What is a gold-backed token and how does it work?

Published at: Sept. 2, 2022

What is a gold-backed cryptocurrency?

A gold-backed cryptocurrency is a type of digital currency that is backed by physical gold. The currency’s value is based on the current market price of gold and can be used for transactions just like any other type of cryptocurrency.

Some cryptocurrencies are backed by gold in order to tie the derivative asset (crypto) to a tangible asset (gold), thereby preventing excessive fluctuations in price. Thus, gold-backed cryptocurrency is often more stable than other digital currencies. This is because the price of gold is generally less volatile than the prices of other assets, such as stocks or cryptocurrencies.

Gold-backed cryptocurrency can also be used as a hedge against inflation. If the price of gold rises, the value of the currency will also increase. This could protect investors from losing money if the price of other assets, such as stocks, were to fall.

Gold-backed cryptocurrencies can be bought and sold on exchanges just like any other type of cryptocurrency and can also be used to purchase goods and services online. People who invest in gold-backed cryptocurrencies enjoy increased returns from the pricing of gold and can redeem tokens in exchange for gold.

How does a gold-backed token work?

The physical gold used to back a certain cryptocurrency is held in gold reserves. These reserves are held by custodians, typically banks or third-party institutions. As for the specific backing ratio, it can vary depending on the cryptocurrency. For example, some are backed 1:1 (1 token to 1 gram of gold) with physical gold, while others may be backed by a fraction of an ounce.

The main advantage of investing in a gold-backed cryptocurrency is that it provides stability and security. Gold has been used as a form of currency for centuries, and its value has generally remained steady over time. As such, the value of gold-backed crypto will not fall below the value of gold, making it a relatively stable investment option. Plus, these cryptocurrencies’ values can (and sometimes do) rise higher than the value of gold.

Most gold-backed tokens are ERC-20 standard tokens, built on the Ethereum blockchain. This means they can be stored in any wallet that supports ERC-20 tokens. These tokens can also be traded like mainstream cryptocurrencies using crypto exchanges.

Are there any gold-backed stablecoins?

Yes, there are gold-backed stablecoins. Technically, gold-backed cryptocurrencies are a stablecoin “variant,” given that stablecoins are cryptocurrencies backed by assets that exist in the real world.

Examples of real-world assets that back stablecoins are government-issued fiat money, commodities and gold. Stablecoins are named as such because their value is pegged or tethered to that of an underlying, more stable asset. So, for example, a United States dollar-backed stablecoin’s price would rise and fall along with the price of the U.S. dollar.

Some of the most well-known stablecoins are the USD Coin (USDC) and Tether (USDT), both pegged to the USD. Gold-backed stablecoins are preferred because:

Tether gold (XAUT) is a gold-backed stablecoin and is the same Tether token behind USDT. Launched in 2020, Tether gold is currently the largest gold-backed stablecoin in the market. XAUT represents one troy ounce of gold on a London Good Delivery bar. The gold is held in a company-controlled Swiss vault.

On top of gold, Tether gold also grants access to traditional financial assets like exchange-traded funds (ETFs). Token holders can check the amount of gold they own on Tether’s look-up website, which provides information on the gold bars these token holders own.

The Tether gold token can be held on an Ethereum-based wallet as an ERC-20 token, as well as on the TRON blockchain as a TRC-20 token. The minimum purchase for Tether gold is 50 XAUT or 50 troy ounces of gold.

Who issues gold-backed tokens?

For a cryptocurrency to be gold-backed, it must be issued or created by a company that owns and stores physical gold in vaults. For example, DigixGlobal, a Singapore-based company, is behind the popular Ethereum token, DigixGlobal (DGX).

DigixGlobal makes investing in gold more accessible by offering fractional tokens. As such, investors can accumulate gold in small amounts and manage their holdings in real time, as well as participate in exchange-traded funds. The physical gold backing DGX tokens are held in Singapore at the Safe House Singapore vault and in another vault in Canada.

One DGX equals one gram of gold, with a minimum purchase amount of $0.50 for gold-backed tokens, $50 to $600,000 for gold bars, and $150 for ETFs. The cryptocurrency is backed by 100-gram Swiss gold bars from refineries such as Metalor, Valcambi and Produits Artistiques Metaux Precieux.

Another example of a gold-backed cryptocurrency is Paxos Gold (PAXG), offered by the New York-based firm Paxos Trust Company. Each PAXG is backed by one fine troy ounce of London Good Delivery gold, stored in Brink’s vaults in London.

The token is an ERC-20 token, and can be traded, stored and transferred much like any other Ethereum-based token. Paxos requires a minimum purchase of $20 for PAXG tokens and does not have any maximum limit.

What are some of the benefits of investing in gold-backed tokens?

The major advantage of investing in gold-backed tokens is that, unlike physical gold, they are digital and can be divided into smaller parts, making them readily transportable, easily transferable and relatively more affordable.

Another key benefit is that since gold-backed tokens are pegged to the price of gold, they will maintain their value even when other cryptocurrencies are crashing. This makes them a good investment during volatile periods in the cryptocurrency market.

Lastly, some gold-backed tokens also offer additional features and benefits, such as access to traditional financial assets like ETFs. Crypto ETFs track the price of digital tokens and are traded daily, allowing investors to further diversify their portfolios.

Are there any drawbacks to investing in gold-backed tokens?

One of the main risks associated with gold-backed tokens is that they are still a relatively new concept. As such, there is no guarantee that these tokens will maintain their value or that the companies backing them will be able to meet their obligations.

Another risk to consider is that, since gold-backed tokens are pegged to the price of gold, they will go down in value if gold prices crash. Although such a phenomenon can be considered rare, it is still a possibility that investors should be aware of.

Furthermore, certain gold-backed cryptocurrencies have trouble with low liquidity. This can be attributed to a limited investor base due to a lack of trading on crypto exchanges, making it difficult to buy or sell these tokens when one wants to.

Finally, accounting for the actual gold may not be as transparent and clear-cut as accounting for digital currencies, which blockchain technology inherently protects. As such, ascertaining whether or not the physical gold exists and if its storage is secure can be a matter of trust for some investors.