Gold-backed stablecoins, explained

Stablecoin is the term used to describe crypto-assets that aim to stabilize their value by reference to certain reserve assets — most commonly, the U.S. Dollar. Stablecoins can aim to maintain stability in different ways, each with their own risks.

In the volatile cryptocurrency markets, blockchain-based tokens that aim to remain stable against fiat currencies and other traditional asset classes can be particularly valuable. Popular use cases involve making payments and maintaining the fiat value of a crypto investment during market downturns without needing to sell the asset.

In this article, we’ll discuss gold-backed stablecoins: a type of stablecoin backed by precious metals.

Gold-backed stablecoins are functionally similar to fiat-collateralized stablecoins like Tether (USDT) or USDC (USDC). 

For every token minted into circulation, the issuing company is supposed to keep an equivalent amount of real-world assets aside to guarantee its value. As such, token holders should always be able to redeem their tokens for the equivalent value of the physical underlying asset, or the cash equivalent.

In the precious metals world, the troy ounce (weighing 31.3g) is a standard unit of gold. 

Most popular gold-backed stablecoins are pegged to the value of one troy ounce of gold, such that one token is backed by one troy ounce of gold and should track close to its value at all times.

How does this ensure the price remains stable? The ability to redeem tokens for actual gold means it’s unlikely that the token’s price will deviate too much from the price of gold: 

• Buyers won’t pay more than the market value of gold for a single token.
• Sellers won’t accept less than the market value when they have the option to redeem their tokens for physical gold, or the cash equivalent.

Once minted as, say, an ERC-20 token, a gold-backed stablecoin can be stored in hardware/software wallets and transferred just like regular cryptocurrency. It achieves the same effect as paper gold, enabling holders to trade and store value without the hassle of transporting and securing physical bullion. 

However, its blockchain-based nature opens up additional possibilities that traditional paper gold does not have. Let’s dive into these in the next section.

As a digital analog to a physical asset, gold-backed stablecoins are unrestricted by their physical counterpart. Storing and transporting gold can prove costly, whereas holding digital tokens can be done with minimal resources — and transfers can be completed for nominal transaction fees (dependent on the underlying blockchain used to issue tokens and network congestion). 

Divisibility is another strong advantage of gold-backed tokens. Dividing both bullion and paper gold is difficult (either due to the physical challenge, or due to paper gold’s inflexibility). Conversely, a token equivalent can be programmed to allow division of a single unit into multiple decimal places that can be transparently tracked on the blockchain.

This has the added benefit of making gold more accessible — while an ounce of gold can be costly, 0.00001 of a token can be obtained for mere cents. It also allows for granular precision, ideal for micropayments.

It’s worth noting the instant interoperability of tokenized gold, too. By launching a token on a well-supported network, it’s immediately compatible with a vast range of dApps, DeFi platforms and wallets.

Why hold a gold-backed stablecoin over a fiat-collateralized stablecoin? For the same reasons you might hold gold over fiat currency: it’s a fundamentally different asset class, enabling you to diversify your investments. Many investors allocate funds to precious metals like gold and silver as a hedge against currency devaluation as, historically, gold has kept pace with inflation.

The primary disadvantage of gold-backed stablecoins is shared among all asset-backed stablecoins: counterparty risk (as the involvement of a trusted third party is unavoidable).

Unlike a ‘pure’ cryptocurrency, the tokens themselves have no value without their link to the underlying asset. They can be thought of more as ‘receipts’ than a currency in their own right.

For a real-world asset (RWA) system to work, holders of the digital asset must be able to redeem it for the corresponding physical asset. Therefore, the issuer aims to custody said assets at a 1:1 ratio — and the existence (or correct quantity) of their reserves cannot be 100% verifiable. 

To alleviate concerns, issuers may commit to regular audits by reputable auditors, but this approach still lacks the transparency that blockchain-native cryptocurrencies provide. Ultimately, the sustainability of any collateralized stablecoin relies on users’ trust.

Though less common than their fiat counterparts, a handful of prominent tokenized gold products exist.

Fittingly, the top entrant in the category is Ethereum-based Tether Gold (XAUT), issued by the entity behind Tether (USDT). At the time of writing, it boasts a market capitalization of over $600m and has just under 250,000 units in circulation (each pegged to the price of an ounce of gold).

In the token’s whitepaper, possible use cases are listed as a mobile “safe-haven” asset, a portfolio hedge, or a sovereign-neutral monetary unit.

In second place is Paxos Gold (PAXG), issued by Paxos. Again, each unit is backed by a troy ounce of gold, stored in London Bullion Market Association (LBMA) vaults.

PAXG has a current market cap of $500m+, and a circulating supply of almost 200,000 units. 

Notably, the company behind the token publishes monthly attestations, in which a reputable auditor confirms the redeemable reserves held by the company.

Though discontinued, the Perth Mint Gold Token (PMGT) was an interesting example of a blockchain initiative by a bullion mint, which evolved its existing system for digital gold certificates (GoldPass).

Like its precursors, PMGT was launched on Ethereum and enabled easy gold transfers between users on the network.

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