March 23, 2021

Digital Gold Special Report: When — Not If — Will The Potential Be Realised?

By Steven Lowe

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:

  1. 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.
  2. For most major institutions, the costs involved with these changes are high. My experience is that most Fintechs have underestimated these switching costs.
  3. 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.
  4. 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.
  5. 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.
  6. 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.