Tokenized Precious Metals: How It Works and Why It Matters

Real-world asset (RWA) tokenization is one of the biggest trending narratives in blockchain and Web3 due to its enormous potential to revolutionize traditional financial markets and other large asset classes.?

Among the various real-world assets that are ideal for digital tokenization,?precious metal commodities?are one of the most talked about as it is linked to the concept of?hard money. It is common to hear of Bitcoin being referred to as “digital gold” due to its scarcity and store-of-value properties similar to physical gold.??

Tokenization refers to the process of issuing digital tokens recorded on a decentralized blockchain network that represent ownership rights to an underlying real asset, such as stocks, treasuries, commodities, art, etc. Having these assets represented on a blockchain provides unique added value:

• Greater transparency of the asset’s properties
• Increased accountability of both the asset and issuing party
• Better transactional security and efficiency on a global scale
• Faster transaction settlement capabilities
• Widened access to investment options
• Immutability of essential records related to transactions and the underlying asset

These offer immense value for both token issuers/asset holders and potential investors looking to purchase such tokenized assets.

Here, we can outline some common steps in the tokenization process of precious metal commodities and their significance.

Key Takeaways

• Tokenizing precious metals can revolutionize traditional financial markets by providing greater transparency, security, and efficiency.
• Asset Backing: Token issuers must hold physical precious metals to back the digital tokens, with third-party verification ensuring transparency.
• Independent Custodian: A custodian securely stores the physical assets, provides reports, and undergoes audits.
• Token Issuance: Tokens can be fungible (interchangeable) or non-fungible (representing a specific physical piece).
• Ownership and Trading: Tokens are traded on marketplaces, with transactions recorded on the blockchain, while the physical metal remains in storage.
• Wallets and Security: Projects use multi-signature wallets, and users should use cold wallets for security.
• Redemption: Token holders may be able to redeem tokens for physical metal, but there might be restrictions.
• Marketplaces: Tokenized assets can be traded on various marketplaces, but KYC, AML, and necessary regulatory checks are required.

1. Asset Backing

Any?tokenization?issuer or platform first needs to procure the physical precious metal (e.g., gold, silver, platinum, etc.) to back the digital tokens that will be in circulation. For instance, one digital token will be equivalent to a certain weighted volume of the asset. Combined with the token supply, the issuer or platform should be able to transparently demonstrate that they have the assets in custody.

Potential token buyers will want a clear and public verification of the reserves of the physical metal before they start adopting and holding the tokens.?

For this reason, the asset typically is verified and goes through an attestation report distributed by a trusted third party to ensure its existence and purity. These third parties should be independent without a vested interest, so they cannot have personal or business ties that overlap between entities.?

High-quality attestations by industry leaders, transparency, and openness by any project looking to enter this space are key, or they risk making adoption harder.??

2. Independent Custodian

The?custodian?is an accredited party that controls the physical asset and is responsible for its storage. This means they must keep the precious metals safely and securely stored in optimal condition and often provide some form of insurance.

Custodians create reports regarding the stocks of metals held for a client. Additionally, they also undergo regular inventory transparent reports to fulfill regulatory requirements and ensure involved parties that the legitimacy of their business operations.?

3. Token Issuance

Next is the?token?minting process using blockchain technology.?

There are two main?options:?

Fungible:?The tokens are interchangeable with each other, and each represents a homogeneous unit.?

Non-fungible:?The tokens represent a particular, specific piece in the asset reserve, such as a bar, bullion, coin, etc. Each token can be mapped directly to the physical unit it uniquely represents.?

Related reading:

• A deeper look at the advantages of tokenizing precious metals
• Why asset tokenization is the future of financial services
• A basic explainer of asset tokenization

Token metadata?could include essential information related to the physical asset and make it more transparent for buyers who demand such information for authentication and other reasons.?

4. Ownership and Trading

The issued tokens can then be bought, sold, or traded in regulated, secondary marketplaces, allowing potential fractional ownership of the precious metal. Ownership and any transactions are instantly recorded on the blockchain, ensuring transparency and reducing the risk of fraud. Settlements also occur quicker due to the usage of blockchain technology and digital asset wallets, enabling buyers and sellers to meet and transact globally 24/7.

Once transacted, the tokens can move freely from one party to another, but the underlying metal itself remains in storage with the custodian, who keeps the reserves secure. That way, without involving physical transportation, the market moves faster.?

5. Wallets and Security

There are two sides to the wallet question: first on the project’s side and second on the user. On the former, the project’s creators must make sure there are ways to prevent just one person or party from moving assets. This ensures greater security and spreads access across different key stakeholders. In most cases, this is done via a?multi-signature?wallet in which each party or individual must sign off on all transactions.

On the user side, the individual(s) must protect the tokens from security breaches. This is best accomplished by using a?cold wallet?which is not connected to the internet 24/7; instead, it only connects when the owner specifically requests it.

Read more: How Yoroi Wallet provides safe custody of digital assets?

6. Redemption

Token holders can sometimes redeem their tokens for the physical metal, depending on the terms set by the issuer. It’s important to note that precious metals, as commodities, are affected by regulatory oversight.?

Certain countries, for example, cannot receive shipments of gold because of sanctions. Also, sending physical precious metals to remote countries can be too expensive. So, the platform developers need to be very clear on the?redemption?requirements and restrictions.

7. Marketplaces

Tokenized assets can in theory be openly traded on any sort of marketplace platform, provided they are regulatory compliant. For example, if the tokenization is done via fungible tokens, then DEXs or CEXs can be used to trade the tokens. If the tokens are NFTs, then NFT marketplaces work in the same way.?

There are two caveats to this reality, and that comes when minting a token or trying to redeem it. To mint a new token of a regulated asset, the user needs to go through?Know Your Client?(KYC) and?Anti-Money Laundering?(AML) checks. A person who tries to take a tokenized precious metal and exchange it for the physical metal needs to go back to the original platform that made the token, go through KYC and AML, pay for shipment, and, in some cases, also insurance, if it is all even possible.?

Some Market Numbers?

In the case of the gold precious metal, its physical financial market (bars, coins, physically backed gold ETFs, central bank reserves) is valued at around?$5 trillion. Other traditional precious metals have a market of?$290 billion. The latter figure represents only the physical trade of these metals, as the financial markets are much bigger but difficult to estimate.?

Now, if we focus on the market for tokenized commodities which also includes other assets such as oil in addition to precious metals it reached around?$1 billion?by the end of 2024. However, over 97% of this market is made up of tokenized gold, while the remainder is split between silver and platinum.?

Some Examples of Tokenized Precious Metals

As we stated, gold remains by a wide margin the most tokenized precious metal in the market. The top projects are all gold-related.?

Here are a couple of examples:

• PAX Gold (PAXG): it has the largest market cap of any project at $555 million.
• Tether Gold (XAUT): the second in the list, has a market cap of $521 million.

Another project in the tokenized gold space is?Kinka (XNK), bringing gold tokenization to the?Cardano blockchain. Kinka is a gold-backed digital asset, and each token is equivalent to one ounce of premium Japanese gold that meets LBMA (London Bullion Market Association) standards.?

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Disclaimer?

You should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by EMURGO to invest.