The Appeal and Problems of Gold

Gold has a long history as a medium of exchange in the global financial system. From its malleable and nonreactive nature, to its shiny and scarce properties, gold has remained a store of value and safe-haven that is largely independent of seasonal or industrial fluctuations. 

Gold can be a cumbersome asset when purchased in large quantities; it can be inconvenient to store safely and difficult to transfer across borders easily. This means that currently available forms of gold trading all come with their own trade-offs. London’s OTC Bullion Market is the largest spot gold market, but is primarily reserved for institutional customers and members of the LBMA and physical delivery of gold via the OTC market can take several days too. 

Traditional retail gold outlets allow consumers to buy fractional amounts – but purity is hard to guarantee unlike LBMA gold, and retail mark-ups can be high. Investors alternatively have the choice of buying gold directly from governmental institutions, such as the UK’s Royal Mint, though the drawbacks of this option include issues around safe storage and the higher premium often associated with Royal Mint gold purchases. Another option for gold exposure is through gold ETFs or futures – which is the closest of the listed options to Paxos Gold’s implementation. ETFs track the price of an underlying asset and can be sold like equity securities. Many gold ETFs are also backed by physical gold, such as BlackRock’s iShares Gold Trust. However, buyers of these ETFs do not own the underlying gold and, in most cases, cannot redeem physical gold via the ETF. Instead, they trade synthetic positions that track spot gold prices. Thus far, when it comes to traditional gold investing, the price for liquidity is a lack of direct ownership. With the scene now set, let’s dig deeper into the mechanics of Paxos Gold and its proposal. 

This report will introduce tokenisation, Paxos Gold, and how Paxos maintains its peg to physical gold. We also aim to assess if Paxos provides a genuine solution to a need in the market, that in turn unlocks the asset class to a new generation of investors, or whether it fails to improve on the existing access to this asset class.

Each Paxos Gold (PAXG) token represents one fine troy ounce of a physical gold bar held under the custody of Paxos Trust Company in London Bullion Market Association (LBMA) vaults. PAXG is an ERC-20 token, meaning it can be used across the Ethereum blockchain’s extensive network of wallets, exchanges, and DeFi platforms. PAXG tokens can similarly be divided into units of up to 18 decimal points, making it incredibly easy to own a fraction of a gold bar for market participants of all types – though as we explain later, there is a minimum PAXG token size required to redeem physical gold.

Paxos Gold and its Pricing Mechanism

PAXG can be considered a stablecoin. There are generally four types of stablecoins: commodity / asset backed, fiat backed, crypto backed, and algorithmic. PAXG is of the first type, utilising commodity backed collateral in order to maintain its peg. Paxos claims to back every PAXG token in circulation by one fine troy ounce of a London Good Delivery gold bar, secured safely in LBMA vaults in London. London Good Delivery gold bars are subject to stringent regulation ensuring their fineness and purity. Furthermore, only Paxos Trust Company can create (mint) and destroy (redeem) Paxos Gold tokens as needed. This structure, however, requires trust in a centralised authority – the custodian, Paxos Trust Company.

As long as users purchasing or holding PAXG tokens trust that Paxos has reserves of physical gold that are equivalent or greater in value to the tokens in circulation, they also trust that it can be redeemed for an equivalent amount of gold at any time – it is by this minting and redemption at par mechanism that Paxos attempts to maintain the peg to physical gold.

As shown in the chart below, PAXG has tightly maintained its peg to the offchain dollar price per troy oz of gold. Gold prices are constantly fluctuating and Paxos uses streaming prices provided by its partner StoneX to ensure the price at which a PAXG token can be minted or redeemed is close to the real-time price of gold on the London gold market.

Minting and Redemption of PAXG tokens play a key role in maintaining the peg to gold, and understanding the full lifecycle of a PAXG token is useful here. We will cover this at a high level in order to primarily focus on the peg system, and later explain some of the nuances in purchases and redemptions of PAXG tokens. 

Minting & Redemption

The life of a PAXG token starts at its issuance. A user must create an account on Paxos and be KYC’d through the Paxos platform in order to purchase or redeem any PAXG tokens. 

Once approved, the user can fund their account in order to mint PAXG tokens. The most straightforward way to do this is a user funds their account by depositing fiat currency and then uses that fiat currency to mint their desired amount of PAXG tokens directly on the platform.

The second is applicable only to users who have a Loco London unallocated gold account (a type of account used in traditional gold trading such as the London gold market, where account-holders do not own specific quantities of gold outright, but instead hold a claim on a pool of gold held by an institution, like a bank).

