The idea of gold-backed cryptocurrencies preceded bitcoin but it wasn't until the advent of blockchain that a secure management and accounting system was available to scrutinize transactions.
Rather like dollar-backed stablecoins such as Tether's USDT, where a single digital token is physically backed by one dollar, a gold-based cryptocurrency can be issued to represent a certain value of gold and have its value supported, not by market confidence, but by physical stocks of the precious metal.
Thus, if one digital gold-backed token is worth one gram of gold, the token will always - at a minimum - equal the market price for bullion regardless of the supply/demand dynamic. Of course, if the popularity of the cryptocurrency is such that a market-moving amount of gold has to be purchased to back it, then demand will move the price of the token.
Importance of Trust
There are some obvious drawbacks to the issuance of a gold-backed cryptocurrency. Storing such a valuable commodity as gold poses the first, immediate problem.
It is a risk that can only be solved by using a third party and this incurs costs that must also be evaluated within the digital token price. The risk of theft of a physical entity such as gold remains a primary risk, however.
Thus, the issue of trust is a further, significant issue. Not only must an investor trust the security and integrity of the company holding their physical reserves of the metal, they must also trust the cryptoasset issuer that all tokens in supply are covered by the required amount of physical commodity.
As seen with the dollar-backed USDT this year, questions arose over the legitimacy of its claim to be fully backed by the U.S. currency after allegations a company it shared management with, the Bitfinex exchange, had used Tether dollar reserves to fill a hole in its finances.
Trust is important when issuing any financial product, so the gold purchasing side of the equation must be as transparent as the transaction of the digital tokens.
Is It for the Crypto-Enthusiast?
Many digital investment companies believe issuing gold-backed stablecoins is an irrelevance as bitcoin fulfills many of the attributes of the precious metal and see the top cryptocurrency as "digital gold" or "gold 2.0".
However, those more interested in the physical attributes of gold are likely to be interested. Investing in physical gold presents storage risks and, while there are derivative products available to gain exposure to the gold market, they usually represent collective funds that incur fees.
Cryptocurrencies backed by gold are more likely to appeal, therefore, to goldbugs rather than cryptocurrency enthusiasts. There are dozens of these cryptocurrencies out there on the market, but none has managed to stand out to the point it regularly makes headlines, making the potentially trustworhy ones harder to find.
Further efforts to tokenize raw materials and other physical assets are likely to be issued in the future to satisfy the appetites of commodity investors rather than crypto-enthusiasts. Last week, Paxos issued a gold-backed cryptocurrency and said it had plans to put further "real world assets" on the blockchain.