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The rise of gold backed crypto currencies

Thank you to Veridu, our new due diligence partners. On announcing our partnership with them they wrote this article about the rise of gold-backed crypto currencies, in relation to the launch of our own, Goldbloc. You can find out more about Goldbloc here.

We’re very excited to have partnered with the Real Asset Co to help bring their dream of a Gold Backed Crypto Currency to a secure and trustworthy reality. We’re helping to verify all users that wish to make a transaction in order to create a safe and secure currency. But first of all, let’s examine what a gold backed crypto currency really is, and why you should consider using one.

What is a crypto currency?

A crypto currency is a relatively modern form of digital currency that operates outside of the traditional fiat currencies we are used to – i.e. those that a government has declared to be legal tender and aren’t backed by commodities. The most commonly known Crypto Currency is bitcoin. Not to be confused with Bitcoin with a capital B – bitcoin refers to the digital currency, and Bitcoin refers to technology behind it. An important part of Bitcoin is the Block Chain – a database that stores every single transaction ever executed in the currency. A crypto currency is a relatively modern form of digital currency that operates outside of the traditional fiat currencies we are used to – i.e. those that a government has declared to be legal tender and aren’t backed by commodities. Crypto currencies achieve a variety of goals – they operate outside of the banking system so they reduce fees; they are decentralized; the block chain creates transparency and accountability; they are independant of any particular country’s regulations; they are fast and easy to transfer globally; and importantly, a digital currency uses encryption techniques that regulate the generation of units of the currency and verify the transfer of funds. Most cryptocurrencies are designed to gradually decrease production of currency, placing an ultimate cap on the total amount of currency that will ever be in circulation. This can mimic the scarcity (and value) of precious metals and avoid hyperinflation.

Whilst not without criticism, cryptocurrencies are undeniably growing in popularity, and the industry is developing safeguards and gathering legitimacy in leaps and bounds. We’ve been working with BitNPlay for a while now, a bitcoin based online gambling platform. This has been a really exciting process for us, as we’ve been able to prove our ability to help legitimise bitcoin as a currency in a highly regulated industry – proving that our methods of social data verification meet anti-money laundering legislation, and that transactions can be safe and verified.

How gold-backed currencies operate in digital form

Purchasing gold has long been a strategy of the cautious investor in the western world. However, it has often seemed out of reach to the average person – reserved for professional investors and commodity traders. However, recent austerity measures have meant that converting your savings to gold and hiding them away in a vault is becoming increasingly popular in the western world. It is shedding its reputation as something that paranoid survivalists do – we’ve all learned the hard way that banks can’t necessarily protect us like we thought they could. Converting savings to gold is also really popular in Chinese and Indian middle classes as they tend to be more risk averse and keen to hold on to what they have rather than speculate.

Historically, all currencies used to be gold backed – the value of money was fixed to the price of gold, as a relic from times when currency actually was gold. The Gold Standard thus refers to standardised portions of gold that represented standardised values. This practice was abandoned by most countries in the 20th century for a variety of reasons. In the UK, the catalyst was a shortage of silver (silver had since replaced gold as standardised currency), with various solutions that eventually resulted in the banks issuing notes that could be converted to silver once supplies resumed. Eventually, the notes themselves became legal tender.

After the second world war, the Bretton Woods system was introduced, creating an international exchange system where currencies could be pegged to those of other countries. Similar to the gold standard, the “gold exchange standard” allowed easy transfer of currency internationally. Under this system, many countries fixed their exchange rates relative to the U.S. dollar and central banks could exchange dollar holdings into gold at the official exchange rate of $35 per ounce; an option not available to the individual or firm. This meant all currencies pegged to the dollar, had a fixed value in terms of gold. In 1971, a variety of circumstances (included the massive cost of the Vietnam war, and countries like France converting dollar reserves to gold to reduce reliance on the US) lead Nixon to end the international convertibility of the dollar to gold (the Nixon Shock). It was meant to be a temporary change, but in reality the price of the dollar continued to float and since then all legal currencies have been fiat money.

Gold was typically chosen to back currencies as it is easily identifiable, it is rare, it is easily divisible, it is durable and is fungible – an ounce of gold in the UK is the same as an ounce of gold in China, compared to other commodities where the quality or purity could be at issue. Gold backed currencies create an international standard that retains its value, no matter what happens to the monetary authority. An example of why this is important is the fall of South Vietnam, where refugees carried their wealth to the West in gold after the national currency became worthless.