Within the (centralised) Paxos platform the user is shown a streaming price quote provided via StoneX’s oracle, which is updated once every 5 seconds, for the price of one troy ounce of London Good Delivery gold. They can then place their order by entering the size of the purchase, and any fees associated with their transaction. If happy, the user can accept this and new PAXG tokens will be minted and sent to an Ethereum address provided by the user. As we explain in more detail later, this system means Paxos is required to have enough physical gold at hand to ensure any newly minted PAXG tokens can be backed.   

Suppose a user deposits the equivalent of 5 ounces of gold using fiat currency, they would be sent 5 PAXG tokens, which were newly minted and issued via their purchase. From here, the user can treat the PAXG tokens like any other ERC20 token – transfer PAXG to different addresses (only minting and redeeming PAXG requires KYC, not general trading or holding of Pax Gold tokens), interact with DEXs, or make trades using their tokens. 

Redemption

Redemption of PAXG follows a similar process to minting but in reverse. While anyone with an Ethereum address can hold or trade PAXG, in order to redeem PAXG tokens, users must create an account and be KYC’d. The user can then redeem their PAXG for either the equivalent value of fiat currency or physical gold by converting their PAXG into USD for example.

Paxos would then destroy (burn) those PAXG tokens, removing them from circulation, and provide an equivalent amount of fiat or gold to the user (gold delivery details are described in full here). In this way, redemption results in the removal of the token on-chain and transfer of fiat / gold.

DEX Pricing

Relying on an oracle to deliver a market-traded gold price means that minting and redeeming PAXG tokens on Paxos’ website platform is only possible during traditional market hours. However PAXG can be traded 24/7 on decentralised exchanges at the prevailing market price of the token without this restriction.

The promise of minting and redeeming PAXG tokens at the prevailing market gold price (and trust in Paxos to deliver on that promise) offer an arbitrage argument that keeps the 24/7 DEX price of PAXG tokens close to that of gold.

Suppose that the market price of PAXG (e.g. the price on a DEX) is greater than the 1:1 redemption guarantee by Paxos (e.g., the price on Paxos platform which is the minting and redeeming price of PAXG equivalent to spot price of one ounce of physical gold): 

• In this scenario, traders can convert fiat to mint more PAXG tokens, then sell those tokens on the secondary market (DEX) which would increase the circulating supply of PAXG. 

Conversely, suppose the market price is less than the 1:1 peg:

• Traders are incentivised to buy PAXG tokens at the market price (DEX), redeem their PAXG tokens on the Paxos platform (which would then reduce the circulating supply of PAXG). 

Both of these arbitrage opportunities would eventually work to bring the market price discrepancy back towards the 1:1 peg during market hours, as the arbitrage can be executed immediately, but also during the intermediary periods as the basis of either spot gold or the token would be eroded once the market reopens. 

Minting & Redeeming Process in Depth

Minting

Equipped with the knowledge of how PAXG maintains its peg to gold, we can explore the nuances of token purchases and redemptions in more detail. 

As mentioned, all users looking to purchase (mint) new PAXG tokens or redeem PAXG tokens into fiat or gold must be KYC’d through their account on Paxos. There are two types of user accounts: individual and institutional – such as hedge funds or trusts. 

Minting and redeeming is only possible during the operating hours of the London gold market which is Sunday 6pm ET through Friday 5pm ET. The market is also closed on weekdays from 5-6pm ET and applicable to gold market holidays. Outside of those opening hours, orders cannot be placed on the Paxos platform. Minting and redemptions via fiat currencies are processed using the FedWire or SWIFT system and thus can take up to 3 business days to settle – this means redemptions are not immediate and subject to traditional weekend and bank holiday hours. 

Purchases and redemptions are also subject to ‘creation’ and ‘destruction’ fees which are listed below. The minimum purchase amount is 0.03 PAXG tokens –  this comes from a minimum creation fee equal to 0.02 PAXG (thereby meaning in this example, users pay 0.02 PAXG in creation fees in order to purchase 0.01 PAXG).

If a user is registered in the U.S. and chooses to mint PAXG using fiat currency, they will only be subject to the creation fee listed above. International customers (anyone outside the U.S.) are subject to a fixed $30 minting fee on top of the variable creation fee depending on their purchase size. Users looking to avoid this fee (or U.S. customers who prefer not to make a fiat purchase) also have the option to mint PAXG using crypto tokens. Some of the cryptocurrencies supported by Paxos’ platform include BTC, ETH, UNI and SOL.

