Gold-Backed Stablecoins: Bridging the Gap Between Crypto- Gold (Part 3) Educational Video by Three Piece Suit Productions LLC, Michael Adamo, Dan Donaldson is licensed under CC-BY-NC 4.0

The Benefits of Gold-Pegged Stablecoins?

Most of the white papers of the existing gold-tied stablecoins exalt the perks of digital currency backed by the world’s most enduring monetary commodity. Many claim the benefits of  1:1 token to gold-backinglow transaction feesa safe-haven hedge against instability and inflationlow buy-in requirementslow transactional costs for people living in remote areas, and the positive aspects of combing blockchain technology (convenience, decentralization, and honest record keeping) with the enduring value proposition of gold. While all these qualities are maybe enticing, the best way to demonstrate the superiority of golden stablecoins would be to compare them to other similar alternatives. 

Standard Cryptocurrency vs. The Midas of Digital Money

The most notable difference between Bitcoin and a stablecoin like Tether Gold would be the value proposition. Jeffery Tucker was bold enough to claim that the use-value of Bitcoin was a combination of trust (immutable transaction and a public ledger )and a universally applicable payment system structure. Tucker’s interpretation of the Austrian Regression Theorem (p. 407) is audacious, but can a concurrent use-value be equated to a past use value? Such an inquiry may be obtusely pedantic. However, what if a form of money could not only have the trust of a blockchain and internationally fluid payment system conjoined with the storied prior use history of gold? This may very well prove to be a superior form of money.

Beyond the intrinsic value of a gold collateralized cryptocurrency, the price stability of gold is far superior to that of Bitcoin, the highest valued digital coin on the market. As previously mentioned uncollateralized cryptocurrencies are highly volatile( 81 percent annualized for Bitcoin), with wildly fluctuating values. Some commentators have claimed that established gold-backed stablecoins such as Pax Gold have a lower degree of volatility when compared to unbacked cryptocurrencies. However, the degree of price fluctuation can also be attributed to how the currency is managed by the firm holding the gold. It would be shrewd of consumers to look for purveyors of stablecoins offering full reserve (1:1) redemption policies or limits on the capacity (to avoid depreciation). Even if an institution has lower reserve requirements, judicially implementing option clauses to prevent bank runs can help maintain customer confidence. 

Gold-Backed Stablecoins and Gold ETF Funds

Gold Stablecoins are frequently compared to Gold ETF Funds which are the darling of derivatives markets. Despite the criticisms of experts, there are some advantages that gilded Stablecoins hold over ETFs. Gold ETFs are essentially investment funds possessing gold-related assets. One key attribute distinguishing ETFs from their blockchain-based cousins is the fact that “..most ETFs, upon redemption, do not pay out by providing the precious metal; they instead provide an investor with a cash equivalent..”. In terms of liquidity, this may be a bit more simplified than cashing out a share of a gold-backed stablecoin token, as most stablecoins redeem in gold specie. However, if the point is to obtain money of “high intrinsic” value, the ETFs have to trade easy liquid for lesser money (fiat currency), in return. It would be dishonest not to bring up that gold-tied stablecoins do have counterparty risks, but that is a chance anyone takes with any third party holding precious commodities in their care. 

ETFs are purely intended to function as a speculative asset, while in contrast, the smooth settlement and distributed ledger and nationally agnostic nature of blockchain structure make tokens like Pax Gold or Tether Gold better suited for use as a medium of exchange. In all honesty, this will probably best bet for re-establishing a gold standard in the post-Bretton Woods era. The political interests of Federal Reserve officials, banks, and politicians are too embedded in the empty promises of easy money policies of the post-2008 U.S. Monetary regime. The temptation lurks for utilizing Quantitative Easing, bent beyond purely macroeconomic objectives (full employment, price stability), to fund the ends of fiscal policy. (Fiscal QE). The temptation of gesturing such a powerful bargaining chip such as open purse strings would make the idea of a fixed money supply more of an obstacle than a virtue. The number of people who stand to benefit from the current monetary policy of using collateralized debt as money makes a gold standard wide-eyed opium dream. Any transition to gold-backed currency; must come from a private currency; no government would ever revert to such a barbarous relic. It doesn’t matter even if the “End the Fed” crowd gets Ron Paul or Dave Smith in the Whitehouse, a meat grinder of the political process will drown out any monetary reforms. 

