November 22, 2023 - 8 min read
Gold’s constrained supply and mining difficulty is looking sensible again to investors as its storage and portability woes are largely resolved by blockchains.
As we know, gold is a physical commodity in that is both difficult to locate and arduous to be mined from the earth. The sheer amount of effort it takes to locate a viable mine, raise and deploy the funds for an operation, and the costs to keep a mine operational are just a few reasons why gold had worked better as money compared to alternatives used throughout history before we abandoned it for fiat paper notes.
It cannot be created or otherwise engineered through some clever process, though we can be sure that people have tried in a number of ways. Honest individuals may dream of happening upon large gold deposits for themselves, while alchemists surely did their best to manufacture gold, and the dishonest ones simply created counterfeit gold coins. Hard money allows for capital accumulation, and people have historically responded to such incentives by creating a lot of wealth.
Gold has been considered a sensible investment for storing value and has been used as both a store of value and medium of exchange for thousands of years. Gold was there in the Renaissance with Italian bankers circulating coins like the Florin, and it likewise funded Napoleon’s efforts to restore glory to France after years of a bloody and disastrous revolution.
Gold may soon need to save the day again as our governments pile onto their debt burdens and dilute the supply of fiat money circulating in peoples’ hands. On the other hand, plenty of ink has been spilled across the pages of history recalling stories of abandoning gold in favor of spiraling debt, currency debasement, and inevitable impoverishment. Let us hope that calmer and more sober heads prevail this time around.
As for solutions, tokenizing gold could result in noticeably more fiscal discipline as people move their money into gold until central banks allow interest rates to rise above the rate of inflation and keep them there. If this is to happen, we’ll need to develop a robust infrastructure for tokenizing, verifying, trading, and redeeming gold in addition to friendly regulatory frameworks within which to work. So, let’s start with tokenization.
Tokenization is the process of making a non-crypto asset into a one that is just such, simply put. Stablecoins are basically tokenized fiat currencies. While Bitcoiners have long run with the narrative that the orange coin is akin to “digital gold,” the moniker has progressively become more of a misnomer of sorts. That is to say that the real digital gold should be tokenized gold, which according to Coingecko has grown past the $1B milestone in terms of market cap.
You see, tokens on immutable public blockchains have far more advantages over traditional financial instruments. Even though gold has a long and distinguished history as being a great store of value, it proved too inefficient as a modern working currency, even after gold coins became standardized under various monarchs, dynasties, and empires.
Gresham’s Law is an economic principle that essentially means that good money drives out bad money. While crude and overly simplistic, the gist is that people tend to hoard good money and spend bad money. It is only by the threat of overwhelming force that governments are able to impose the use of bad money via legal tender laws.
People around the world commonly convert their local currency into a stronger currency, most commonly the USD, though it was gold not long ago. Others argue that Bitcoin is simply a natural progression of Gresham’s Law. Internal strife stems largely around whether the digital commodity was discovered or invented by Satoshi; but alas to give this debate it’s due would lead us astray so we will leave it for another time. See A Catalyst for Peace for further reading along these lines.
Tokenizing gold means that each digital token is backed by a specific amount of physical gold. Before tokenization can occur, there has to be physical gold backing the tokens stored in vaults. The purity, weight, and other specifics of the gold are examined and documented by experts.
To ensure the authenticity and purity of the gold, it undergoes an auditing process. Oracles like Supra’s DORA can be employed to validate that any gold undergoing tokenization has gone through a rigorous examination so that it meets every standard.
Next comes the token generation event. Using blockchain technology, digital tokens are created to represent the physical gold which is used as collateral. For example, token issuers could set 1 token to represent 1 gram of gold, and so each token issued on a blockchain must never exceed the gold which is stored in their vaults.
Once the tokens are minted, they can be sold to investors, traders, or anyone interested in owning gold in its much more liquid, digital form. The tokens can then be traded on whichever blockchain they’re issued on between peers, as well as on centralized, custodial exchanges.
