by Simon Black, Sovereign Man:
In the year 1120, a French noble named Hugh of Payns took up residence in a former mosque on the Temple Mount in Jerusalem with his brotherhood of knights.
The palace was a gift from King Baldwin II, who ruled the Kingdom of Jerusalem, carved from lands conquered by the Catholics in the First Crusade two decades earlier.
Hugh of Payns’ brotherhood would become an elite force of warrior monks sworn to defend the Holy Land. And because their first headquarters was referred to as the Temple of Solomon, they became known as the Knights Templar.
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Expanding throughout Europe and the Middle East, the Knights Templar’s castles and convents became known for impenetrable security. Along with the order’s reputation for honesty accountability, this made these fortresses the perfect place to house valuables such as important documents, jewels, and gold.
By 1150, a Second Crusade was underway, and Catholic knights were swarming into the Holy Land to fight the Seljuk Turks.
Wars are expensive, and the crusaders needed to bring the wealth to fund their campaigns.
But that posed a problem. The journey to the Jerusalem was long and uncertain, and carrying vast treasures made crusaders a target of thieves.
So the Knights Templar created a solution. Crusaders could deposit their gold in a Templar castle near home, and receive a letter of credit. This letter of credit was good to withdraw the same amount of gold at any other Templar branch.
And to secure their letters of credit against forgery, the Knights Templar developed a coded writing which could only be deciphered by other Knights Templar.
These encrypted, gold-backed letters of credit were essentially a very early form of gold tokenization.
Today there are more than 100 gold-backed digital tokens in the marketplace… though the cryptography used to encrypt the tokens is somewhat more complex than what the Knights Templar used.
But the idea is basically the same— each token distributed represents a set amount of gold held in a vault.
It’s worth asking the question— why not just own physical gold?
Owning gold can certainly make a lot of sense. Physical gold has long been an excellent hedge against major systemic risks. And, more relevant to today’s market environment, gold is heavily undercorrelated to other major asset classes.
In other words, there’s very little correlation between the price of gold and, say, the performance of the US stock market. Or the bond market. Or even the entire US economy.
This makes gold an excellent way to diversify an investment portfolio, especially in a time when there’s so much uncertainty in the market.
Owning physical gold, i.e. actual bars and coins that you can hold in your hand, instead of an ETF or mutual fund, means that you can access your gold whenever you need it.
And if you store it at home, you become your own custodian. There’s no banker, broker, or any other middle man standing between you and your assets. And this is a pretty powerful feeling.
You could also choose to store gold in a private, secure vault. And there are several companies (including prominent security companies) who will gladly charge you a fee in exchange for safeguarding your gold.
This is a great way to have peace of mind about the safety and security of your gold. And if you select a storage facility that’s outside of your home country, you’ll receive some asset protection benefit as well.
But handing your gold over to another company does introduce some counterparty risk; unlike storing gold in your home, using a secure storage company means that there is someone standing between you and your asset. So obviously there needs to be a lot of trust and transparency for that relationship to work.
Similarly, you can also choose to own gold through various financial instruments, like ETFs or futures contracts. But these instruments mean that there is a broker or banker involved. YOU don’t actually own the asset. They do. And that relationship also requires a great deal of trust to work.
Adding ‘tokenization’ to gold ownership adds even more layers of complexity and risk.
First, you have to trust that the organization issuing the tokens actually has the physical gold to back it up.
(We’ve seen this trust violated recently with some stablecoins that were supposedly backed by US dollars… and then it turned out they didn’t have as many US dollars as promised.)
Second, you need to have the confidence that someone else is willing and able to accept your tokens, and to exchange your tokens for real gold when the time comes to redeem it.
Then there are risks associated with the token itself.
For example, was the code properly designed? Are there any security holes that can be exploited by hackers? Can the underlying distributed ledger technology (like blockchain) be compromised? Will a securities regulator like the SEC ban the token, or deem it a ‘financial security’ subject to a laundry list of regulations? Will there be crazy tax implications?
As you can see, the further away you get from being your own custodian, the more risks and complexities are introduced.
Of course there are gold-backed tokens which have been audited to show that the gold backing them really does exist. And there are tokens with an open-source code which can be verified and tested.
But it’s also worth asking— do you even need tokenized gold?