Redemption

Redeeming PAXG tokens can be done in four different ways. We will cover the three options via the Paxos platform and then the fourth  option, which is through Alpha Bullion, an official partner of Paxos. 

The first is redemption for USD (this is the only supported fiat currency for withdrawals). Just as with minting, users are shown a price quote provided via StoneX’s oracle which changes every 5 seconds – if happy with the quote, users can accept and redeem their PAXG tokens for U.S. dollars. This type of redemption will be subject to the variable destruction fee as well as a fixed $20 redemption fee for U.S. customers and a $30 fee for international customers. This can make small fiat redemptions quite costly for users.

The next two redemption options involve allocated and unallocated gold. Allocated gold refers to the situation where a user possesses enough PAXG tokens to redeem an entire London Good Delivery gold bar(s) allocated to their PAXG holdings. This option requires a user to possess slightly over 430 PAXG tokens in order to also cover the destruction fees of redemption. Users that possess any multiple of 430 (plus the equivalent amount of PAXG needed to pay the destruction fees) will also be able to redeem more than one physical bar. Users will be sent an email by Paxos with instructions on how to receive delivery of their London Good Delivery gold bar(s) though the contents/ process described in that email does not appear in any documentation. Paxos’ terms and conditions also state the user will be responsible for the delivery of their bar(s), not Paxos.

Paxos directly states that it can take “several business days” for a user’s account balance to reflect their redemption and that Paxos will make “commercially reasonable efforts to convert and/or redeem your PAXG quickly”. This means despite every PAXG token transparently being backed by a portion/ full gold bar, redemption for a physical gold bar is not an instantaneous process and may take a few days. 

Paxos users can also redeem PAXG tokens into their Loco London unallocated gold account. Users can enter the quantity of PAXG they want to redeem along with their Loco London unallocated gold account details on Paxos’ platform and will receive the corresponding unallocated gold ounces to their Loco account.

Put more simply, unallocated gold accounts are very popular in traditional gold trading. Users are not entitled to specific bars of gold as with allocated gold – rather they have a balance in their account reflecting a more general entitlement to an amount of gold which is held by one of the clearing members/ banks for Loco London gold such as HSBC or JPMorgan. This is essentially analogous to a regular checking account held with a bank and allows for easier trading in and out of gold holdings, without the need for physical delivery. So whilst their PAXG tokens are backed by specific, allocated gold, this redemption method does not involve redeeming that specific gold. This option can be useful for users who own a significant amount of PAXG but short of the 430 needed for an entire bar of gold. 

The last redemption option is likely the most important one for retail traders as it allows PAXG tokens to be redeemed for physical gold at smaller quantities than just an entire gold bar. This can be done through Alpha Bullion –  a platform collaborating with and created by Paxos which only takes PAXG as payment. 

Users need to register on Alpha Bullion’s platform and be KYC’d (in a similar manner as needed on the Paxos platform). Once KYC’d, Alpha Bullion allows PAXG holders to redeem their tokens for nine different gold products which vary in size and purity from one gram to one kilogram. We note that all options here are of lower quality gold than the LBMA gold that backs PAXG tokens and shipping is currently limited only to the U.S. and Canada. The gold used to facilitate these redemptions is from Bullion Exchanges, a precious metals retailer located in New York.

Token Ownership

Up to now it is apparent that only the users who hold an incredibly large number of PAXG tokens are able to redeem it for the LBMA accredited gold. Users with smaller holdings are not completely disregarded, however, through Alpha Bullion redemptions, though the quality of gold here is of a lower standard. It is also apparent that the fees for minting and redeeming can be quite costly and in some cases not worth it for smaller amounts. However, the final key question yet to be answered is the legalities of token ownership – which may make up for some of the drawbacks listed above.

Paxos Trust Company, the issuer and custodian of the PAXG token, is a New York State-chartered trust company regulated by the New York State Department of Financial Services (NYDFS). The NYDFS ensures consumer protection through frequent regulatory examinations of Paxos to ensure it maintains a substantial capital reserve and uphold standards of transparency and accountability in line with NYDFS rules. It does not just regulate Paxos at a company level, but each Paxos product such as PAXG is directly regulated by the NYDFS. 

Ownership of PAXG tokens are equivalent to a warehouse receipt, where each token a user owns represents a legal, fractional share of ownership in a specific, allocated London Good Delivery gold bar held by Paxos on behalf of the token holder. This means that when a user mints a PAXG token, they are effectively entering into an agreement with Paxos, granting them the legal right, governed under New York law and regulated under the NYDFS, to the full economic value of the gold represented by their token holdings.

