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Is Gold-backed Crypto the Way Forward?

Thursday, May 23, 2019

Anyone who has invested in gold since the 2008 financial crash will know that gold prices have hit something of a price ceiling - since 2011, the yellow metal has been unable to break above $2,000. As of May 2019, the gold price has drifted closer to $1,300.

It would be easy for anyone in the business of buying or selling gold to say that the bull market is over - some have been as blunt as to say the great gold bull is dead. They might think that, but behaviour by central banks from some of the world’s largest economies suggests otherwise.

Is gold actually just a sleeping dragon? Is a gold-backed cryptocurrency on the cards?

Central banks can’t get enough

Despite the apparent pessimism within gold markets, central banks have been buying up more gold in the last year than they have done for a considerable number of years. In the first quarter of 2019 alone, central banks of the world bought a combined total of 145.5 tonnes of gold, a level of accumulation the World Gold Council hasn’t seen since 2013.

China and Russia have been keen to get in on the action - China’s central bank is estimated to have added as many as 651.5 tonnes to its total gold reserves, which are believed to be as much as 1,852 tonnes in total. Russia is reported to hold as much as 2,113 tonnes, or approaching $500 billion worth of gold reserves through the Central Bank of Russia (CBR).

The US is one of the world’s top holders of gold reserves - 75 per cent of its foreign reserves are held in the form of gold. That’s quite an investment, for a precious metal supposedly in a bear market.

Part of a larger trend

China and Russia have opted to build closer economic ties in recent years - this reflects a shift away from US economic interests, towards a mutual shared interest between the two countries.

China and Russia’s decision to accumulate more gold through their central banks reflects a systemic shift towards tangible assets with a more fixed value. Russia has faced a raft of sanctions from the United States since 2014, when it was accused of annexing Crimea. China has also had a tricky relationship with the US - President Donald Trump has approved of escalating tariffs against China, via imports worth $200 billion.

Markets have understandably corrected on news of a possible trade war, but gold remains available as a safe haven amidst the market turbulence.

Crypto - gold 2.0?

The creation of cryptocurrencies has provided another means for investors to diversify away from traditional investments such as stocks and bonds or treasuries. Cryptocurrencies offer a whole new means of transferring sums of money through the blockchain - the only constraint on cryptocurrencies is your computing power. No central bank can claim control of your cryptocurrency and print as much as it likes.

Whereas some turn to gold as a hedge against inflation and financial crises, cryptocurrencies offer a decentralised means of exchange through the blockchain, independent of central bank interference. Governments can try to regulate them, but the blockchain has great potential to shake up the established financial order.

What if you could take the safe haven status of gold and merge it with the independence of the blockchain? Enter gold-backed crypto.

A number of gold-backed cryptocurrencies already exist but aren’t established by sovereign states. Coins are typically issued, representing a particular amount of gold at a certain value. The gold that backs the coins is kept by a third-party and can be traded with others who possess the same gold-backed cryptocurrency.

Could gold-crypto rival the Dollar?

Russia and China have demonstrably built up their gold reserves, but they have made a habit of seeking greater regulation of cryptocurrencies in the past, or simply outlawed the mining of them, as China did. Both countries have more reason now than ever before to go their own way, and rival the Dollar with a gold-backed cryptocurrency of their own.

The Dollar was originally backed by gold, as part of the Bretton Woods system, a post-war currency mechanism that fixed the value of the Dollar to gold - its value depended on gold reserves. President Nixon’s decision to upend this, by ending the Bretton Woods system in 1971, opened up the Dollar to the prospect of devaluation and higher inflation.

Rather than backing Dollars with something tangible, the Dollar is now fiat money, and the Federal Reserve has demonstrated its ability to create money out of thin air, through zero-percent interest rates (ZIRP) and quantitative easing (QE) following the financial crisis of 2008.

A gold-backed cryptocurrency would be independent of Federal Reserve interference to an extent - to be viable at scale, it would require the backing of at least one sovereign nation or more. As transactions shift towards this new gold-backed cryptocurrency, the Dollar’s status as a reserve currency would be limited - it would remain a fixture of the world economy but look increasingly sidelined.

Stumbling blocks for the blockchain

Independence from US influence could only be to an extent - this is because the US remains one of the biggest holders of gold deposits on the planet. In 2016, the US was estimated to hold as many as 8,133 tonnes of gold, worth over $300 billion - in pure quantity terms, the US holds more than twice the amount of gold that Russia and China hold combined. Russia and China could try to sever dependence on the Dollar, but the US could simply flood the markets with gold, greatly affecting market value.

The cryptocurrency aspect also requires some clarification - how would countries be able to uphold the usage of a blockchain to handle transactions? Would one country have more input than another? These factors would need to be addressed, to make a gold-backed cryptocurrency sustainable, in order to rival the US Dollar.

There is great potential for such a currency, but there are equally many questions to be answered before anyone can say if a gold-backed cryptocurrency could really rival the Dollar on the global stage.