What the Perth Mint Gold Token can teach us about Cryptocurrency Investing

“I’m not sure it answers a need that people have”

Just over three years ago, the Perth Mint announced that it was creating a new cryptocurrency, which came to be known as the Perth Mint Gold Token.  At the time, Today Tonight did a story and asked me to make some comments.  Frankly, at the time I couldn’t see the market demand for this.  It seemed to me that they had succumbed to the then-current hype around crypto. Creating a purported type of stablecoin that was backed by physical gold was simply creating a solution to a problem that didn’t exist.

Since then I have done a lot more work and study in blockchain technology. Frankly, I had totally forgotten about the PMGT (as it turns out, spoiler alert,  so had most everybody else).  Then I got one of those ‘this happened three years ago’ reminders regarding the story, so I thought I would see what had happened.  

A timely intervention it seems.  Several weeks later the Perth Mint ran into some other problems and subsequently, they announced that the PMGT is now being discontinued.

Regardless of the merits of the project or the manner in which it was implemented, the PMGT turns out to be a microcosm of the lessons that investors need to consider when looking at crypto. 

Investing in cryptocurrency can be a daunting task, especially given the volatility and complexity of this emerging asset class. To make informed investment decisions, investors must assess the merits of any particular cryptocurrency and understand the reasons behind its creation.

Remind me: why Blockchain and Cryptocurrencies?

Check out my earlier posts here and here for more detail on this important topic for sophisticated investors.  In summary, Blockchain technology is designed to create a decentralised, immutable, and scalable system for storing data records.  As such, it has the potential to both create and transform industries in that it reduces the costs of compliance (amongst other things). 

To transact on a blockchain, you need to use cryptocurrencies that are native to that particular blockchain. Ethereum blockchain was innovative in that it developed a standard that allowed different cryptocurrencies to use the same blockchain. 

However, valuing cryptocurrencies can be challenging, resulting in high volatility that makes them difficult to use as a store of value. To address this issue, stablecoins were developed – cryptocurrencies that are backed by an asset such as fiat currency or gold.

Investors can learn from the PMGT example that it is essential to understand the business model behind a particular cryptocurrency before investing. It may be innovative, new, and exciting technology, but the same rules that apply to 'bricks and mortar’ businesses need to be used when considering investing in cryptocurrency.

So why Perth Mint?

Over three years ago, the Perth Mint announced that they were developing the Perth Mint Gold Token cryptocurrency, designed to track the price of gold. Each PMGT was backed by one ounce of gold. At the time, they promoted it as an innovative solution to the challenge of valuing cryptocurrencies. 

Personally, I felt it was an over-engineered solution to a need that didn’t exist.  There are plenty of other ways to buy gold if that is what you want to do. Physical gold is easy to buy,  there are gold ETFs (also backed by physical gold), and professional traders simply transact based on the price of gold in a derivative fashion. Alternatively, if you are after a stablecoin, why not use a US dollar stablecoin rather than a gold stablecoin, given that the gold price internationally is a derivative of the value of the US dollar?

Unfortunately for the Mint, it seems I had a point.  Three years later, the PMGT is about to be discontinued.  The stats for this aren’t flattering.  Despite the Mint holding billions of dollars worth of gold, the market cap was only ever a couple of million. There were only about 1125 tokens ever issued. This lack of adoption is evident in the low number of addresses with PMGT.  The top wallet holds 67% of the supply, and the Top 10 wallets account for nearly 92% of the tokens that were minted. 

Perhaps more damningly, the PMGT failed to be true to its label.  Despite its 1 to 1 backing with physical gold, its price varied materially from the actual gold price. Chart 1 below shows the daily prices of PMGT and Gold for the past year, revealing material variance between the two. 

Perth Mint Gold Token and Gold Price comparison

 

Chart 2 highlights the variation as a percentage of the daily gold price.  For a clever trader, there could be a potential opportunity for arbitrage here, though I suspect the limited liquidity in PMGT may have proved difficult.

Perth Gold Mint Token Price as a percentage of Gold
Sources: 

PMGT prices – https://finance.yahoo.com/quote/PMGT
Gold Prices: www.gold.org
Note: there may be some slippage on daily pricing due to time differences in captured prices however, any effect is consistent across the period illustrated

 

What is surprising is how much the price of PMGT varied from the actuarial physical gold price – in both directions.  At times it moved over 10% from the asset it was supposed to track.  Although the overall PMGT price trend roughly followed the physical gold price, it significantly lagged behind physical gold for the last 6 months.

