Digital gold for a digital world?

I went along to the Centre for the Study of Financial Information (CSFI) lunchtime roundtable on “Gold in the Internet Age” because I am fascinated by the link between gold, money and now (of course) digital money. I take my hat off to Andrew Hilton and his crew because the event was outstanding. The panel of experts was as impressive you would expect from the Institute and the audience were well-informed and just as interesting. The panel comprised Haruko Fukada (who used to the run the World Gold Council, WGC) and Jason Cozens of Glint (an electronic gold scheme), Harry Sanderson from the Financial Times, gold market expert Ross Norman and an Andre Voineau from HanETF who have just launched a gold exchange traded product (ETP) with the Royal Mint.

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This is far from my field of expertise but what I learned, if I interpreted the comments correctly, was that it is low Treasury yields rather than the coronavirus or trade wars with China that are behind the rise in gold prices. The Economist made a similar point earlier in the year, noting that while investors typically rush into gold when geopolitical risk soars, the gold price has been rising for a while, climbing by more than 25% since November 2018. The reason is falling real. If inflation-adjusted interest rates rise, gold’s relative attractiveness falls; when they fall, it rises.

I also found out that central banks are buyers of gold at the moment (so you have to wonder what they know that we don’t!) and also that exchange traded funds (ETFs) have been successful at smoothing price fluctuations in the physical gold delivery market. ETFs in fact currently hold around 3,000 tons of gold, which is approximately one year’s worth of production.

I learned a couple more things that help me to refine my mental position on gold. The first was that the “preppers” (some of whom were at the roundtable, judging by some of the comments) don’t want ETFs, “smart” “contracts” or pieces of paper, they want physical metal and the physical metal only. The second was that while China is a massive importer of gold, potentially looking forward to the time when the US dollar is no longer the world’s reserve currency, the digital Renmibi will not be backed by gold and, as I mentioned in my invited closing comments, there has never been any indication of such from the People’s Bank of China.

Oh and I also learned some interesting things about the gold supply chain. For example I learned that with a gold price of $1640 per ounce, the refiners (the refining market suffers from gross overcapacity) make approximately $0.10 per ounce.

Then on to a couple of businesses working with “digital gold” of one form or another. Jason talked about how Glint is getting along. I remember going to see Jason and Haruko three or four years ago when Glint was just getting off the ground because I was at the time looking at a project (which in the end didn’t go anywhere) to create an Islamic payment product based on gold in the Dubai depository. It wasn’t a new idea then – here’s what I wrote about it in 2007: “Given the desire to transact with the convenience of a card but in a non-interest bearing currency, it would seem to be a straightforward proposition to offer a gold card that is actually denominated in gold.  An Islamic person tenders their chip & PIN gold card in Oxford Street to buy a pair of shoes: to the system it’s just another foreign currency transaction that is translated into grams of gold on the statement”.

Anyway Jason said that Glint is now live in 33 countries, including the USA, and is growing steadily. Essentially, you open a glint account and then you add money to this account which is used to buy actual gold and you have a claim over that gold. The gold backs a payment card so that you can spend your gold with ease. The Glint card is a prepaid MasterCard, issued by Sutton Bank, so that you can spend your gold anywhere that MasterCard is accepted. They are launching their peer-to-peer platform in a few weeks time.

I was reminiscing after the event with a couple of the people there because I remember some of the pioneering work in this space by James Turk of Goldmoney and Douglas Jackson of E-Gold, both of whom I spoke to many years ago about digital gold. Douglas was responsible for one of my all-time favourite quotes from the electronic money world when, a few years ago, I was chatting with him about the trajectory of the gold and he said, in answer to my questions, “it was all going very well, right up until I got indicted by the federal grand jury”. (Here’s a podcast I made with Douglas a few years ago.)

(There are other people who want to turn gold into a currency for idealogical purposes, of course. An example is ISIS, who created a physical gold currency for their new Caliphate. It didn’t really work out that well because all their international trade, including oil, was executed in U.S. dollars. So in spite of the group’s declared war on U.S. hegemony, its economy was actually facilitating U.S. dollar dominance.)

So, what do I think about gold now, after this excellent update?

Gold can serve as a unit of account, means of exchange, store of value and a mechanism for deferred payments. All well and good. However, the digital world is not an electronic version of the analogue world. It is different. It does not have the dynamics of the physical world, and this applies to money just as much as it applies to everything else. This is not a new thought by the way. In fact it was one of the first things that occurred to me when I first began thinking about electronic cash way back in the 1990s. For example, I talk about this unbundling in a paper I wrote called “E-Cash, So What?” that I presented at a Unicom conference “Digital Cash and Micropaymens” in London 1997.

