As part of our Digital Gold series of webinars, the LBMA invited a market expert to share their views on digital gold, its potential and the challenges to be overcome. In this piece, Steven Lowe reveals his insights and predictions derived from 30 years working in the market.
With a tenure of some three decades in the precious metals markets, most of which was spent managing a world-leading bullion bank, I have some longitudinal experience of the gold business. This involvement, combined with my recent role as head of business development for a digital gold provider, has given me a unique perspective of the growth potential for digital gold.
I will start by declaring that I am a believer in the process of digitising assets; the benefits are clear. Much of the revolution that has occurred in the financial system over the past few decades — with the launch of securitisations, and exchange traded funds (ETFs) for example — has been driven by the quest to find secure mechanisms to allow ownership, quick transfer and hypothecation of assets with minimum friction. This evolution has had the added benefit of making ownership accessible to an ever-broadening range of participants. Digitisation is just the next step in this continued progression of financial markets.
Disintermediation and the creation of peer-to-peer transactions are inevitable. These networks will eventually be highly liquid, cost effective and allow access on a scale not seen before. The case for digital gold is compelling: it provides secure, low-cost physical ownership of a regulated liquid asset which is easily accessible and divisible and can move at the speed of the internet. However, despite a plethora of digital gold product launches over the last few years, the total amount invested is approximately $400 million — a tiny fraction of the $10 trillion total market for gold investment, or the $1 trillion Bitcoin market. So why such a small market cap given the upside?
This question was raised during the recent series of LBMA Digital Gold webinars, as well as what needs to change for this transition to happen, and when?
Why Doesn’t the Move to Digital Gold Have More Momentum?
There are six factors limiting momentum:
- As with all new technologies, there is significant inertia to overcome in order to change behaviour. For digital gold to be embraced, many participants must first adopt blockchain technology and then apply this new platform to digital gold. This double adoption creates more apathy.
- For most major institutions, the costs involved with these changes are high. My experience is that most Fintechs have underestimated these switching costs.
- There is no uniformity or fungibility. There are many competing products with little standardisation with respect to product specifications, as well as the underlying technology.
- There are still security concerns, both regarding the underlying physical asset and the digital key. Most companies and markets where digital gold trades are unregulated, and there is considerable legal uncertainty which also potentially undermines the product.
- A major hurdle with many of the digital gold offerings is the cost of marketing and building brand awareness. To date, the high customer acquisition cost limits large scale marketing plans.
- Uncertain regulation. Pending EU MiCA (Markets in Crypto Assets) created in consultation with G20 nations could dramatically impact the future landscape.
This slow momentum is borne out by a variety of observations from participating experts in these recent digital gold webinars, which included:
“We are so, so early - still lots of challenges - including technical challenges. Patience is needed.”
“There are lots of issues still to be worked out when tokenising hard assets.”
“We need to be honest, realistic and pragmatic about what point we sit in the development cycle. There is still a degree of experimentation and trial and error within the digital asset ecosystem.”
“I have to admit there is still risk in this marketplace.”
“The vast majority of gold tokens run on Ethereum but it is not scalable; we will see some migration to other networks.”
“We still need to make access and the user experience much easier”
Looking at the comments from digital gold insiders we start to see why adoption is slow. The other major factor is that the current system, at least for the investor segment of demand, satisfies the needs of both the buy side and sell side reasonably well. Large investors can access the gold market very efficiently via ETFs, Comex or the London OTC market. Retail investors, albeit less efficiently, have access through ETFs or a host of bullion dealers across the globe. There is no doubt that digitisation will bring numerous efficiencies while allowing broader access, but the advantages are not revolutionary and don't necessarily outweigh the implementation costs, time involved or trust issues.
These assessments are a long way from the rhetoric and conversations that were occurring in the market several years ago, yet the pattern perfectly echoes Gartner’s Hype Cycle1 and refers to a typical pattern of technological development.
Digital gold, like blockchain and distributed ledgers, is now transitioning from the ‘Trough of Disillusionment’ into the ‘Slope of Enlightenment.' The hype has gone and now the hard work of building pragmatic and useful products and ecosystems has begun.
What Needs To Be In Place For Meaningful Adoption?
Some argue that for digital gold to become mainstream, an exchange or a sovereign vault needs to adopt a blockchain platform. This would ignite large scale network participation. The network effect would begin to materialise, allowing the digital gold ecosystem to develop and bloom. I believe this scenario is unlikely in the short term. Most experts refer to the need for a ‘replumbing’ of the whole financial system to create digital payment rails. This infrastructure is necessary and, until this occurs, large-scale digital gold adoption will be limited.
Digital gold can’t thrive in isolation; it needs interaction with a greater digital asset network.
Once this new infrastructure is in place, gold may well be one of the first asset classes to migrate, and only then will exchanges and vaults quickly adopt digital gold. The fundamental problem is that gold is too small an asset class to motivate the whole financial system infrastructure build or 're-plumbing' that necessitates mass scale adoption of digitisation.
When Will This Infrastructure Be Built?
