Digital gold, that is the nickname some have given to Bitcoin. That is because Bitcoin is the first widely used deflationary medium of exchange in the market since gold. Maybe this has opened the door for those who suggest that cryptocurrencies backed by gold could not only be feasible but could actually make the esoteric nature of a decentralized, digital asset, disappear. People are used to gold, but not to cryptocurrencies, the argument goes. Well, that is precisely the problem: backing the unknown with something familiar doesn’t change anything. In fact, the very suggestion that this can or should be done exposes deep logical flaws. Here is why cryptocurrency backed by gold is such a bad idea.
The main strengths of Bitcoin and many other leading cryptocurrencies is that they are effectively decentralized, distributed and transactions on their blockchains are immutable. This system eliminates intermediaries, but anyone who tries to launch a cryptocurrency backed by gold, must re-introduce intermediaries. Gold must be:
- Kept in a safe place
- Accounted for within those physical confines
- Transported in armored vehicles
All these processes require a trusted third party. There is no way – at least not yet – to automate these processes and remove the trusted human component from them.
Gold Backed Cryptocurrencies Would Be Expensive
All the elements required to keep the gold safe and accounted for are also costly. This would make it expensive for users to transact with their cryptocurrencies backed by gold. Costs should also cover insurance, after all any vault that holds gold in a respectable jurisdiction under sound conditions, should be insured. Any service that offers to hold the gold for those operating any cryptocurrency backed by gold should also be insured, which means the cost for that insurance will be included in their fee.
Where is the Gold?
Jurisdiction is also a key component of any cryptocurrency backed by gold. Where will the gold be located? Can all the cryptocurrency holders redeem their coins for gold from that jurisdiction – without considering how cumbersome the transportation of that gold would be? Assuming that the jurisdiction where the gold is located, is also cryptocurrency friendly, will it stay that way? What would be the KYC/AML requirements for holders? How would those KYC/AML requirements affect the transactions that users can make? These are critical unknowns that show how cryptocurrencies backed by gold can run into trouble just by storing the precious metal in the wrong place.
Cryptocurrencies Backed by Gold Don’t Have Backing All the Time
There are other issues that seem to be too complicated to solve when it comes to cryptocurrencies backed by gold. For instance, how can anyone guarantee that there is enough gold to back the number of coins in the market at all times? How would the coin’s creators issue and control the money supply to ensure this is the case and make all their work independently verifiable? Controlling the money supply in a system is extremely complex; there are bound to be mistakes, even if the creators of the coin are honest brokers. These mistakes will effectively undermine the coin itself.
It’s the Devs Stupid!
In fact, if people need to trust other people to keep such a complex system running constantly, then they would be better off if they just trusted in a team of developers who can develop any cryptocurrency that works as advertised. It is easier to invest your trust in fewer people on a project that many in the space can audit and works by itself once deployed.
Cryptocurrencies Backed by Gold can be Scams
This brings us back to the original point, which is that backing something people don’t know well with a familiar asset, doesn’t solve anything. The 2008-09 economic meltdown is a clear example of how this logic can go terribly wrong. Banks and other financial institutions sold mortgage-backed derivatives for years. Buyers didn’t really understand what they were buying, and the scam eventually brought the world economy to its knees.
Once people understand how cryptocurrencies work, they are not likely to want assets that governments can easily confiscate, backing their crypto holdings. Once people acquire the necessary knowledge to understand cryptocurrency at its most basic level, the need to back it with a familiar asset in order to expand adoption, becomes moot. Knowing this, the only people that are likely to stick with the idea of a cryptocurrency backed by gold are scammers.
Scammers Love Gold!
The gold backed cryptocurrency scheme is appealing to scammers because they can combine a few elements to swindle people out of their money:
- The buzz that Bitcoin and other cryptocurrency prices have created
- FOMO, the fear that those who have seen the prices increase have of missing out on the opportunity of their lifetimes
- A lack of general knowledge about how cryptocurrencies work and what they are about
- A promise to protect buyers from wild price swings, offering them a digital asset backed by a well-known physical asset
A cryptocurrency backed by gold is an excellent front for scammers to offer a lot of potential upside and little downside to those who are not well-versed in crypto. There might be honest actors out there launching cryptocurrencies backed by gold, for example companies looking to finance extractive operations at a site that has shown significant potential for gold reserves.
Nevertheless, the scammers are the ones who can really exploit the idea of gold backed cryptocurrencies for financial gain. Honest projects looking to take advantage of how much the idea of gold backed cryptocurrencies shines, are not likely to find enough funding for their endeavors; scammers just steal, so they don’t have a fundraising goal in mind. Cryptocurrencies backed by gold are a terrible idea, no matter how you look at it.