Gold-Backed Cryptocurrencies

What Is a Gold-Backed Cryptocurrency?

A gold-backed cryptocurrency is a stablecoin that is pegged to the price of gold. Its price mimics that of gold based on how much gold is held in reserve by the issuer. Gold-backed cryptocurrencies are intended to maintain a more steady value than cryptocurrencies without reserves, but because they are backed by commodities they are less stable than fiat currency-backed stablecoins.

History of Gold-Backed Cryptocurrencies

A so-called stablecoin is a class of digital currency that attempts to provide price stability by using a reserve asset. Stablecoins have gained traction as they attempt to offer the best of both worlds: the faster processing and privacy of cryptocurrencies, and the less volatile fiat currencies.

Developers and investors have had an interest in creating a gold-backed digital currency since the earliest days of the cryptocurrency industry. Gold-backed digital currencies link one token or coin to a specific quantity of gold (for instance, one token to 1 troy ounce of gold). The gold, like dollars or other fiat currency, is generally held in reserve, and typically, the gold is stored by a third party.

The first digital currency claimed to be 100% backed by gold is believed to have been E-gold, created by Douglas Jackson and Barry Downey, the owners of Gold & Silver Reserve, Inc. E-gold was shut down by U.S. regulators in 2009 for operating an unlicensed money transmitting business and facilitating money laundering and illicit activities.

Gold-backed cryptocurrencies have been classified by regulators as commodity-backed stablecoins or asset-referenced tokens, depending on the jurisdiction you're in.

Concerns About Gold-Backed Cryptocurrencies

Cryptocurrency developers wishing to peg their tokens to gold must be able to back up the value claim, typically by holding that commodity in reserve. The thinking is that if the cryptocurrency fails for some reason, the tokens that investors hold will be redeemable by the issuers in gold (the gold would likely be liquidated for cash payments or electronic transfers).

Holding large amounts of commodities, such as gold, in reserve is often a difficult challenge for pegged digital currency issuers. Gold is very costly to transport and store, so nearly all of it is held in custody for issuers in vaults around the world. The coin's issuers must be able to demonstrate ownership of the gold they claim to hold and rely on third parties to audit these claims for transparency.

Concerns About Holdings

Paxos Gold is the most well-known gold-backed token. It is an Ethereum-based token that claims to be backed by 100% gold. Paxos uses a third party, WithumSmith+Brown, PC, to verify its holdings. In its May 2024 auditing report, Withum reported that it obtained "reasonable assurance" that Paxos Gold is 100% backed by a 1:1 ratio of troy ounces to tokens issued but:

...our procedures did not include the observation of gold held by these custodians and did not include any validation of the quality of gold held by these custodian(s) on behalf of the Company and the PAXG token holders.

In other words, a third-party auditor risked its reputation on evidence provided by other third parties. It's very likely that the claims made are in good faith because they are risking their business reputations, but doubts always remain when physical evidence is not examined and presented.

Investors should carefully examine who stores the gold for a particular cryptocurrency and where it is housed before investing. If the gold disappears for any reason, the value of the token does too. Transparency between cryptocurrency developers, third-party holders of gold, and investors is crucial to building investor trust and, in turn, value in the digital tokens themselves.

Advantages of Gold-Backed Cryptocurrencies

One advantage to gold-pegged digital currencies is that the baseline or minimum value of the token will always be equal to the market value of a fixed amount of gold. Because it is pegged to gold prices, a gold-backed cryptocurrency might also serve as a hedge against falling overall market prices or inflation.

Investors have traditionally used gold and other precious metals to preserve capital during economic downturns—this is also one of the reasons gold-backed cryptocurrencies were created.

The Bottom Line

Gold-backed cryptocurrencies are blockchain tokens pegged to the value of a specific amount of gold held in reserve by the issuer. To be considered legitimate, these assets should be audited regularly by third parties and publish statements at regular intervals for investors to see.

These assets are designed to offer more stability than cryptocurrencies—which have no assets backing them—but they allow for appreciation if the underlying asset's market value rises.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes only. Read our warranty and liability disclaimer for more info. As of the date this article was written, the author owns BTC, ADA, ETH, and XRP.