Why?  Frankly, I have no idea but I suspect the cause is structural and related to the tight ownership spread, small market cap and low liquidity.  There simply wasn’t sufficient volume for price discovery to operate efficiently.

So what can we learn?

Investors can learn from the PMGT example that it is essential to understand the business model behind a particular cryptocurrency before investing. It may be innovative, new, and exciting technology, but the same rules that apply to ‘bricks and mortar’ businesses need to be used when considering investing in cryptocurrency. 

Part of me admires the quest for innovation that the Mint demonstrated with this product, but equally, I wonder how much market research they did before agreeing to proceed.  This whole exercise would not have been cheap to run and will have cost someone a lot of money.

To me, there is no doubt that Blockchain technology will play an increasingly important role in the future of finance. Cryptocurrencies Investors should consider the use cases, market demand, and systemic risks of each cryptocurrency. In all of this, it pays to invest in professional advice, not only for the specific investment but also in seeing how it fits into your overall investment objectives.

Like to know more about how I work with my international investor clients to achieve their goals?  Contact me and tell me your story!

Should you have Cryptocurrency in your Investment Portfolio?

If you accept – as I do  – that blockchain is an important and transformative technological development, then it makes sense for investors to ask if they should get exposure to this through owning cryptocurrency.  

You don’t have to be a crypto maximalist to take this position.  For all the sceptics and initiates:  regardless of the value of the tech, crypto as a trading asset is here to stay.  There is too much volume, value and usefulness for cryptocurrency in world markets for it to go away (despite arguably the recent best efforts of the SEC in the USA who continue to base their approach on a court ruling from 1946).

But don’t take my word for it: For some good background reading to understand the macro tailwinds for blockchain technology, refer to both The Network State by Balaji Srinivasan and the amazingly prescient The Sovereign Individual by James Davidson and William Rees-Mogg. At the very least, you will get an insight into some of the broader societal changes that support this technology.

However, I am not talking to the traders here – I am looking at the role, if any, crypto should play for investors.  That is, those that build and invest wealth through classic Modern Portfolio Theory portfolios.  Those folk who remember that diversification is the only free lunch the market offers.

It’s in this area that there is some fascinating research. Analysts have shown that adding cryptocurrencies to a portfolio has the effect of both increasing returns and decreasing volatility. Interestingly, this effect plays out whether it is a conservative or aggressive portfolio. 

How Much Cryptocurrency Should You Have in Your Portfolio?

Cryptocurrency in portfolios is like salt in cooking – too little and you still have a healthy, if not somewhat bland, meal – but too much and it can become inedible.  Many articles you will find quote experts that settle on a  figure of 5%, but this seems to me like a compromise with little science behind it (which is ok, just be honest about it). 

Andrianto (2017) suggests that an optimum allocation of crypto should be between 5% and 20% depending on your risk tolerance. Other studies suggest even broader ranges, but these are very academic in nature and assume certain technical aspects of portfolio constructions that rarely translate into the real world (see the Geek Corner for more detail). 

In my experience, unless you are living and breathing crypto as a trader, even the most aggressive investor (remember, investor, not trader) 20% is a level that will cause you to miss sleep at night no matter how much you embrace volatility. Balancing this research with my own experience, I believe a range of between 1% and 5% of your total investable wealth is a more appropriate starting point.

Like other assets, depending on the quantum, your investment can be dollar-cost averaged into the market.  In most situations, these investments should be seen as very long-term exposure to future technology trends.  Of course, in future rebalancing, they can either be topped-up or profit taken depending on the performance within the time frame being reviewed.

 

Cryptocurrency in portfolios is like salt in cooking - too little and you still have a healthy, if not somewhat bland, meal - but too much and it can become inedible.

What Should I Buy?

The specific crypto purchases need to be determined by your adviser.  But, just like the good old days in Australia when a diversified portfolio was BHP, Rio and the 4 banks; it is hard to go past Bitcoin and Ether:

  • Their combined market capitalisation is nearly 3 times larger than the next ten cryptos combined
  • They are the most liquid
  • Continued technological advancements for both blockchains should act as a tailwind to their acceptance

Alternatively, look at what crypto ETFs are available in your jurisdiction (if any).  These make life much easier but you need to keep an eye on the management fees.

