Asset-backed Cryptocurrencies – Oxymoron or Feasible?

By Medium August 30, 2023 In Blockchain, Cryptocurrencies, Gold

In recent years, cryptocurrencies have exploded in popularity and value. Despite all the bubbles and scandals — such as TERRA & FTX — featured in the last period, one concept gained genuine traction: asset-backed(A-B) cryptocurrencies. But is it possible to create a cryptocurrency guaranteed by real-world assets?

This article will introduce you to these financial instruments.

We will examine what are asset-backed cryptocurrencies, the pros and cons, and some examples.

What are Asset-Backed Cryptocurrencies? How Does it Work?

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Definition of Asset-Backed Cryptocurrencies

Asset-backed cryptocurrencies are digital assets represented by tokens and guaranteed by real-world assets such as commodities, real estate, or art. The value of the underlying assets pegs the value of the token. They are different from traditional cryptocurrencies like Bitcoin or Ethereum, which are not collateralized by any physical assets, relying on market demand only for their value.

How Do A-B Crypto Work?

The process of creating an asset-backed cryptocurrency involves issuing tokens that represent a specific underlying asset. For example, a gold-backed cryptocurrency would issue tokens that represent a specific amount of gold held in a secure storage facility.

They can be then bought and sold on cryptocurrency exchanges like traditional cryptocurrencies, with value of the tokens tied to the value of the underlying assets. So, if the value of the gold goes up, the value of the gold-backed cryptocurrency should also go up.

Examples of Real-World Assets Used to Collateralize Cryptocurrencies

  • Commodities such as gold and silver are a great example of what’s usually used to guarantee a cryptocurrency, with each token representing a certain amount of the commodity held in a secure storage facility.
  • Real estate — with each token representing an ownership stake in a specific property.
  • Artwork and other collectibles
  • Carbon credits, which represent the reduction of carbon emissions, can also be used to guarantee a cryptocurrency.
  • Others such as precious stones, diamonds, and even intellectual property.

A Plausible Example of Use in the Art World:

Imagine a sale for a piece of art. The information identifying it (author, origin, D.O.C., precedent owners, etc.) gets registered on the blockchain.

When the buyer completes the purchase, he will receive the token on top of that blockchain to transfer the ownership.

Pros of Investing in A-B

No “Pump and Dump”

One of the key advantages of investing in asset-backed cryptocurrencies is that there is no risk of a “pump and dump” scheme, where the value of the cryptocurrency is artificially inflated and then crashes.

Cheaper and faster

The cost per transaction is less than 1$ * 10^-3 in most cases. There are other reasons why using crypto would make it cheaper. For example, if governments start recognizing property transfers validated through blockchain, all the associated costs, such as those for notaries, would also disappear.

Cryptocurrencies are quicker than any other payment system, with some ecosystems allowing up to 5000 transactions per second.

Always tradable

Asset-backed cryptocurrencies also offer the benefit of being quicker and always tradable, as they can be bought and sold on various cryptocurrency exchange platforms, 24/7, unlike the underlying assets that may have limited trading hours or may be illiquid.

Cons of Investing in A-B

Regulatory Challenges

Laws and regulations in most countries, even the most developed ones, aren’t yet in place to accommodate this kind of assets, creating regulatory challenges for investors.

Complexity

A-b cryptocurrencies are complex, and require a certain level of knowledge and expertise to understand how they work and how to evaluate their performance.

Limited Usability

A-b cryptocurrencies are still not widely accepted as a form of payment and have restrictions in specific markets.

Frauds and Risks:

The assets collateralizing the cryptocurrency are usually very hard to verify, with chances of fraud occurring. E.g. if the underlying assets are not secured or have a lower value than the one claimed. For this reason, before choosing to invest money into a crypto project, it’s always wise to check if it passed any reputable audits. Of course, these risks are on top of the already existing ones for traditional cryptocurrencies.

Examples of Typical Cryptos Frauds

Here are two examples of typical fraud in the crypto world:

  1. Using fake or overvalued assets to guarantee the cryptocurrency.
    E.g. a fraudster may create a cryptocurrency backed by gold and claim that the gold is of a higher quality or quantity than it is. They may also use fake documents or other forms of deception to trick investors into believing that the assets backing the cryptocurrency are of high value.
  2. Since all blockchain transactions are online, the authentication is through a mobile or pc. What can happen is that while browsing malicious websites, a user signs a transaction, maybe because the website offers free tokens, causing the user to lose all his funds.

The End

In conclusion, the answer is no: these cryptocurrencies are not ready to be adopted soon. Sure enough, they offer some potential benefits, but the drawbacks these could bring are several. Waiting is not wrong here.

Still too early to say whether or not this type of cryptocurrency will become a mainstream value transfer option, but worth keeping an eye on developments in this field.

Stay safe 🙂

The content of this post in no way constitutes financial advice or solicitation of public savings and should not be taken in any way as a service on which to base investment decisions.

This post mirrors solely the author’s point of view and does not represent operational suggestions or advice and should not be taken as predictive support on the future performance of the markets and financial instruments analyzed.

All trades described are intended to be executed in simulated mode at all times, even where not indicated. Each analysis is reported as mere food for thought for popular and educational purposes.

The analyses proposed cannot in any way substitute for the free and informed judgment of the investor, who always acts exclusively at his or her own risk.

No liability is accepted for any consequences that may result from investments based on the contents of this post.

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