In this paper I noted that money has several different functions in society and gave the standard set of definitions, beginning by noting that as just about every economics book in the world has done, that money has four basic functions:

  • A Unit of Account. The unit of account does not, of course, have to have any physical reality (see, for example, Libra).
  • An Acceptable Medium. Money is useless as a medium of exchange unless it is acceptable to both parties to a transaction.
  • A Store of Value. Unfortunately, inflation can erode the value of stored money no matter what medium is chosen!
  • A Means for Deferred Payment. In order for a society to function, it must support contracts between parties that include provision for future payment.

One of the reasons why I remain slightly sceptical of “digital gold” is that it is the nature of digital to “unbundle” functions of money so that there is no economic niche for the maximum bundle that gold provides any more.

Unbundling

Now, we think of these functions as facets of the same thing (eg, the Pound Sterling) but in the past each of these functions could have been implemented in a different way. In my book “Before Babylon, Beyond Bitcoin” I use the example of the American colonies at the turn of the 18th century. The colonists used sea shells (known as “wampun”) for their medium of exchange, a form of cash borrowed from the Native Americans (who were, in effect, the central bankers of this monetary system, converting the shells into animal pelts which were used to store wealth and for external trade). The unit of account was the English Pound (despite the fact that most of the colonists had never even seen one) and the means for deferred payment was bullion.

A contract, then, might run like this: Person A would contract with Person B to pay “£1 in gold per annum for rent of the field” or whatever. When the rent fell due, it would be commuted to £1 worth of wampun (since no–one actually had any gold or silver, as the English refused to export bullion to the colonies). Accumulated wampun was traded for beaver pelts and these were kept as a store of value.

The economy worked and the “money supply” was based on commodities (the pelts, generally) and stable for many years, until over–harvesting lead to a decline in the beaver population: as pelts became scarce, the “exchange rate” for wampun against pelts rocketed, eventually rendering it a useless medium for exchange.

(The reason why that in the American colonies bullion for coins was scarce because Britain wouldn’t export any, an action that led to one of the great revolutions in money: the issuing of banknotes not as a means of substituting for some otherwise inconvenient means of exchange but as a means of creating money. Starting with the Massachusetts Bay Colony in 1690, banknotes were issued by impoverished authorities to avoid the high costs and uncertainties associated with borrowing and the need to impose taxation.)

Since the time of the American rebellion, the financial system developed in such a way as to do away with wampun and beaver pelts and bullion to the point where the Federal Reserve dollar dollar bills yo are used for everything. But that’s not a law of nature. I came to that understanding from a technical perspective, so didn’t realise that proper economists already knew that technological change would mean that each of these functions of money could be implemented using a different technology, with each function of money implemented using the technology optimal for that purpose. In fact it will be another example of going back to the future, as the functions of money used to be implement quite separately in the past.

Rebundling

Now I discover that proper economists are also interested in the “rebundling” of the functions of money along with other functionality. In their superb National Bureau of Economic Research paper on “The Digitalization of Money” (working paper 26300, September 2019) Markus Brunnermeier, Harold James and Jean-Pierre Landau discuss how innovation unbundles the functions of money and, as they put it, renders the competition between currencies “much fiercer”. Then they go on to discuss the role of platforms (ie, two-sided markets where buyers and sellers exchange multiple products) and explore their interaction with digital currencies.

Their point is that digital currencies associated with platforms (what I called a form of “community currency” in my book) will be far more differentiated than currencies are today because they will differ not only in their monetary functions but also in the functions provided by the associated platforms. As they put it, “a currency’s appeal will likely be governed by other platform features such as information processing algotithms, its data privacy policies and the set of counterparts available on the platform”. This is a really interesting perspective on the dynamics of digital currency and has set me thinking about how both governments and businesses will deal with the digital currencies.

Privacy? Reputation? Relationships? It’s almost as if it’s identity that is new… well, you know.

(After the roundtable, I began to wonder that if ETFs hold approximately one years worth production of gold and have helped to contribute to a functioning market, I wonder if ETF’s holding a years worth of bitcoin production could have a similar impact on the crypto currency market. This led me somewhat and productively have to say to try to work out what a years worth of production of bitcoin’s is before I abandoned the project on the grounds that the answer was irrelevant because bitcoin is a thin and opaque market this and ETF’s would be trivial to manipulate.)