Gold has always been a popular choice for investors who want to protect their wealth and diversify their portfolios. Because of its strong reputation and steady value, it has also caught the attention of the crypto world. However, owning physical gold can be difficult—it needs to be stored safely and isn’t easy to use for transactions. With blockchain technology, gold can now be turned into digital tokens, making it easier to buy, sell, and use. In this article, we’ll look at how gold-backed stablecoins work and the benefits they offer.
Gold-backed stablecoins
Before defining gold-backed stablecoins, it’s important to first understand what stablecoins are, as this will provide the foundation for the concept. A stablecoin is a crypto asset designed to maintain the value of a real-world asset it represents. These assets can include real estate, precious metals, commodities, or fiat currencies—anything with a well-established and easily tracked value.
Stablecoins are categorized based on the asset(s) backing them. For example, a gold-backed stablecoin is backed by gold reserves and represents ownership of gold managed by an issuer under a specific arrangement. Gold has maintained its value for centuries, making it a strong candidate for stability in the highly volatile crypto market.
How gold-backed stablecoin works
Just as banknotes once served as representative money that could be exchanged for gold through traditional banks, a similar concept applies to gold-backed stablecoins. The key elements in this historical financial system—banknotes, gold, and banks—can be thought of as variables, with gold being the only constant. In the context of cryptocurrency, banknotes are replaced by stablecoins (tokens), while banks take the form of stablecoin issuers.
In practice, a stablecoin issuer mints tokens on the blockchain, with each token representing a specific amount of physical gold held in reserve. The standard unit of gold is the troy ounce, which equals 31.1035 grams of 24-carat pure gold. This means that if you hold one gold-backed stablecoin, you essentially own one troy ounce of gold, which can be redeemed for the physical asset or its equivalent value in cash (approximately $2,917.30 USD at the time of writing).
For a gold-backed stablecoin to maintain its value, trust in the issuer is crucial. Regular audits must confirm that the issuer holds enough gold reserves to back all circulating tokens. As long as holders believe that their tokens are fully backed and can be redeemed on demand, the stablecoin retains its credibility. This trust ensures that the token’s value remains closely tied to the real-time price of gold in the open market, making it a viable asset for trading and investment.
Benefits of gold-backed stablecoins
- Hedge Against Inflation: Holding gold-backed stablecoins can serve as a hedge against inflation. Historically, gold has proven to be a reliable store of value, especially during periods of economic uncertainty. Tokenizing gold on the blockchain adds further advantages, such as divisibility, making it more accessible compared to traditional gold investments.
- Security and Transparency: Acquiring gold-backed stablecoin is secure and transparent, much like other cryptocurrencies. Stablecoin holders typically use dedicated wallets, which allow for easy verification of ownership. In contrast, purchasing physical gold comes with risks, such as counterfeit products and the challenge of finding a trusted dealer—issues that many individuals lack the expertise or tools to navigate.
- Easy Liquidity: Gold-backed stablecoins are easier to liquidate than physical gold. They are listed on major cryptocurrency exchanges with large trading volumes, ensuring high liquidity. This makes it simple to convert them into USD or other cryptocurrencies at any time. Additionally, trading stablecoins is often cheaper and more efficient than dealing with physical gold.
- Portfolio Diversification: In the crypto market, gold-backed stablecoins help diversify portfolios and reduce volatility. Cryptocurrencies like Bitcoin and Ethereum are highly volatile, so adding gold-backed assets provides stability. Since these stablecoins reflect the value of physical gold, they allow investors to gain exposure to gold without the challenges of storing and managing the physical asset.
What are the Risks associated with gold-backed stablecoins?
- Issuer Credibility and Transparency: The value of a gold-backed stablecoin also depends on the credibility of the third-party issuer. This includes the security of the physical gold reserves, as each issued token should correspond to an equivalent amount of gold. While periodic audits help verify this, traditional auditing lacks the same level of transparency as blockchain-based verification.