As some final steps, consider what strategies, like ‘staking’ or liquidity pools, you may adopt to enhance your yield and also understand how your particular jurisdiction treats crypto from a tax perspective.

Conclusion

It’s true – the world of cryptocurrency can be both confusing and intimidating when first approached.  The combination of jargon, technological minutiae and poor user interface can make it very easy to put in the ‘too-hard’ basket.  

Don’t let these factors dissuade you.  Do your research, talk to your adviser, and make a decision that is best for your own situation, having regard to your cash flow and need for future access to equity.

Like to know more about how I work with my international investor clients to achieve their goals?  Contact me and tell me your story!

Geek Corner

For all the academics in the room, here’s some further reading on some of the research mentioned in this blog:

Should Investors include Bitcoin in their portfolio?  A Portfolio theory approach. A very interesting summary of a 2020 paper. 

The Value of Bitcoin in Enhancing the Efficiency of an Investor’s Portfolio – looks only at BTC but also includes some helpful background for new investors.

Investing with cryptocurrencies – evaluating the potential of portfolio allocation strategies  A paper from 2018

The Effect of Cryptocurrency on Investment Portfolio Effectiveness  Andrianto and Diputra’s paper referred to above.  It is also back in the distant past of 2018, an eon in crypto terms but interesting reading.

 

Why Blockchain Matters to International Investors

Several years ago, I began researching the hype around blockchain and cryptocurrency. It quickly became clear that the technology was not a mere fad, but I wanted to separate the hype from the substance. There seemed to be much promise for international investors, especially those looking to hedge against sovereign risk.  I had received enough inquiries from clients in both Australia and Switzerland to warrant further investigation.

What I found was a dearth of reliable information available for international and sophisticated investors trying to make sense of how blockchain could add to their wealth. Technology experts struggled to explain their work in layman’s terms and mostly knew nothing about economic fundamentals.  At the same time, the financial expert commentators didn’t really understand anything about the tech. 

Frankly, most of what I could find was 95%, ahem, less than useful. So, I dipped my toes in the water.  I bought and sold crypto, experienced the process as a user, made some trades, used both centralised and decentralised platforms, investigated wallets.

That might not sound like much, but apparently, it is more than the current chair of the SEC has done! Through this practical experience, I learned enough to conclude:

  • There really was transformative technology potential in blockchain
  • The user experience was light years away from the average person in the street being able to embrace it
  • Crypto was a fast-moving chaotic field as everyone from charlatans to regulators tried to get their heads around the opportunity.
  • Blockchain was important enough that it could not be ignored or dismissed

I needed to develop some rigour around my understanding. So I decided to spend 12 months doing a Graduate Certificate of Blockchain in Business through the Royal Melbourne Institute of Technology, so that you didn’t have to. 

What exactly is this Blockchain thingy?

Blockchain is simply a way of digitally storing data, but with some very important differences from conventional methods. It is a decentralised ledger system that uses cryptography to secure data entries and prevent tampering. 

Put another way: Blockchains can store any digital data, in the order that it happens, in a way that cannot be altered.

The key feature of blockchain is that it is immutable; no one can modify the data without everyone else being aware of it.  This makes it incredibly secure. Because all transactions are permanently stored on the blockchain, exactly as they happened, in the order that they happen, you don’t need to trust the other participant. This has made blockchain technology attractive for many different industries, from finance to healthcare.

By contrast, consider a database: say, for example, a company’s customer records. These are stored in one central location, with any number of operators having access and editing control over the data. This has advantages, but it also introduces vulnerabilities. Blockchain prevents all this because it synchronises any changes across multiple copies, in different locations, using cryptography to ensure that they can’t be altered.

A study in 2010 estimated that fully 35% of US employee time was spent on various forms of compliance. Blockchain promises to eliminate much of this expense through its cryptographic advances, at significantly less cost. This is a promise that businesses cannot afford to ignore.

Blockchain is simply a way of digitally storing data, but with some very important differences from conventional methods. Blockchains can store any digital data, in the order that it happens, in a way that cannot be altered.

But I Keep Hearing About Crypto!?

Most of the hype in the media has focussed on the price – and crazy volatility – of cryptocurrency prices. But what is crypto anyway? 

Blockchain networks don’t operate for free. Keeping them running and maintaining all these copies and security has a price.  That price is denominated in the particular cryptocurrency of the specific blockchain.

