about the true identity of Satoshi Nakamoto- the founder of the world's first publicly traded digital currency, Bitcoin. It's a rage because prices of popular cryptos have soared far more than any other asset class over the years, encouraging more investors to dip their toes into what was once thought to be a myth that cryptos are primarily used for illegal activities.

With the evolution of digital currencies, wary investors who were once unsure about spending and distributing cryptos are gaining more clarity as several businesses continue accepting them as a payment method for goods and services. Some of them include Microsoft, PayPal, Expedia, Coco-Cola, food chains and airBaltic.

The bludgeoning market size-

Cryptocurrencies are gaining widespread acceptance after Bitcoin's cautious start in 2009. The one major concern was 'Would banks allow customers to transact in virtual currencies?' After years of steering clear, banks like JP Morgan, Goldman Sachs, Barclays, National Bank of Canada and many others allow customers to transact in cryptocurrencies via their debit, credit and checking accounts. This has not only opened the floodgates for retail investors but created an environment for digital currencies to go mainstream.

Crypto research firm CoinMarketCap believes more than 10,000 digital currencies with a combined market cap of $1.5 trillion trade on almost four hundred crypto exchanges globally. Of these, only five digital currencies account for more than two-thirds of the total traded value. Among them, the most dominant players are Bitcoin and Ethereum, which garner more than 50% of the total market cap.

Source: CoinMarketCap (29th May 2021)

Categorising cryptocurrencies-

Cryptocurrencies are broadly categorised into-

1. Proof of work (PoW)- These rely on blockchain technology to process transactions. On this blockchain network, several computers (nodes) compete with one another in a process known as mining to solve a complex cryptographic problem. The one to come up with an answer first broadcasts it to the rest and is rewarded in the process. Example: Bitcoin, Ethereum.
2. Altcoins- These are alternate versions of the PoW concept. Besides using different algorithms, some Altcoins also use Proof of Stake (PoS). Here, instead of miners, you have small pools of nodes to validate transactions using their cryptocurrency holdings as a deposit. As a reward, nodes receive interest on their deposit. Example: Dash, NEO, Tron.
3. Tokens- Unlike traditional cryptocurrencies, Tokens are distinct since they do not have their own blockchain. Instead, the applications are built on crypto blockchains of Ethereum and others. Investors opting for Tokens should first convert them into a digital currency before cashing out, adding to the liquidity of the underlying cryptocurrency. Example: Tether, BAT.
4. Stablecoins- Represent a hybrid between the traditional cryptos and tokens by providing a reliable store of value. They achieve this by pegging the token to one or more fiat currency and maintaining reserves of those currencies to guarantee the token's value. Some crypto exchanges use stablecoins like a tokenised fiat currency. Example: Tether.

Cryptocurrencies volatility-

If you have traded cryptocurrencies or even monitored their prices from the sidelines, it won't take you long to figure out that they are incredibly volatile.

In February 2021, Tesla revealed in an SEC filing that it had purchased $1.5 billion Bitcoins. The CEO Elon Musk later said that the EV giant would accept Bitcoins from customers for all its car models in the US. The announcement drove the widely popular digital currency to all-time highs of $64899 on the Coinbase exchange. However, the EV maker reversed its stance in May, sending Bitcoin and the other cryptocurrencies into a tailspin. Bitcoin, in particular, was hit hard. The cryptocurrency slumped to $30000 or about 54% from its ATH to the lowest in four months.

Daily chart- BTCUSD

Source: TradingView

While the high volatility has drawn many investors to this asset class, the uncertainty has alarmed several others keen on investing in digital currencies but terrified of the volatility. However, the most recent category of gold-backed cryptocurrencies could provide low-medium risk investors with the choice to invest in less volatile cryptos. Backed with the intrinsic value of gold, the downside risk of these digital assets should protect investments from going into oblivion.

Gold-backed cryptocurrencies-

They are a specific category of crypto stablecoins backed by physical gold. Each token is pegged to the gold price of varying quantities, making them far less volatile than traditional digital currencies like Bitcoins or Altcoins. Although digital gold existed in the late 1990s, blockchain technology has assured a new era of gold-backed digital currencies. The most significant advantage of these digital currencies is that since a Token value is backed by physical gold, the price cannot drop below it. At the same time, the token has unlimited upside potential.

How do gold-backed tokens function?
For instance- If each token equals one gram of gold, its value can increase to any extent depending on the demand-supply, popularity, and other factors of the stablecoin, while the price of the gold bullion supports the downside risk. Gold-backed cryptos are a better option than traditional stablecoins backed by fiat currencies like the US dollar, Sterling or the Canadian dollar. That's because the stability of these coins could falter during trade wars, conflicts or political differences. But tokens backed by gold not only combine the historical reliability of the precious metal, but they also act as a liquid asset, store of value and are movable from one wallet to another quickly. What's more, every token is equivalent to a particular quantity of physical gold held in a secure vault.

Volatility increases when the price of an asset drops. Since the physical gold bullion price supports gold-backed tokens, typically, they should be less volatile than traditional digital currencies. Also, these tokens can spike based on demand. So, although low volatility is not guaranteed, unlike traditional cryptocurrencies, investors can be assured that the price of the stablecoins cannot drop below the value of the gold backing it.

Daily chart- Pax Gold

Source: TradingView

Firms offering gold-backed cryptocurrencies-

Several firms are offering digital tokens backed by gold. Some of them are Digix Gold Token (DGXUSD), deVere Group's Pax Gold (PAXGUSD), Perth Mint Gold Token (PMGT), DGLD (OTC:DGLDF). For more info on the list of gold-backed cryptocurrencies, click HERE.

So, what are the various platforms available to trade or invest in gold-backed cryptocurrencies? The straight answer is a gold-backed crypto exchange like Binance, Coinbase or Gemini. In addition to offering crypto wallets, these exchanges allow investors to invest in digital currencies via their bank accounts and convert assets into stablecoins, including those backed by gold. According to the Blockchain Council, these exchanges also allow investors to redeem their digital currency for gold bullion.

The bottom line-

We're all aware that cryptocurrencies are a peer to peer electronic cash system, decentralised from Government control, interference and influence. The virtual currencies are distributed across an extensive computer network, run on blockchain technology and secured by cryptography, making them almost impossible to counterfeit. Although digital currencies do not directly come under Government control, trading and holding cryptos is legal in the US, many countries in the European Union, Japan, Australia, China, Canada, South Korea, Russia and others. However, the scope of legality and its uses varies from one country to the other.

As we head into the second half of 2021, the discussion has shifted from the transactional value of digital currencies to what extent they can be used as a store of value or hedge. Gold-backed cryptocurrencies could be the answer.

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