Why Tokenized Gold: Benefits for Emerging Markets and the Role of DeFi

Introduction

In the dynamic world of financial innovation, tokenized gold has become a prominent investment option. Tokenized gold represents physical gold in a digital format using blockchain technology, providing enhanced access, liquidity, and security to investors. This approach is particularly advantageous for emerging markets, where traditional financial systems may be less developed. This article explores the benefits of investing in tokenized gold, especially for emerging markets, and its potential to revolutionize financial inclusion and economic growth.

What is Tokenized Gold?

Tokenized gold is a digital token that stores the ownership rights to physical gold bullion or bars on a blockchain. Each tokenized gold token represents a specific quantity of physical gold held in reserve by a custodian.

Unlike gold ETFs, with tokenized gold, you directly own the gold; you’re not buying shares in a fund or an underlying asset. Tokenized gold was created to allow investors to easily buy, sell, and transfer gold securely on-chain.

The tokenization of gold offers greater accessibility, liquidity, and transparency for individual and institutional investors. It also makes fractional ownership (partial ownership of assets) easier for investors.

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Real-World Asset Tokenization and DeFi

As decentralized finance (DeFi) continues to expand into financial services, we're witnessing the tokenization of real-world assets such as artwork, intellectual property, real estate, corporate securities, luxury cars, commodities, and gold. Recently, HSBC launched a platform using distributed ledger technology (DLT) to tokenize institutional clients' physical gold stored in HSBC’s London vault.

HSBC's tokenization process creates a ‘digital twin’ of physical gold, specifically loco London gold, stored in its vault. This tokenized gold can be traded between HSBC and institutional investors through the Evolve single dealer platform or an API. This digital representation of physical gold holdings is integrated into HSBC’s infrastructure, allowing clients to track their tokenized gold trades and positions, creating a more efficient and cost-effective way to manage gold investments.

John O’Neill, Global Head of Digital Assets Strategy at HSBC, noted, "In addition to demand for native digital assets, we are seeing appetite for tokenization solutions that can maintain a link to specific real-world use cases, such as gold."

What is Gold Tokenization?

According to Chainlink, gold tokenization involves creating digital tokens on a blockchain that represent ownership rights of physical gold bullion or coins, typically stored in a vault by a third party.

The Gold Tokenization Process

1. Custody: A trusted entity securely stores physical gold in vaults.
2. Token Creation: Digital tokens are issued on a blockchain, each representing a unit of the stored gold.
3. Verification: The gold's authenticity and ownership are verified and recorded.
4. Tokenization: Tokens are backed by the gold's value and can be traded or held electronically.
5. Transparency: Blockchain records provide transparency, allowing investors to verify the gold's existence and ownership.
6. Trading: Tokens can be bought, sold, or used for various financial purposes, offering flexibility and access to gold investments in digital form.

How is Gold Tokenization Different from Gold ETFs?

Gold tokenization digitizes physical gold into blockchain tokens, offering direct ownership and potential transparency. In contrast, gold ETFs represent ownership in a fund holding physical gold, offering indirect ownership. The two have different custody, liquidity, transparency, and cost structures.

Buying Gold from HSBC

HSBC’s Evolve platform allows institutional investors to trade tokenized physical gold through a single dealer platform or an API.

Safety of Tokenized Gold

Gold has long been regarded as a safe haven asset, retaining value during economic downturns. As a Tether Gold spokesperson mentioned, “Gold has a long history as a store of value. Unlike fiat currency, gold maintains its value over time.” Tokenized gold offers similar stability and security, combining the intrinsic benefits of gold with the advantages of blockchain technology.

However, tokenized gold carries risks, including market volatility, regulatory uncertainties, custody risks, potential liquidity challenges, security threats, technology vulnerabilities, and diversification concerns. While blockchain provides transparency, proving ownership of physical assets remains a key concern.

The US Federal Reserve recently highlighted the broader financial stability implications of tokenization, noting risks such as firesales in tokenized markets impacting traditional finance (TradFi) markets, volatility transmission, and automated DeFi margin calls triggering liquidations.

The Potential of Tokenized Gold for Emerging Markets

Financial Inclusion

Globally, approximately 1.7 billion adults lack access to traditional banking services. In Africa, 50% of the population remains unbanked or underbanked, limiting economic participation and growth. Financial inclusivity is crucial for unlocking economic potential, as more cash in the system leads to increased savings, capital for enterprises, and job creation.

Gold as a Hedge Against Inflation

Gold is seen as a hedge against inflation, appealing to governments and investors in emerging markets. However, physical gold is often inaccessible and expensive for lower-income countries, limiting its adoption.

Tokenized Gold: A Solution

Tokenized gold offers a secure, accessible investment option, lowering barriers to entry and enabling fractional ownership. This is particularly beneficial in high-inflation countries, allowing retail investors to preserve their purchasing power and save for the future. For example, Zimbabwe has benefited from gold-backed currency, reducing month-on-month inflation by 30%.

Challenges and Opportunities

While tokenized gold may not revolutionize lower-income countries overnight, it can pave the way for greater financial inclusivity. The rise of blockchain technology and digital wallets allows anyone with a smartphone to participate in the digital economy, addressing proximity issues to financial institutions.

Tokenized Gold Projects

Several notable tokenized gold projects include:

• Tether Gold (XAUT): Each token represents one troy ounce of gold stored in a Swiss vault.
• PAX Gold (PAXG): Each token represents one troy ounce of gold held in Brink’s vaults.

These projects highlight the growing interest in tokenized gold, with trading volumes exceeding $23 million per day.

Risks of Tokenized Gold

Despite its benefits, tokenized gold involves risks such as compliance challenges, custody security, market volatility, and the potential for scams. Investors should conduct due diligence and select reliable providers to mitigate these risks.

Conclusion

Tokenized gold offers numerous advantages, including accessibility, liquidity, security, and cost efficiency. For emerging markets, tokenized gold can enhance financial inclusion, economic stability, and technological advancement. As blockchain technology continues to evolve, the adoption of tokenized gold is likely to grow, providing new opportunities for wealth preservation and economic development. By embracing this innovative investment vehicle, emerging markets can unlock significant potential, fostering economic growth and improving financial well-being.

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