Think of it this way: Blockchain networks can be likened to countries, with the cryptocurrency token being its native currency.  For example, Ethereum has Ether just as Switzerland has the Franc. Solana has Sol the way Australia has the dollar. Trick answer: Bitcoin has, well, Bitcoin. As the first serious Blockchain, they didn’t give the token a separate name.

The problem arises when trying to put a value on each of these. Blockchain is so new, most of its applications are within the crypto universe, rather than extending anywhere to what is known as RWA – Real World Applications. And when they do, the poor User Experience and price volatility work against consumer adoption (not to mention various jurisdictions’ tax departments).

The result is that most cryptocurrency valuations are speculative, or at best, self-referential. They don’t have any underlying business model to support a valuation. Or, unlike fiat, they don’t have the backing of a national government and long history of yields. Where yields are offered, they are usually in the form of the same or another token, rather than fiat (which, if you talk to a libertarian, is actually the point). I am not saying this is necessarily a bad thing, just another point to understand when you next read of some lucrative yield-farming opportunity.

See the chart below for an example of this regarding Bitcoin. It makes the case that Bitcoin is cheap because it is cheap in relation to itself, and in the past when this ratio was this low, people started buying again. To me, this mixes causation with coincidence, and I am reminded that the market can stay ‘cheap’ a lot longer than most people can stay liquid.

Bitcoin price relative to Total Bitcoin Market Capitalisation

However, focusing only on the prices of crypto is fine for speculators, but this misses the bigger picture for investors. In the long term, cryptocurrency valuations are largely driven by the long-term demand for the underlying blockchain. Look at cryptocurrencies, not as an investment in and of themselves; but as a way to create exposure to the technology that powers them.

Limitations of Blockchain

When I first started my journey of understanding, it seemed that perhaps Blockchain was the cure for many ills, based on some of the claims of its proponents. But like most things, Blockchain is not a perfect solution.  There are compromises that have to be made when constructing a blockchain architecture. 

These compromises are known as the trilemma of blockchain architecture and must be taken into consideration when evaluating a blockchain’s suitability for a particular task. The trilemma consists of three components: security, scalability, and decentralisation. In order to maintain a high level of security, blockchains must sacrifice scalability or decentralisation; this means that either the network can only process a certain number of transactions per second or it must rely on trusted central authorities for validation.

Blockchain developers are obviously working on minimising these issues and blockchain performance – and hence applicability – will continue to improve exponentially. Any business considering using blockchain needs to seriously consider whether it is the right solution before they spend a mountain of cash to discover that maybe a good old-fashioned database is a better answer. Australian Stock Exchange yes, I am looking at you.

Opportunities for International Investors

Real gains can be made when existing businesses are able to use blockchain technology to improve their profitability and productivity. For example, businesses can use smart contracts to automate payments or enable peer-to-peer trading without the need for intermediaries. It is important to identify which businesses are integrating blockchain technology into their processes and how transformative this can be to their bottom line. International investors should also keep an eye on developments in the regulatory space, as regulators are beginning to create frameworks for governing cryptocurrency transactions.

For example, leading businesses such as Microsoft, Amazon and Walmart have all integrated blockchain into their business processes to improve back-office performance. IBM has sponsored an entire blockchain – Hyperledger – as a platform to assist their clients to implement blockchain applications in a private environment.

What Next?

The lesson here is to look through the hype and distraction that various actors and their agendas have put onto blockchain and cryptocurrencies, and consider how this incredible technological advance will transform existing legacy businesses. Scandals such as FTX and Terra/Luna are examples of human frailty set in within the theatre of new technology, not a refutation of the technology itself.

Blockchain is a transformative technology that will, over time, completely change the face of how companies do business with each other. As an international investor, don’t ignore this or put it in the too-hard basket. Understand the basics of how it works and look to see how companies are intending on using it to improve their results.

Want to know more?  Contact me here for an initial discussion to explore how we might work together.

Further Reading – Geek Corner

Want to really sink your teeth into some extra reading?  This short but sweet selection will give you a great start:

Bitcoin: a Peer-to-peer Electronic Cash System the original whitepaper that launched it all, from the pseudonymous Satoshi Nakamoto

Ethereum Whitepaper by Vitalek Buterin, one of the co-founders of Ethereum.  Ethereum is the leading blockchain for business applications.

Messari Crypto Theses Every year, Messari publishes a whopping insight into all things crypto.  It is a rollicking read and the 2023 edition is no different.