The Benefits Over Physical Gold

Beyond the benefits of tokenized gold lending itself as a medium of exchange from blockchain technology, it is worth noting that most transactions are now digital. The ease, portability, and divisibility of a digital version of gold are hard to beat; versus lugging around cumbersome bars or pressed coins or employing costly storage solutions. Like ETF exchanges, gold exchanges or reputable storage facilities may not be accessible in rural areas. There is an affordability factor; instead of buying by the gram, ounce, bar, or coin, investors can purchase a fraction of a coin for as little as $1. They are reducing the logistical and monetary costs of investing in gold. 

Prisoner’s Dilemmas: XVI – Coinbase’s Bankruptcy Policy

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Trust is one of the guiding principles of any business relationship. It is the proverbial glue that has spurred the interest in decentralized digital currency over the past decade. Most people lack the technical literacy to mine Bitcoin or navigate the complexities of blockchain transactions without a middleman, a cryptocurrency exchange. Hence the surge in the popularity of  FTXCrypto.comKraken, etc. One of the earliest entrances to the crypto exchange market, Coinbase, revealed in its first-quarter earnings report that it could hold on to user assets in the event of bankruptcy. Per Fortune:

Coinbase said in its earnings report Tuesday that it holds $256 billion in both fiat currencies and cryptocurrencies on behalf of its customers. Yet the exchange noted that in the event it ever declared bankruptcy, “the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings.” Coinbase users would become “general unsecured creditors,” meaning they have no right to claim any specific property from the exchange in proceedings. Their funds would become inaccessible.

Only subverting the property rights of the investors utilizing the exchange, but it also sullies the image of one of the pioneers of this nascent investment market. In the absence of trust and reliability, there is no reason for patrons to continue doing business with Coinbase. With no guarantee that their investments are secure with the exchange, customers will seek alternative service providers. In effect, Coinbase’s own internal bankruptcy policy has created a Prisoner’s Dilemma. By implementing a policy that would not allow the user to claim their assets in the event of the firm’s financial demise, Coinbase is veering away from the interests of its customers. A foolish decision, but a defection. Patrons will reciprocate this defection by transferring their assets to either cold storage or other reputable crypto exchanges. The unfortunate consequence is that trust in the crypto community will be eroded. Cryptocurrency was founded on the principles of permissionless, immutable, and decentralized transactions and this culture will lose traction due to the infidelity of unscrupulous service providers. Especially considering the absence of trustworthy exchanges, the technical literacy required to participate in the crypto sphere is far too high for anyone without a programming or financial background. Effectively puts the whole claim of cryptocurrency being a path to financial inclusion into question. 

How Adam Smith Beat the Prisoner’s Dilemma

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Constitutional economics founder Gordon Tullock in his paper Adam Smith and the Prisoner’s Dilemma (1985) applies a game-theoretical lens to the Smithian assumption of “the discipline of continuous dealings”. In other words, the famous game theory trope of the Prisoner’s Dilemma actually substantiates the idea that vendors are less likely to cheat customers if there is the chance of repeat business. Often in a Prisoner’s Dilemma, there is a strong incentive for defection, as we do not know how the other person will respond to our cooperation. It’s possible that we sustain a loss due to being double-crossed by the other player, even if the reward is greater if both parties choose to cooperate. In situations where the is a degree of asymmetry in the behavioral information and risks of losing is too high, cooperation is not likely.