Many cite the recent Bank for International Settlements (BIS) and some central banks’ confirmation of their interest in digital currencies as evidence that this ‘re-plumbing’ is imminent. In fact, the announcement merely states these institutions are exploring digitisation, and before adoption begins, the following core features must be incorporated:
- Resilience and security in order to maintain operational integrity
- Convenience and availability at low or no cost to end users
- Underpinning by appropriate standards and a clear legal framework
In January the BIS issued its third paper on Central Bank Digital Currency (CBDC) and despite recent trials by China, Sweden and the Bahamas — and the fact that 86% of central banks are having active dialogue around CBDCs — the paper’s conclusion reinforces my view that innovation isn’t being led from this sector:
“International policy coordination on CBDCs is set to intensify over the coming years as central banks thoroughly review the cross-border and economic implications of issuing digital currencies and technical design choices and operational complexities continue to present practical challenges.”
In my opinion, the market should look to large corporations for leadership in creating the necessary ‘plumbing’ for mass adoption of digitised assets. Several months ago, the JP Morgan coin went live and Facebook’s Diem (previously known as Libra) is to be launched imminently. It’s unclear how these private stablecoin networks will affect the speed of advancement in digital gold, but there is no doubt that these developments are evidence of belief in the future of digitisation and that the digital infrastructure is being constructed.
Bitcoin And/Versus Digital Gold
I am also firmly in the camp that one should not compare cryptocurrencies, more specifically Bitcoin, to gold. They do share two important features — limited supply, and potential alternatives to fiat currency — but this overlooks fundamental differences in terms of their demand/supply dynamics, investment rationale, risk profile, liquidity, performance and the role they play in portfolios. Gold is a physical asset with a 2,000-year track record of storing value, while Bitcoin is a nascent digitally native asset with stellar returns in an environment of excess liquidity and cheap money.
Gold is a known quantity, and poses no threat to central banks or governments who play a significant role in the market dynamics. When it comes to cryptocurrencies, central banks continue to see these as niche products with no widespread use as a means of payment. As long as it remains niche, it will quite likely be allowed to bubble along nicely. But you can expect some regulatory muscle to be flexed when challenging the power of central banks to create and manage currencies.
While I see the two asset classes as vastly different, I do see the continuing acceptance of Bitcoin as a legitimate asset class as good for the future of digital gold. The more companies, asset managers and custodians that build the infrastructure to make cryptocurrencies increasingly accessible and efficient, the quicker digitised hard assets will thrive.
Where Does This Leave Precious Metals Business Leaders in Making Strategic Decisions About The Digital Space?
Business leaders in the precious metals arena are continually asking themselves: “When do I need to get my organisation ready, and how do I position my company to benefit — or, at a minimum — not lose out to this inevitable shift?”
My advice to business leaders in the precious metals space is to watch closely. There is still too much uncertainty about how the market will develop, who will be the winners, and which platforms will prevail. As progress in these areas is made, adoption could quickly mobilise. The business that stays current and agile is well-positioned to benefit.
I recommend watching other asset classes to determine when the digital infrastructure and ecosystem is established enough to facilitate the inclusion and mass-adoption of gold.
It is likely that development will move more quickly in economies with volatile currencies where there is less trust in traditional style banks and there is a high level of comfort with technology. The other force that might accelerate the growth of digital gold is supply chain tracking. There are many companies trying to apply new technologies (based on distributed ledgers) to this critical issue. When a viable solution is found, there will be significant interest and backing from the mining and investment communities.
It is essential to maintain open communication with dominant institutions in order to understand their digital strategy. While many argue that digitisation might disrupt these players, it is far more likely that Fintech companies will look to partner with them. These large competitors control distribution which, as mentioned, is a significant challenge for Fintechs. Other strategic issues (regulatory, security, standards, legal) are more difficult to monitor. The LBMA is committed to both facilitating, tracking and publishing market developments.
Once new infrastructure is in place, digital gold will be widely adopted. Maintaining technological agility, analysing and understanding parallel market developments and building a skilled, digitally literate team will all be essential factors for success.
1 Gartner 2020, Hype Cycle for Blockchain Technologies, viewed 22 March 2021, https://www.gartner.com/en/doc...
2 BIS Papers No 114 Ready, Steady, Go? – Results of the third BIS survey on central bank digital currency by Codruta Boar and Andreas Wehrli Monetary and Economic Department January 2021
Steven spent most of his career as Managing Director of ScotiaMocatta London overseeing all aspects of their precious and base metals business. In 2018 he entered the digital world as Head of Business Development for Tradewind Markets, leading their initiative to digitise precious metals and other assets.
Currently Steven is advising companies in the digital / DLT space as well as working with supply chain tracking technologies to raise the bar for responsible sourcing and create demand and brands for the most responsible LSM and legitimate ASM production.
Find Out More About Digital Gold
The LBMA series of webinars on digital gold examines the various hot topics surrounding digital gold, including opportunities and potential challenges, and discusses whether digital gold will ever be a success – and if Bitcoin and gold can co-exist. You can watch the webinars below.