Gold is a physical commodity that has a long history of being traded and used as money for several thousands of years. Nowadays, it’s seen more as a traditional store of value and a safe haven asset for governments, businesses, and individuals.
In recent years, the first cryptocurrency, Bitcoin, has been increasingly emerging as a popular alternative asset to become a digital store of value, among its other features, by leveraging the unique technological properties of decentralized blockchain technology.
Due to their shared perception as a store of value, some have started to explore the merging of physical gold and digital blockchain technology to expand the use cases for both.
In this blog, we’ll further explain this synergy between gold and blockchain and five potential benefits that can be derived from the tokenization of traditional gold.
What is Gold Tokenization?
First, we must explain the basic concept behind gold tokenization, which is a merger of physical gold and blockchain technology.
It achieves this by utilizing a blockchain network to issue or mint digital tokens representing physical gold bullion or coins which can then confer ownership rights to the token holders.
According to the objectives of the issuer, one gold token can represent a specified amount of physical gold. Once the tokens are minted, the token holders can then choose to store, trade, or redeem the tokens for physical gold when desired. This tokenization enables the relative stability of traditional gold to merge with the customization, flexibility, and efficiency of digital assets.
Gold tokenization can be done over several steps. Some of these include:
- Acquire and store the necessary amount of physical gold to tokenize
- Determine the desired gold type to tokenize: 1 oz of gold bullion, gold coins, 1 kg gold bars, etc.
- Define the token type: Fungible tokens or NFTs (non-fungible tokens).
- Create gold proof-of-reserves: Gold requires proof-of-reserves. In some cases, third parties can perform audits that are posted on-chain for enhanced transparency. In others, an oracle network can provide information regarding the reserves.
- Mint tokens: Digital tokens are created on a blockchain network based on gold reserves.
- Transactions: Once the tokens are in circulation, people can start exchanging their tokens, with transactions recorded automatically on the blockchain network.
These are some of the basic processes and there can be additional steps and measures needed, depending on the scope of the gold tokenization project and the blockchain platform selected to issue the tokens.
It must also be noted that varying regulations according to jurisdictions must be considered and followed to ensure compliance.
Read more: EMURGO provides gold tokenization technology to Kinka
Benefit #1: Enhanced Liquidity
One of the main drawbacks of physical gold is that can be relatively cumbersome to store and inefficient to trade.
Given its weight and volume, the precious metal can be difficult to ship, and additional cost factors such as insurance and logistics must also be accounted for. While there are available products such as Gold ETFs, they do not necessarily confer gold ownership rights to investors.
However, when gold is tokenized, there can be enhanced liquidity along with instant ownership rights as blockchain networks run around the clock and never stop, unlike traditional markets. There are no opening and closing hours. This allows for complete around-the-clock trading.
As blockchains are also digital, global networks, potential buyers and sellers in tokenized gold can be onboarded from anywhere, at any time through the internet. It would also make it potentially easier to find a counterparty for trades.
With tokenized gold, there can also be lower transaction costs due to fewer middlemen. In blockchain, the fees charged by the network are typically made transparent before transactions are processed.
Related reading:
- Learn more about the basics of asset tokenization
- What is the potential for asset tokenization in the future?
- 5 reasons why the Cardano blockchain network is ideal for asset tokenization
Benefit #2: Greater Transparency and Accountability
In the past, there have been instances of scams involving physical gold where companies have misrepresented their gold holdings to trick investors. This can be attributed to a lack of transparent accountability from the custodian of the precious metal about their holdings.
Tokenization can potentially solve this by using a decentralized blockchain network which can enable anyone to view a complete record of all transactions and other relevant information whenever desired. These records would be public and verifiable by any party to ensure proper accountability, and also be updated in real-time, without revealing any unnecessary user information.
Tools such as blockchain explorers can offer gold token users the ability to search for any smart contract regarding a transaction or other relevant information for free and at any time.
Within the gold token itself, the token metadata can also include important information related to the issuer, the state of reserves, and its composition, among other things.
Benefit #3: Increased Accessibility
In some cases, investing in physical gold may seem impractical since it could require a rather large upfront amount of capital. This would be needed to not only purchase the gold itself, but also to pay all the intermediaries like brokers, clearinghouses, storage facilities, and more.
However, gold tokenization offers greater accessibility through benefits such as:
- Fractional ownership potential for some gold tokens as it can be split into smaller amounts for those interested.
- International accessibility in real-time as gold tokens can be traded globally.
- A greater amount of people and businesses can potentially participate meaning a truly global pool of traders can form an international market that runs around the clock.
Benefit #4: Greater Efficiency
Metal markets tend to be difficult to enter since they often have to deal with the supply chain of the asset.
Yet, in the case of gold tokenization, decentralized blockchain networks can process transactions efficiently without the need for intermediaries. Token transfers around the world can be processed over the blockchain network with instant settlement, even on a weekend or holiday.
Anyone can also track the status of a transaction as it happens in real-time and not have to rely on third parties for updates on the transaction.
Benefit #5: Integration and Use Cases with DeFi (decentralized finance)
Blockchain opens a whole host of potential utilities for tokenized gold, many of which are not necessarily available in traditional markets.
For instance, tokenized gold has the potential to expand its use cases beyond mere representation of gold and be integrated with DeFi products and services. Liquidity pools, lending marketplaces, collateralized loans, and staking, are just a few of the DeFi services available for tokens in blockchain.
Developers can develop mechanisms to integrate uses for gold tokens into popular DeFi applications depending on user demand.
As blockchain and DeFi continue to grow, this can lead to more potential integration and utility for tokenized gold.
Challenges of Gold Tokenization
Even though there are several potential benefits of gold tokenization, the concept is still relatively nascent as blockchain itself is still an emerging technology. Thus, there are some challenges facing tokenization services and the gold sector in particular including:
- Unclear and varying regulatory requirements as laws and regulations are not uniform across jurisdictions for these kinds of assets. However, this is starting to turn around as blockchain starts to grow in awareness.
- Custody risks as not all third-party custodians are trustworthy. It’s very important to research which custodial services a gold tokenization platform is using to store its reserves.
- Technology risks as there is still an educational gap when it comes to blockchain best practices for users. Additionally, there are still challenges with the security of smart contracts on certain decentralized blockchain networks and the user must always assume all risk, especially when utilizing DeFi services on a blockchain network.
- Crypto market volatility is a risk as the market is still new and can result in periods where assets change prices quickly.
- Other counterparty risks are also present as there is no way to unilaterally reverse a blockchain transaction. If a user sends their tokens to the wrong wallet, there is no way to recover them without the consent of the counterparty.
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EMURGO is a global blockchain technology company and a founding entity of the Cardano blockchain. With experience in asset tokenization platform development, EMURGO is a technology provider for stablecoin issuers, tokenization projects, and more.
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Disclaimer
You should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by EMURGO to invest.
