If you’ve been following Peter Schiff for his prediction of the 2008 financial collapse or strictly because of his affinity for gold, then you’re probably aware that he is not a fan of Bitcoin, but would he be interested in gold-backed smart contracts?
The United States Federal Reserve cut interest rates by another quarter-point on Sept. 18 following the European Central Bank’s Sept. 12 announcement on its negative interest rates and decision to re-introduce quantitative easing. With negative-yielding bonds looking like a shaky refuge from the storm looming on the horizon, prominent investors such as Ray Dalio, Paul Tudor Jones and Stan Druckenmiller have been suggesting gold as a safe haven from what has been called a world war of currencies, with China and Russia appearing particularly keen to weaken the U.S. dollar’s political hegemony.
Meanwhile, central banks around the world have been on the largest gold-buying spree since Nixon took the dollar off the gold standard in 1971 — but what about everyone else? How does one go about purchasing gold?
Although the easiest way to invest in gold today is through gold futures, exchange-traded funds or mining stocks, gold is usually bought under the assumption that it will act as a hedge against broad economic instability. If the institution that is trading or issuing these contracts becomes insolvent (such as Bear Stearns during the 2008 financial crisis), the value of their investors’ gold contracts subsequently disappears.
Many financial advisors suggest purchasing gold bullion instead of so-called “paper” gold because the physical metal itself is not inextricably tied to the financial system. However, owning gold bullion comes with its fair share of inconveniences: physical gold is bulky and cumbersome, it’s not easily divisible nor is it easy to transport. The insurance required for transport is expensive and so are the costs of transforming a kilo of gold into smaller, more liquid chunks. In addition, many people do not want to store large quantities of gold at home, which results in having to find a vault or custodian that is trustworthy.
How do you know that the gold held in a vault is real and not counterfeit and that the people managing your gold aren’t exploiting their contract? It’s no one’s liability, as there’s no centralized authority for gold. If you take your gold to someone for appraisal, you really have to trust them not to swap your coins or undervalue them like with JPMorgan’s precious metals desk, or when we learned that there are millions of dollars in counterfeit gold circulating, some of which was also found in JPMorgan’s vaults.
While blockchain technology has been touted as a panacea for problems that are outside of its scope, transparent accounting for contracts is one function that it performs to a tee. PAX Gold (PAXG) — recently cleared by New York’s Department of Financial Services — as well as Digix Gold Tokens (DIGX) from Singapore and OneGram (OGC) are all digital representations of gold that is tied to physical gold optionally held by a bank or third party, but the record of gold ownership will always show how much an individual owns, and that cannot be negated.
To create a gold smart contract — first, a bullion exchange or mint certifies that a piece of gold held in its vault has a guaranteed purity of 99.9%. This certificate is then insured against the plethora of damages or liabilities that could ensue (such as being counterfeit), virtually guaranteeing that the certified value of gold will be backed in the event of any unforeseen events. These assurances are then programmed into a smart contract that is published on a public digital ledger. Since this process is encoded and executed using cryptography, the contents of the agreement remain private, thereby enabling the owner to independently verify and prove their legal title to ownership using public internet infrastructure without disclosing their personal information.
Instead of representing gold as a derivative, a gold smart contract is, in effect, a digital legally-bound title. By using a public network, a tangible asset like gold becomes untethered from its physical constraints and can enjoy the versatility afforded by digital assets such as being movable, divisible and tradeable with drastically less overhead. If a customer wanted to retrieve their physical gold bars or coins, they simply present their proof of title (using their private cryptographic keys) at the institution that is holding their gold, such as a bullion exchange or mint.
The marriage of blockchain technology’s open truthfulness with gold’s alluring scarcity makes for a highly transparent, secure and liquid financial instrument with which to hedge against currency depreciation, allowing average consumers and retail investors to hold onto the value of their savings. Going out and finding a buyer for physical gold can be arduous and time-consuming, but tokenizing gold under a legal smart contract increases its portability, giving the vendor immediate access to a worldwide market, which drastically increases its liquidity.
By leveraging blockchain technology, gold can be traded on cryptocurrency exchanges, opening new markets for the gold industry. As precious metals and cryptocurrencies share a common vision of hard money, the synthesis of these markets has the potential to create a powerful economic counter-force should currency devaluation continue unabated.