For instance, PAX Gold (PAXG) tokens are on the Ethereum blockchain and are backed by one fine troy ounce of gold, stored in LBMA vaults in London. PAXG tokens can be swapped for other ERC-20 tokens on Uniswap, and also can be purchased on Coinbase and subsequently withdrawn to external wallets for safekeeping. The risks associated with using centralized exchanges are commonly tolerated due to the convenience of their fiat on-ramps and liquid markets.
Next, self-executing smart contracts give the tokens in circulation their salability in that buy and sell orders are conducted and then recorded on immutable blockchain ledgers. The publicly decentralized nature of these immutable ledgers is critical for establishing a trustless or trust-minimized network with 24/7 liquidity.
If token holders wish to redeem their digital tokens for physical gold, they’ll be able to do so through the token-issuer’s platform. The specific redemption process will vary depending on each issuer’s policies, but delivery is undoubtedly going to be expensive and cumbersome.
Regular audits of the gold stored in vaults are conducted to ensure transparency and confirm the amount of collateralized gold matches circulating supply of tokens. These audits are then reported to blockchain oracles who validate it in a quorum vote and write it on-chain by leveraging advanced cryptography to optimize for security, speed, and costs. We’ll cover the details just below.
Security is paramount in such complex systems. Both the digital tokens and the physical gold need to be safeguarded, and a robust oracle with blockchain-like properties needs to be employed for interoperability between all parties involved. Of course, the blockchain itself provides security regarding the on-chain ownership of tokens, while the physical gold requires additional security measures to secure it like guarded vaults, surveillance, audits, insurance, and the cost of maintaining compliance with local regulations over time.
Oracles are third-party services that provide smart contracts with external information. Since blockchains can’t natively access data outside their own networks, oracles validate cross-chain and off-chain data so that a variety of ecosystems can interoperate effectively. This most often takes the form of price feeds, which are reported in trading pairs like ETH-USDC, for example.
Smart contracts can use the current spot price of this pair in order to execute based on price-event triggers set in advance. To illustrate, one could agree to swap PAXG for USDC if the price relationship reaches one’s desired target. As mentioned, it’s crucial to verify that the physical assets backing the tokens exist and maintain the proclaimed quality and quantity.
Oracles can report the price of tokenized gold in just the same way as fiat or crypto assets, providing the opportunity for smart contracts to maximize liquidity between the gold tokens and the most in-demand assets. If audits reveal any discrepancies between vault storage and the circulating supply of tokens, oracles relay this information to a smart contract, which then takes corrective action, like burning the appropriate amount of tokens.
Tokenizing assets requires adherence to specific regulations, including KYC and AML laws. Oracles can be useful in communicating relevant data to regulatory agencies to ensure compliance on an ongoing basis. Once this is fully automated, we can reduce compliance overhead by orders of magnitude across a number of sectors both public and private.
However, while oracles are invaluable, they also introduce security liabilities if not carefully designed. If they are too centralized or lack comparable security parameters to their blockchain counterparts, they are rife for exploitation. That is, if an oracle network is compromised, for example, it can provide faulty data to smart contracts, which then execute erroneously. The damages from this could lead to unacceptable, catastrophic losses.
Tokenizing gold offers several advantages, such as fractional ownership, global liquidity, and public records of vault storage. However, while the issue of portability gives tokenized gold a salient use case, there are still issues of redemption and trust which must be addressed. This is not something taken lightly and requires a strong network of oracles to validate the authenticity of the gold as well as the amount held as collateral reserves.
Supra’s DORA is poised to play a crucial role in the tokenization process and the subsequent security and auditing of tokenized assets. Their validation of external data ensures that tokenized assets remain backed by real-world value and that the associated smart contracts operate accurately. The future of global markets is a hyper-liquid one in which the trading of tokenized real-world commodities never ceases, just as DeFi never sleeps. So, don’t sleep on DeFi, either.
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