Why the First Round of Digital Gold Companies Failed to Achieve a Free Gold Standard

From 1996-2008 the Internet facilitated the rise of an international digital gold system, with multiple issuers and exchange agents in many countries.  At its peak this system was seeing above 84 metric tonnes per year in gold transactions used for a very wide variety of purposes ranging from commerce to international remittances.

This system was led by e-gold, which was quickly followed by a number of competitors including GoldMoney, e-Bullion, Pecunix and several others. e-gold, which published live transaction statistics, had an average velocity of 78 turnovers per year from 2002 – 2007.

e-gold enabled a network of independent exchange agents to develop.  The competitors to e-gold who were trying to take its market share also had an incentive to allow independent exchange agents so customers could move their gold from e-gold to the competitor.

The international digital gold system was short-lived however, because the companies with the largest market share were based in the U.S.A.  (Critical Flaw #1.)  Once the digital gold community got big enough to get the government’s attention, the U.S. Treasury Department used the Patriot Act to indict all the US-based gold systems for not having money transmitter licenses – shutting down four such companies from 2005-2010; this was over 80% of the market’s volume and user-base.  The government failed to mention to the courts that gold book-entry systems were not considered to fall under the definition of “money transmitter”, as each of them had in fact applied for such licenses which were denied because gold was not defined by the US Treasury as “money” or “currency.”  (e-gold tried in vain for years to get a ruling on this.  The treasury finally ruled in 2005 that e-gold was not currency.  Yet they turned around and indicted e-gold one year later for failure to have a money transmitter license.)

By 2008 all the US-based systems had been shut down by indictment, which left only GoldMoney (Jersey) and Pecunix (Panama/New Zealand) still standing.  GoldMoney prohibited independent exchange agents, and never created its own network of exchange agents. Consequently, GoldMoney never gained traction as a gold money system – though it has been wildly successful as a gold savings system.  Institutions and individuals held their gold in GoldMoney but never spent it.  GM finally turned off the P2P transfer feature in 2011 because nobody was using it and the regulatory cost was too high.  Likewise, Pecunix failed to gain significant traction, though it was never shut down.  It just sat there for a decade doing nothing (while the founder invested in real estate).

The Crime Wave

While the US Treasury clearly had political reasons for persecuting digital gold, e-gold and the other systems were overwhelmed with a wave of digital crime from 2001 onwards.  Hackers, auction fraud and Ponzi schemes were the primary pathogens infecting the digital gold systems.  This was possible because the requirements to open an account usually did not require identity verification. (Critical Flaw #2)  This second major flaw allowed miscreants to open hundreds or thousands of accounts in false names for criminal purposes.

This wave of crime was resisted by digital gold system operator, but their failure to control it gave the US government the pretext it needed to indict and shut them down.

What About Gresham’s Law?

The decade of digital gold proved that Gresham’s Law does not prevent a free international market in digital gold currency.   Bad money only drives out good when the Emperor has the power to force people to accept the two at par.  As has been demonstrated in many countries with failed currencies, if the Emperor is weak, then good money (from elsewhere) drives out the bad local money.  Current examples include Zimbabwe, Somaliland and Panama, all of which use the US Dollar since their local currencies were effectively devalued to zero.

Capital gains tax does create a backhanded link between gold and fiat currency.  As the fiat is devalued the holder of gold finds himself liable for a tax on the “appreciation” of the gold in USD or other fiat.  After paying that tax he has less gold.

No fiat currency is currently pegged to gold, Gresham’s Law cannot be entirely blamed for the failure of gold to circulate as money.  The Emperor of no country is requiring people to accept fiat at a pegged price to gold.  It is only countries with capital gains tax on gold that should see effects from Gresham’s Law.

This means that it should be possible to get gold into circulation again in countries that do not directly tax gold – and there are many such countries in the world.

Unfortunately, the liquidity of internet money was highly appealing to sectors of society that had difficulty opening regular bank accounts—namely criminal enterprises.  Therefore, the failure of the first decade of digital gold currency to create a permanent free gold standard was, firstly because it was unwise to operate from the United States of America, and secondly, due to failure to protect their systems from abusers.

The third flaw of the first wave of digital gold was that all the companies used the spot price of 400 oz gold bars on the London market, and their contracts were deliverable at that spot price.  To cause physical gold to circulate the digital gold must be contractually deliverable in the smallest specie, not the the largest one.  The premium on the smallest specie and the demand for digital gold creates an arbitrage opportunity that will pull gold out of hoards and into the mints to be turned into higher value small specie.

The fourth flaw was that each digital gold company behaved as if they were the only one, and did not consider any kind of common clearing system to allow transactions between accounts at different institutions.  Digital gold requires a common transaction and exchange protocols that will allow interoperability.

If these four flaws are corrected, we believe that digital gold currency can rise again to support a new gold standard in favorable jurisdictions in the near future.

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