Gold forgery crisis demonstrates the need for Bitcoin

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A forgery crisis is disrupting the global gold industry, reported Reuters, emphasizing the need for an easily verifiable store of value—like Bitcoin

Forgeries slip into the gold supply

Gold bar forgeries are seeping into the vaults of the world’s largest financial institutions. Unlike ‘fake’ gold bars, which are made with cheaper metals plated with gold, these forgeries are made with pure gold and instead pirate the branding of bars from reputable mints.

These counterfeit bars allow gold from conflict zones and sanctioned countries, such as Iran and North Korea, to trade at the premium of ‘clean’ gold. Nevertheless, corporations that come into possession of these forgeries inadvertently risk breaking money laundering and anti-terrorist financing laws.

“It’s a wonderful way of laundering conflict gold. The gold is genuine, but it’s not ethically sourced… They look completely genuine, they assay correctly, and they weigh correctly as well,” said Richard Hayes, CEO of Australia-based Perth Mint.

Experts approached by Reuters estimated that several thousand of these bars have been discovered so far, worth anywhere between $100–$300 million. However, the total number of undetected bars is much higher. There are “way, way, way more still in circulation,” said Michael Mesaric, chief executive of gold refinery Valcambi.

High verification costs are problematic

Facilities which find a tainted bar are compelled to audit the entire vault’s reserves. These audits are another expense on the already high transportation, insurance, and security costs associated with precious metals.

“This is such a big problem because it’s very costly to reverify gold at each step, so gold relies on a trusted supply chain. Now the integrity of the supply chain is in question,” said Nic Carter, co-founder of blockchain analytics firm Coin Metrics.

Because of these high verification costs the gold ecosystem tends to centralize. This can lead to undesirable outcomes, argued Carter.

Systems with high costs of verification tend to have “walled gardens,” like the London Bullion Market gold. Only large institutional players are allowed to participate in these marketplaces, giving them favorable treatment over end-purchasers. 

Average people screwed by gold

Meanwhile, the average person is only able to participate after several rounds of markups and middle-men. For physical bullion it’s even worse.

An average person is easily at a 10 percent loss right from the point of purchase for gold bullion. This friction is a large contributing factor as to why physical gold tends to accumulate in financial institutions.

It’s necessary for central banks and financial institutions to hold and settle the underlying metal on behalf of participants. This setup exposes gold holders to additional risks—such as government confiscation. 

The most notable example occurred in the United States in 1933. President Franklin D. Roosevelt’s Executive Order 6102 made it illegal to hoard gold coins, bullion, and certificates in the U.S. Tons of gold were coercively ‘bought-back’ from the public. The reasoning behind the order? To allow the Federal Reserve to increase the money supply (when the U.S. dollar was still on the gold standard) in an attempt to dampen the Great Depression. 

Bitcoin as a superior alternative

Instead of gold, there is a strong argument for Bitcoin as a cost-effective store-of-value.

Verifying the authenticity of a Bitcoin is simple by design. The blockchain organically tracks the origin of any one coin. Anybody can participate in Bitcoin’s open and permissionless network—from mining, to node operation, to sending and receiving transactions.

As Nic Carter argued succinctly in an April essay:

“Bitcoin provides auditability guarantees that are incomparably better than those provided by gold, doing away with the need for a trusted supply chain, costly overhead for storage, or costly inbound verification.”

Through Bitcoin’s use of cryptography, “faking” a coin is near-impossible. The equivalent, double-spending coins, would require billions of dollars in computer equipment to conduct a costly 51% attack. Alternatively, someone could create a provably non-Bitcoin fork—like Bitcoin Cash or Bitcoin SV—and attempt to manipulate public opinion to have it adopted as the “real” Bitcoin.

From the network side, for just $10 a month a person could run a Bitcoin full node to verify the authenticity of coins and transactions. Moreover, those who do not adhere to the network’s rules are automatically excluded without the need for a centralized regulator.

“Nodes will not propagate transactions and blocks which break the rules. In fact, nodes will disconnect and ban peers which are sending invalid transactions and blocks,” stated developer and renowned Bitcoin advocate Pierre Rochard.

In contrast, obtaining the equipment needed to detect the gold forgeries described earlier would cost, at the very least, thousands of dollars. 

One anonymous guerilla-activist summarized Bitcoin’s advantage best.

“Bitcoin is an impenetrable fortress of validation.”

Questions around fungibility

One question that still remains around both gold and Bitcoin are issues of fungibility—the equivalence in value between units.

Tainted gold is not fungible (not equivalent in value) with ‘clean,’ verified gold. Bitcoin has similar issues.  

Because Bitcoin is cryptographically traceable on the blockchain each coin can carry a unique history. These histories may involve hacks or criminal activity, potentially diminishing the value of tainted coins. The magnitude of this discount depends on how heavily law enforcement chooses to police fiat on and off ramps, like exchanges.

But methods for laundering Bitcoin are also becoming more sophisticated. Through the use of coin mixers, or by purchasing mining equipment to obtain virgin BTC, criminals and tax evaders can obfuscate the origin of their coins.

These coins then re-enter circulation. As a result, by merely purchasing coins off an exchange an investor could inadvertently interact with illicit funds. And, potentially be in violation of a slew of anti-money laundering laws.

How will institutions respond?

JP Morgan’s response to the gold situation could foreshadow what may happen next in Bitcoin. The institution simply stopped purchasing gold from Asian refineries, except for a closely-monitored handful. 

Now, if Binance or Coinbase were found to be dealing in tainted BTC would large financial institutions stop doing business with them? How regulators will treat exchanges and users when it comes to the origin of purchased Bitcoin is a question that demands an answer.

The debate around fungibility and provenance also raises questions about base-layer privacy. Now, with privacy-coins such as Monero and Zcash, cryptocurrency users can make transactions near-impossible to trace. How authorities will reconcile these powers against current laws is still highly uncertain.

Bitcoin has value

Like gold, Bitcoin provides measurable utility both as a method of settlement and as a store-of-value. Like gold, Bitcoin can aid people in “opting-out” of the traditional financial system and can even allow citizens to subvert a country’s monetary controls.

These features are part of Bitcoin’s core value proposition—it cannot be controlled, whether it’s used for lawful or unlawful purposes. 

This will bring Bitcoin under intense government scrutiny, especially as governments realize the risks it poses to the financial system. Fortunately for hodlers, stopping a distributed and permissionless system at the scale of Bitcoin’s is a futile endeavor.

As for fake gold bars, maybe blockchain could even solve that problem.

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