As long as the tokens remain unredeemed, holders’ ownership will be tied to that allocated gold. Once redeemed however, this relationship changes. If redeemed for fiat or crypto, holders give up their fractional ownership of the allocated gold and the warehouse receipt ownership no longer applies. If redeemed for unallocated gold, users exchange their claim to the specific allocated gold for a general entitlement to unallocated Loco London gold. If smaller amounts are redeemed via Alpha Bullion, given that Paxos cannot chip off smaller amounts of a single bar, users give up the entitlement to that specific amount for gold of their choice. The only scenario where tokenholders physically receive the allocated gold tied to their tokens is if they redeem 430 PAXG tokens (or multiples), i.e., entire gold bars. 

Regardless of where a tokenholder lives, should they have any problems in their redemption of PAXG tokens they can file a complaint with the NYDFS, as they are the main regulators of Paxos. Ultimately though, not only are investors reliant on a centralised provider (Paxos) to manage the storage of the physical gold that backs each token, non-U.S. users are reliant on U.S. legal enforcement rules when it comes to ownership.

In order to aid the redemption of Paxos Gold, the gold bars allocated to each PAXG token are often reshuffled automatically. Most users are less likely to purchase 430 PAXG tokens at once, or equally own 430 PAXG tokens at any one time, meaning multiple users will usually own different parts of the same bar. This means when a user makes a purchase, the newly minted tokens can typically be allocated to part of a gold bar Paxos already stores.

As an example, suppose a customer buys 100 PAXG and gets partial ownership of a gold bar A, alongside other PAXG holders. If the same customer then buys 330 PAXG tokens the next day, instead of owning a portion of bar A and another of bar B, Paxos would automatically reallocate ownership to give the customer full ownership of A or some other bar in its entirety. The partial owners of bar A prior to this would be reallocated to another bar. This helps account for redemptions and new minting of PAXG tokens and does not require any action on the end of the user. At any time, users can use the Paxos lookup tool, enter their ETH wallet address and see exactly which gold bar they have been allocated. 

Paxos has accounts with Brink’s bullion vaults in London which store the allocated gold corresponding to PAX Gold tokens. For sourcing gold, Paxos has an account with StoneX, an established gold wholesale institution, that buys and sells gold to Paxos as needed for token issuance and redemption. In the exception that PAXG tokens are minted and cannot be allocated to their physical gold bar holdings, Paxos state they will “promptly” act to maintain the 1:1 ratio. This means that if you mint 5 PAXG tokens and there isn’t any available gold to allocate these tokens to, Paxos Trust Company will hold in custody an additional five troy ounces of London Good Delivery Allocated Gold, though this means there will be a brief period where those new tokens are not backed. 

Paxos also produces monthly attestation reports verifying the number of PAXG tokens in circulation and the amount in troy ounces of gold held by Paxos Trust Company. The most recent October report can be found here. This means that whilst Paxos does have complete control in minting and destroying PAXG tokens, the monthly attestation reports mean customers must trust that upon any redemptions, the relevant PAXG tokens will be removed from circulation and the redemption assets will fall accordingly. Though we note, these reports are only produced on a monthly basis. 

Given Paxos’ role as a qualified custodian, it also means the gold that backs PAX Gold tokens is held in a segregated account separate from Paxos’s assets. This makes PAXG tokens bankruptcy-remote – gold bars cannot be used to pay Paxos shareholders or creditors in the case of bankruptcy and so tokenholders will always have their claim to the gold.

Wrapping it Up 

Paxos Gold represents a fascinating innovation in the tokenisation of real world assets – a trend we have seen grow particularly in this current crypto cycle. PAXG tokens give their holders the flexibility of blockchain-based ownership with the stability and trust of gold-backed collateralisation. It helps individuals own smaller pieces of gold that are more liquid to trade and transfer. 

However, despite its merits, PAXG is not without limitations. For those that want to redeem LBMA standard gold, they are required to hold 430 PAXG tokens. Smaller amounts of physical gold can be redeemed, though of lesser purity and standards. Smaller redemption amounts are also subject to fiat fees which can be significant relative to the redemption size. However, Paxos certainly does make it easier for individuals to have gold exposure, backed with real gold and redeemable at smaller quantities.

Users holding PAXG tokens ultimately still require trust in the centralised custodian, Paxos Trust Company, to manage the gold reserves effectively and transparently. Those outside the U.S. are relying on U.S. laws and legislations, under the NYDFS, should they have any problems with redemption. Finally, given that minting and redeeming can only be done in traditional gold trading market hours, redemption of gold or even fiat may not always be instant.