Tullock shrewdly points out that market transactions differ radically from most Prisoners Dilemma scenarios in one crucial way. In commerce, our partners are chosen and can change at any given time (p.1074). Meaning that not only is trade less static than the typical Prisoners model, but the characteristic of fluidity also alters the rules of the game. If our trading partner is opting to be non-compliant, we can always choose to do business with someone else. Versus being limited to only one partner who may or may not have an adequate incentive to be cooperative. Also, unlike the controlled experimental conditions under which most Prisoner’s dynamics are observed, in commerce the relationships are ongoing (barring death, bankruptcy, or termination of the relationship) (p.1075). Under such conditions maintaining a positive reputation as a trading partner is much more crucial. Engaging in dishonesty or uncooperative behavior could be the death knell of that relationship.

Due to the desire to establish credibility among other firms and potential customers the “… prisoner dilemma vanishes..”(p.1076). If a firm is not cooperating with its customers and suppliers this will impact future interactions. The Masterpiece Cake Shop case is a classic example of this. Yes, the Cake Shop owners were well within their First Amendment rights to not bake a cake for a gay wedding due to religious convictions. However, that does not mean that their decision was a prudent one for the longevity of their enterprise. The bakery received a massive amount of bad press and poor reviews from socially conscious consumers. Resulting in a substantial loss in revenue. Providing the shrewd observer with an allegory conveying the importance of working with your customer base rather than against them. Ultimately, bad press can be the kiss of death for any mom-and-pop establishment.

Consequently, unfettered trade is uniquely insolated from the occurrence of Prisoners Dilemmas due to being able to choose trading partners for extended periods of time. Tullock details a scenario that reflects the typical cartel arrangement among competing firms in a specific industry. If there are five domain firms and one decides not to comply with reducing production there is not much the other participating firms can do (p.1076). Providing some insight into why most price-fixing agreements have a proclivity of failing. There is no safeguard preventing participants from reneging. The inability to choose our partners also explains the issue surrounding international relations. As we cannot choose our “neighboring countries” (p.1077).

Tullock also describes how to trust in business is established. It goes beyond merely providing a superior level of service or a high-quality product. In society, we are judged on a multitude of criteria, even when some of these characteristics do not pertain to the nature of our business. A business person may attend religious services or engage in philanthropy to cultivate the image of being a “safe partner” (p.1077). In the process of establishing one’s self as a “safety partner” what they really are doing is conforming to societal norms. This is precisely what fostering a good reputation entails. Through conforming to societal norms you are presenting yourself as a trustworthy person, who given a Prisoner’s contingency you will be more apt to cooperate (p.1077). Whereas an individual of a more subversive disposition would be more likely to defect. The true irony is that the customer is able to better trust the vendor than the vendor is the customer. Why? The high degree of costs involved in vetting and validating the integrity of the customer (p.1078). Outside of the customer writing a bad check (if anyone still writes checks anyone more) or is caught stealing it is difficult to monitor the myriad of patrons flowing in and out of the store.

Another consideration arises from the observation of the Public Choice pioneer that penned the cited paper. What if a firm or vendor already has a sullied reputation? It is insurmountable difficult to mend a shattered public image. Those with a poor reputation will “rationally respond” by continuing to engage in off-color behavior and practices (p.1079). From a prima facie standpoint, this self-defeating behavior may appear to be anything but rational. However, due to the high costs of repairing a damaged reputation, it is most effective to continue down the path of poor business practices (p.1080). Once trust has been broken it requires a lot of time and effort to win over the hearts and minds of the public.

Considering all of Tullock’s observations, it would appear that Smith’s notion of “the discipline of continuous dealings” is an enduring maxim of economic exchange. If we are accessible to multiple trading partners and are not held hostage by a monopoly, the potential for a Prisoner’s Dilemma dissolves (p.1081). Tullock also notes that with more potential vendors there is “improved” market information (p.1081). Meaning that proprietors will be much more knowledgeable about industry trends and intricacies of the product market. This partially due to having to keep one leg up on the competition. A bigger impetus for this accumulation of market knowledge is observable trends present in daily transactions. Hence why prices serve as the great information bridge between vendors and patrons. It can also be assumed that in a highly competitive market that customers are also savvier in markets where there are many vendors to choose from. As they are too beneficiaries of the follow of market information.