- Gold Price Volatility: Although gold is relatively stable compared to cryptocurrencies, it still experiences price fluctuations. These movements directly impact the value of gold-backed stablecoins, making them less stable than fiat-backed stablecoins, which are pegged to government-issued currencies.
- Regulatory Considerations: Regulations surrounding stablecoins vary by jurisdiction, and some countries impose strict requirements on stablecoin issuers. As a result, certain issuers may not be able to operate in all regions, limiting options for users. In extreme cases, some users may have no access to gold-backed stablecoins at all.
- Redemption Limitations: Not all issuers allow holders to redeem stablecoins for physical gold. It is crucial to review the issuer’s policies and understand the redemption process before investing.
- Security Risks: Just like other crypto assets, gold-backed stablecoins are vulnerable to hacks. Cybercriminals use sophisticated methods to target wallets and exchange accounts. To protect your assets, always follow best security practices, such as enabling two-factor authentication (2FA) and using secure, non-custodial wallets.
Examples of gold-backed stablecoins
PAX Gold
PAX Gold (PAXG) is one of the most popular gold-backed stablecoins in the crypto space. It has been available on major exchanges for nearly six years since its launch on the Ethereum blockchain. While physical gold may be out of reach for small investors, Paxos bridges this gap by issuing tokens fully backed by troy ounces of gold stored in London Bullion Market Association (LBMA)-approved vaults. For clarity, the LBMA is the global authority on precious metals, acting as a gatekeeper that stakeholders consult for various services.
What makes PAX Gold unique is that Paxos is a regulated financial institution, providing a level of trust and compliance that most investors look for. Token holders can redeem PAXG for physical gold or its cash equivalent. Additionally, Paxos publishes monthly attestations from reputable auditors, verifying the gold reserves backing PAXG tokens
Tether Gold
Tether Gold (XAUT) is another gold-backed stablecoin that allows holders to redeem each token for a fine troy ounce of gold. Its operations comply with LBMA standards, removing the burdens associated with owning physical gold. XAUT offers all the advantages of a crypto token, including easy transferability, divisibility, simplified storage, 24/7 trading availability, and more.
Tether’s prominence in the stablecoin market further strengthens XAUT’s credibility. Tether’s USDT, the third-largest cryptocurrency by market cap ($141.93 billion at the time of writing), has been operating since 2014. Each XAUT token represents ownership of one troy ounce of gold on a specific gold bar, which can be identified via a unique serial number. The physical gold backing XAUT is securely stored in Swiss vaults and can be shipped upon request to addresses within Switzerland.
Meld Gold
Meld Gold issues gold-backed tokens on the Algorand blockchain, enabling seamless trading and movement of digital gold certificates. Each token represents one gram of gold, securely stored across a network of vaults. Token holders can easily redeem their gold-backed assets through Meld Gold’s redemption partners.
To facilitate physical gold ownership, Meld Gold has partnered with leading bullion companies such as Imperial Bullion, MKS PAMP, and The Perth Mint. During the redemption process, holders can choose from various bullion formats, including cast bars, minted bars, and coins. The tokens are supported on popular wallets like Pera Wallet and Ledger. For instance, users can purchase Meld Gold tokens ($GOLD) with ALGO via Pera Wallet. Once acquired, these tokens serve as proof of gold ownership and can be exchanged for physical gold through authorized redemption partners.
Conclusion
We have demystified the concept of gold-backed stablecoins and explored the mechanisms that make them possible. Additionally, we’ve examined the key reasons why crypto investors may choose to gain exposure to these assets, such as stability, divisibility, accessibility, and other advantages.
We have also highlighted the risks and challenges associated with gold-backed stablecoins, including regulatory uncertainty, security threats, and redemption limitations. Current gold-backed stablecoins were also discussed in detail. Despite these concerns, it is safe to say that the tokenization of real-world assets on the blockchain will continue to grow. Given the rapid advances seen in the crypto space over the past decade.