One of the key ‘advantages’ of fiat money is that a government can manipulate its flow in and out of the economy. However, it is exactly this kind of centralised control (and the instability that flows on from it) that crypto currencies are trying to avoid. bitcoin and many others using Bitcoin’s technology (block chain) are not only decentralised, but also have a cap on the currency in circulation which is designed to reduce the risks inherent in floating currencies that can be adjusted and manipulated by governments to suit and keep the value consistent. Cryto currencies are completely transparent, accessible and have significantly lower transaction costs.

What makes a currency anyway?

The basis for forming a currency is far more simple than trying to understand whether they are based on a complex algorithm and digital mining, how the federal reserve works, exchange rates or a commodity like gold. A currency is a simple understanding between two people that an “item” is valuable, and can be exchanged for something else. The most simple example of this is the common pop culture reference of cigarettes in prison. Prisoner’s can’t have money, so they typically exchange cigarettes for items they would like. A bar of soap might be worth one cigarette, a rare bar of chocolate might be worth a whole pack. It all comes down to what the two parties agree it is worth. When it comes to the currency of a country (legal tender), the value is determined by the Government reserve, and it is standardised in terms of the cash value – i.e. a £10 note is a fixed value. However, the goods that can buy vary wildly. But that’s another issue altogether.

So can anyone just start their own currency?

Yes and no. As per the prison example, it is all about perceived value. Just as companies often have contra agreements where they swap services based on what they agree the corresponding values are, you might agree with your friends that your famous casserole is valuable enough to swap for things they have that you need. The problem with this is you have to negotiate how much casserole you’re going to make, factor in whether the meat is the same price it was last week, and go to all the effort of convincing them it is a good trade. Government issued currencies make that easier – everyone understands that a £10 note is worth £10 all over the country. There are plenty of cases where people think it is worth going to that effort, such as drug dealers in the US, who are apparently trading Tide laundry detergent for drugs (fun fact: in New Zealand it is bacon, rather than laundry detergent that is the covert currency of choice). The common thread here, is that there is still some relative standardisation of the product used as currency – whether it is cigarettes, Tide, bacon or your casserole – in order to cut back the time and cost of negotiating what to trade. Legal tender is simple and easy for everyone to understand. The Tide trade, or cigarettes in prison, still only serve a small community where everyone interacts and agrees on the value.

If you want to trade using legal tender, especially on international markets, and even more so if you want to make electronic transactions, there are a great deal of legal hurdles you need to overcome. The market is heavily regulated in order to prevent fraud and crime. One of the key regulations anyone dealing with money (particularly where they create a form of account) needs to comply with applies almost globally. Most financial centers around the world are members of the Financial Action Task Force that require member countries to have Anti Money Laundering legislation (that typically also covers financing of terrorism) where anyone processing financial transactions needs to be identified, and cannot have multiple accounts.

The identification process is referred to as KYC or Know Your Customer. The multiple accounts side is important – you can’t set up 10 different PayPal accounts under 10 different names to transfer money between them, and the onus is on the provider (e.g. PayPal) to stop this from happening. Thus being able to identify who all your customers are (and prove it with certainty) is a really important process for a growing number of online businesses that provide user accounts. We’re working with a range of different companies to meet these regulations, from online gaming site BitnPlay to Payfriendz – an app that allows users to transfer money quickly and easily between friends after a night out or when splitting bills.

We’re excited to see the use of crypto currencies growing, and even more so when users can transact safely and securely online – bringing trust to the internet is what we’re all about. If you’d like to know more about what we do and how we do it, we’d love to hear from you!

About the Author

Jan SkoylesJan Skoyles is Head of Research at The Real Asset Company, a platform for secure and efficient gold investment. Jan first became interested in precious metals and sound money when she met Ned Naylor-Leyland whilst working alongside him in the summer of 2010. Jan then went on to write her undergraduate dissertation on the use of precious metals in the monetary system. After graduating from Aston University in 2011 Jan joined The Real Asset Co research desk. Her work and views are now featured on a range of media including BBC, Reuters, Wall Street Journal, Mail on Sunday, Forbes and The Telegraph. She has appeared on news channels including Russia Today to discuss the gold price and gold investing. You can keep up with Jan's commentary by subscribing to our RSS feed Gold Investment News.View all posts by Jan Skoyles