The blockchain could revolutionize the case for gold as a means of exchange, offering the benefits of bitcoin – also known as digital gold – without its drawbacks. This is the view presented by a research report by Celent, titled Micro Gold: Assessing the Use Case of DLT and Physical Gold.
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John Dwyer, Celent |
A currency typically requires three qualities, says John Dwyer, senior analyst in Celent’s securities and investment practice, who authored the report: it must be a store of value; a medium of exchange; and a unit of account for valuing goods and services. Regardless of personal preferences, few dispute gold’s relevance as a store of value, but it has long since relinquished its role as a significant means of exchange. Few items are purchased around the world in exchange for gold.
“Gold has been impractical to own in small fractions, with the normal minimum size measured as a troy ounce, which equates to 31.1 grams,” says Dwyer. “Consequently, gold has had little utility from a medium of exchange perspective for individuals or firms directly.”
In addition, there are high costs involved in storage and insurance.
However, distributed ledger technology (DLT) – or the blockchain – resolves the issues around gold ownership, argues Dwyer. He cites the example of Goldmoney, a fintech firm that stores gold in central vaults and provides a prepaid MasterCard with which payments can be made.
“The benefit of integrating gold onto a digital ledger is that the ownership of the gold bar can be fractionalized into very small increments,” says Dwyer. “In the case of Goldmoney, this is 0.001 grams worth of gold. This ownership is maintained on a digital ledger and facilitates the movement of micropayments.”
Tight bid/offer spreads for gold, coupled with DLT, permit micropayments to occur in a cost-effective manner, he says.
This raises the question of why people might be looking to revive gold’s role as a means of exchange at all. Some worry that central-bank actions will inevitably destroy trust in fiat currencies, but there appears to be little evidence of this in the mainstream.
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Rus Newton, Global Advisors |
Rus Newton, owner of Global Advisors, an asset management firm that formerly traded commodities and now runs a bitcoin programme, says: “I haven’t noticed a material deterioration in trust in fiat currencies yet, which is surprising given quantitative easing really ought to be having the same effect on GBP, USD, EUR that it did on the reichsmark in the 1920s and 30s.”
Negative rates
However, Dwyer notes that recent global monetary policy has turned traditional assumptions about the properties of currencies on their head. Many of the fiat currencies that dominate everyday life now deliver negligible or negative nominal interest rates (NNIR), and therefore no longer fulfil the store of value function.
Even their utility as a medium of exchange could come under pressure, says Dwyer, as the negative carry cost of currency works its way through multiple layers of international payments and settlement.
“As soon as an individual or institution receives a negative nominal interest rate on cash balances they hold on deposit, in sovereign bonds or in corporate bonds, [they have] an incentive to take their money out of that institution or negative yielding security and, in the absence of no other low risk assets with sufficient yield, they may decide to hold physical cash or low carry commodities,” says Dwyer.
This is being seen in Japan, he says, where one response to NNIR by consumers has been an uptick in the number of safes being acquired to allow people to keep cash outside financial institutions.
There has been talk of fully digitizing fiat currencies and withdrawing physical cash to prevent such behaviour.
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“It is interesting that the European Central Bank announced on May 4 that production of the €500 note will cease in 2018,” notes Dwyer. “This move certainly makes hoarding large quantities of physical cash by financial institutions more difficult and costly.”
Whether or not this nudges people towards gold as a store of value, Adrian Ash, head of research at BullionVault, doubts large numbers of people will flock to it as a medium of exchange.
“Technology cannot repeal Gresham’s Law,” he says, referring to the idea that money of lower intrinsic value will always circulate more freely than money of higher intrinsic and equal nominal value.
“Gold doesn’t act as a universal means of exchange anywhere in the world today,” adds Ash. “Several internet start-ups have tried to revive that function, but with so much official money sloshing about, savers and investors would far rather spend currency and hold on to their bullion when they go shopping.”
Dirk Baur, professor of finance at the University of Western Australia, agrees. “Gold is a physical and tangible asset,” he says. “This is what investors find attractive. I don’t see why a blockchain is needed and how it could make gold more attractive.”
Tangibility builds trust
Gresham’s Law implies cryptocurrencies such as bitcoin have huge potential appeal as a means of exchange, given their lack of intrinsic value. However, cryptocurrencies still lack what gold offers, which is a long track record. Trust is built over long periods, and by tangibility, notes Baur, and “cryptocurrencies lack both”.
Global Advisors’ Newton says: “A lot of people are going to find it somehow easier to buy into the idea of gold as a store of value than bitcoin, given that gold has been around rather longer.
“But consider this: my kids have never bought a CD. All their music is digital or on-demand, so they totally get it. It’s only the crusty old farts like me that have an issue with tangible versus intangible assets.”
That might be the case, but the speed of adoption of micro gold via platforms such as Goldmoney has been extremely rapid when compared with other technologies, says Celent, suggesting the crusty old farts still have the bigger wallets. Goldmoney says it had working capital of $57.1 million as at the end of June, to satisfy $715,700 of liabilities.
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Bitcoin has not seen such rapid growth, notes Celent. “One of the questions we have had about bitcoin is that the adoption rate is much, much slower than other types of technologies, but the familiarity that customers have with gold is clearly a strength,” it says.
There is more than $7 trillion of physical gold, compared to around $12 billion of cryptocurrencies. Daily trading volumes for gold are approximately $70 billion; there is no reliable trading figure for bitcoin, but it is considered illiquid in comparison.
Gold is widely recognised as a form of currency, especially in emerging markets. And direct ownership of the yellow metal places investors squarely within regulatory scope, while arguably protecting them from the systemic risks associated with the financial system.
Dwyer says: “Interoperability with legacy systems, in-built regulatory compliance, seamless user experience and a developer API platform without the inertia of incumbency faced by other use cases indicate that micro gold may be one of the leading use cases for DLT.”
Whether Goldmoney and other platforms like it continue their rapid growth, they will not be the only way DLT makes its mark on the gold market. Earlier in the summer, Euroclear teamed up with itBit, a financial services company delivering blockchain services for capital markets, to develop a settlement service for the London gold market.
BullionVault’s Ash believes this kind of application offers the most interesting opportunities for the blockchain in the gold market. “Trade association the London Bullion Market Association is currently reviewing how wholesale deals are cleared and reported, and several blockchain solutions have been proposed,” he says.
“These would necessarily be private-loop, not public, for commercial and security. They would also build on, not revolutionize, the existing provenance and vaulting network in London’s bullion market, centre of global gold and silver trading.”