A few minutes or two days? In dangerous financial times, the time it takes to settle a transaction—exchange cash for goods—is vital.
Now gold market participants are using new tech to shorten the wait.
Tradeable digital gold tokens use the technology behind cryptocurrencies like bitcoin to exchange unforgeable records of precious metal ownership within a few minutes, rather than days.
For gold investors, who are famously cautious about the conditions in which their bullion is stored or transacted, this approach offers many new possibilities, says Danny Masters, chairman of digital asset manager CoinShares.
“It gives them flexibility. The gold becomes liquid, you can sell it out, you can swap it for bitcoin or dollars,” Masters told New Money Review.
How tokenisation works
To digitise the precious metal, an issuer needs to create a fixed number of tokens, each of which is redeemable for a standard amount of gold—for example, one troy ounce or one London Good Delivery bar.
These tokens can be held in mobile phone-based digital wallets, bought and sold and even exchanged for physical gold, though this incurs an extra cost.
Tokens can also be used to show the provenance of a particular unit of gold—who mined it, who processed it and who assayed it before it became a bar or coin.
“The gold becomes liquid, you can sell it out, you can swap it for bitcoin or dollars”
The token wave
In the last few years there has been a boom in gold token offerings.
Some are private-public partnerships that aim to exploit the brand name of an established vault.
Last year, Australian fintech firm InfiniGold launched a digital token backed by gold stored in the vaults of Perth Mint, which is owned by the government of Western Australia.
In Canada, a firm called Tradewind issues gold tokens backed by bullion held at the Royal Canadian Mint.
However, a comparable project involving Britain’s Royal Mint failed to get off the ground. Reuters reported that in 2018 the UK government vetoed a joint plan by the Royal Mint and exchange group CME to list a new gold token called RMG, reportedly due to concerns over the use of a cryptocurrency exchange for trading.
Other token initiatives emphasise gold provenance, blockchain technology, or both.
A California-based start-up called G-Coin says it uses blockchain technology to track conflict-free and responsibly sourced gold from mine to vault.
In Singapore, a firm called Digix is issuing locally custodied, gold-backed tokens whose ownership is recorded on the ethereum blockchain.
In Russia, a firm called GoldMint issues gold tokens representing 1 troy ounce of the precious metal, with ownership records stored on a proprietary blockchain called Mint.
London-based CoinShares has teamed up with MKS SA, a Swiss precious metals firm, and Blockchain, a digital wallet provider, to issue gold tokens recorded on the bitcoin network.
New York-based Paxos issues gold tokens called PAX Gold, each representing a troy ounce gold vaulted in London. PAX Gold tokens operate on the ethereum blockchain and follow the widely-used ERC-20 token protocol.
Paxos says its token is the only one investors can redeem for 400-ounce London ‘good delivery’ bullion bars, the industry standard for the wholesale trade.
Gold tokens or gold ETFs?
These largely retail-focused gold tokens have to compete with gold ETFs, which are used by many investors within their brokerage accounts or pension plans.
Gold ETFs, invented in the early 2000s, recently increased their holdings to 3,033 tonnes of gold (worth $144bn), an all-time high.
The differences in scale between gold ETFs and gold tokens are stark: while SPDR Gold, the world’s biggest gold ETF, has assets of $47bn, Paxos, which says it manages the world’s leading gold token, has so far raised only $17m.
But gold token issuers say their structure can compete on efficiency.
For example, PAX Gold says trades in its tokens settle instantly, compared to a two-day wait to settle a trade in a gold ETF.
It says its tokens are also superior to ETFs by offering immediate access to allocated gold (the most secure form of gold storage) and by being instantly redeemable for physical metal.
“Our marginal cost of production is close to zero”
Fee comparisons between gold tokens and gold ETFs are tricky, however.
In a gold ETF, a fee is built into the market price of the fund, calculated as a gradual depreciation of an ETF share’s entitlement to gold over time.
But token issuers have no standard way of charging.
PAX Gold, for example, has no management or custody fee but charges a transaction fee within its proprietary digital wallet. This is charged on a sliding scale of up to 1 percent whenever the token is converted or redeemed for other currencies.
Another token issuer, CoinShares, charges a 1 percent annual management fee for its DGLD token. It also levies a transaction fee, plus a redemption fee for anyone wanting to take physical delivery of the precious metal.
But according to CoinShares’ chairman, despite his firm’s higher headline fee, the token structure is inherently more efficient than an ETF.
“Our marginal cost of production for DGLD—even though we price it at 100 basis points a year, while a decent gold ETF costs 40 basis points—is close to zero,” Masters told New Money Review.
“We’re not competing on price with gold ETFs yet, because we don’t think there are enough access points or distribution. When institutions become comfortable with DGLD and can trade it on multiple exchanges with multiple custody solutions, then we will have a serious institutional push. If we need to compete on price, we can.”
“Some of our potential clients, who are serious holders of gold ETFs, are interested in the DGLD project because they think 25 percent of the gold in the world will end up being tokenised,” Masters said.
Wholesale gold market seeks blockchain
While retail gold tokens are in their infancy, it’s the wholesale market that may prove the catalyst for digitisation of the precious metal.
“I think the impetus for putting gold on the blockchain will come from the settlement and clearing community,” Ross Norman, founder and former CEO of bullion dealer Sharps Pixley, told New Money Review.
Norman said that many London bullion dealers are already using a technology platform run by token issuer Paxos to speed up post-trade processes.
“Settling a gold transaction on the blockchain is near-instant,” Norman said, “while in the traditional bullion market gold normally settles two days after a transaction is agreed.”
“It’s a far more effective and efficient way of settling trades”
Paxos declined to talk on the record about its initiative.
However, a source with knowledge of the situation said that the firm is looking at ways it can use PAX gold and other digital tokens to effect settlement in the wholesale markets.
Paxos, said the source, already offers dealers a service that automates the trade confirmations, the settlement affirmations and the transfer instructions in gold.
And, according to the source, a pilot platform run by Paxos is now also trying to address lack of in-built delivery versus payment (DvP) in gold.
While DvP is standard in the markets for shares and bonds, where central counterparties ensure that payment and ownership transfer are simultaneous, this type of settlement doesn’t exist in the gold market, which operates on a bilateral basis.
The lack of DvP in gold trading means that if one dealer pays another before being assured of possession of the purchased metal, they could incur a large risk exposure.
The problem is exacerbated by timing differences, said the source: precious metal settlement typically happens at around 4pm UK time, but the dollar leg of a transaction doesn’t settle until the end of the day in New York, creating a gap of several hours during which counterparties have risk exposure to each other.
According to Sharp Pixley’s founder, there are many other potential benefits to digitising wholesale gold transactions.
“On the blockchain, you can also embed smart contracts, for example specifying that the funds are there before you release metal, that you can’t double-count, and so on. It’s a far more effective and efficient way of settling trades,” Ross Norman told New Money Review.
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