Cryptocurrencies are emerging as a form of digital assets preferred by retail and institutional investors. Institutions and high-net-worth individuals are adding them to their investment portfolios. However, for many people, how cryptocurrencies work remains a mystery. One key reason for their hesitation is the high volatility and unpredictability of cryptocurrencies. To address this volatility issue, a new kind of digital asset has been created with more stable value, powered by traditional assets like fiat currencies and precious metals: stablecoins.
What Are Gold-Backed Stablecoins?
Stablecoins generally refer to cryptocurrencies created with the intention of stabilizing their value by linking to reserve assets, such as the U.S. dollar. Gold-backed stablecoins are blockchain-based tokens backed by gold. Compared to mainstream cryptocurrencies, they experience less volatility because their value is tied to the price of gold.
These tokens work by having the issuer set aside an equal amount of gold for every token to guarantee its value. Token holders can redeem their tokens for the equivalent value of gold at any time. For gold, the troy ounce (31.1035 g) is the standard unit. Gold-backed stablecoins are typically tied to the value of one troy ounce of gold, ensuring that one token’s value closely aligns to the current price of a troy ounce.
The price of these stablecoins remains stable because the ability to redeem tokens for actual gold means buyers won’t pay more than the market value of gold for an individual token, and sellers won’t accept less when redeeming their tokens. This mechanism keeps the token price closely aligned with the actual gold price.
Gold-backed stablecoins are more liquid than physical gold and even gold ETFs. They also do not require physical storage, unlike gold bullion. While ETFs are highly regulated and gold’s value depends on its intrinsic nature, stablecoins fall somewhere in between, with some issuers being regulated and others not. Additionally, stablecoins are often easier to acquire and trade than physical gold and, to some extent, gold EETFs.
Prominent examples of gold-backed stablecoins include Tether Gold (XAUT), Pax Gold (PAXG), Perth Mint Gold Token (PMGT), and Meld Gold (MCAU).
How Gold-Backed Stablecoins Might Affect the Precious Metals Market
Gold-backed stablecoins are becoming popular as they merge the flexibility of digital assets with the stability of precious metals. Through gold-backed stablecoins, investors looking for exposure to gold can easily achieve their goals without needing to purchase and store physical gold. Since all gold-backed stablecoins need to be attached to the value of gold, the issuers have to acquire physical gold, which in turn boosts the demand for physical gold.
Although both gold-backed stablecoins and physical gold derive their intrinsic value from gold, the former’s ability to hedge against inflation may vary since it relies on the issuer’s ability to maintain enough reserves and regulatory compliance.
Noteworthy Challenges and Considerations
Gold-backed stablecoins carry counterparty risk. The original cryptocurrencies have value for themselves; however, stablecoins are just tokens indicating the value of gold; they don’t have a value of their own. The real value of these tokens comes alive only when the holder redeems it as physical gold or cash equivalent.
Research papers highlight that gold-backed stablecoins experienced similar volatility to Bitcoin during the pandemic, contradicting their main objective that they would be more stable due to their link to gold. Additionally, gold-backed cryptocurrencies are likely to be more reactive to negative shocks in the gold market.
Gold-Backed Stablecoins Are Not So Stable
Knowing the risks and returns of gold-backed stablecoins is important for investors, as these assets might not provide the expected stability and safety consistently. Policymakers should recognize the limitations of gold-backed stablecoins, as they do not serve as effective safe-havens. While gold-backed stablecoins may appeal to investors because of the speculative potential and cryptocurrency features, they cannot effectively replace physical gold as a long-term growth investment.
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