Introduction to the Gold Economy

I am currently the admin of a private loan program based on DXGold, in addition to being an active DXMerchant for the last 9 months. I was doing a google search under 'dxgold' and found this forum.

After reading the archived threads regarding DXGold here, I wanted to contribute to everyone's general knowledge about just what digital currency is.

I got the impression that this imformation would dispel some of the confusion regarding how an exchange agent gets paid.

In order to understand how an exchange agent makes money trading/exchanging digital currency, it would help to know what digital currency is.

I found this article useful in clearly explaining the functionality of a
gold-backed digital currency account, and serves as an excellent
introduction.

The article is included in it's entirety, sourced from
http://goldeconomy.com/

After reading this a few times, you should have a clearer idea on exactly
how a gold-backed digital currency [like e-gold or e-bullion] functions.

Doro Ajani

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"Gold Currency: Gold Economy Terminology
Posted by: admin on Jun 16, 2003 - 10:19 PM

Due to the fact that traditional banking, e-commerce, and gold currencies
have quite a bit of overlap, it has become common to see terms misused in
discussions about the gold economy. In this article we will attempt to
clarify a few words, and hopefully explain the gold economy a little
better in the process.

To Bank or Not to Bank?

In the banking industry, a bank is an institution that accepts deposits
from depositors and reinvests deposits in interest-bearing instruments of
various types, keeping a minimum cash reserve on hand to satisfy
withdrawal requests. Banks in most countries are regulated. In the banking
industry a cash reserve specifically means, a quantity of assets kept on
hand as a percentage of the total deposits. So a bank might only have a 4%
cash reserve on its deposits, or $4 on every $100 deposited. Some have
even less.

Banks are institutions built around lending and interest, and therefore
have significant risk. Governments regulate banks for the purpose of
managing risk and protecting the public from “wildcat” speculation and
catastrophic bank failures. (Whether or not that is an appropriate role
for the government is beyond the scope of this article.)

As you can see, banking is a tricky and dangerous endeavor, which is why
it has come to be strictly regulated in most countries.

When you deposit money into an interest-bearing bank the bank LOANS your
deposit out to other people. This is NOT the case with gold currencies, as
we will explain below.

Gold Currencies

Gold Currencies are not banking institutions because they do not lend the
gold deposits out to third parties.

The real question is, what is gold currency? There is quite a bit of
confusion about this even within the industry.

E-gold claimed to be a custodial institution back in 1996 when the company
first launched, meaning that an e-gold account represented a warehouse
receipt for some gold in custody. However, over time e-gold has moved away
from that definition.

James Turk, the founder of Gold Money, was granted a US Patent in 1998 for
“Digital Gold Currency” which he defined as something different than
deposit currency because the account holder was the actual owner of the
gold. In other words, the Turk Patent claims to invent a system of
circulating digital warehouse gold receipts as a digital currency.

In 2001 Gold Money filed a patent infringement suit against e-gold in
United States Court. In the Fall of 2002 the court dismissed the case
because Gold Money failed to define how e-gold had infringed on the Turk
patent. One of the issues that became clear as a result of the lawsuit was
that e-gold is actually a deposit currency institution, not a custodian
that keeps electronic warehouse receipts.

In order to understand why, you have to understand the difference between
a warehouse receipt and a deposit.

A warehouse receipt is issued by a custodian for a specific object held in
custody. For example, when you drop your car off with the valet, you are
given a warehouse receipt for your 1999 Gold Lexus. When you return to
pick up your car from the valet you present your receipt and expect him to
return the exact same vehicle to you. If he happens to have five of the
same model and color Lexus in the garage, he can’t just give you any of
them. It has to be the same car that you placed in his custody.

Likewise, a gold repository is a custodian for gold bars and other bullion
objects. If you place a dozen 400 Toz bars in a repository you are given a
warehouse receipt with the serial number, weight and fineness of each bar.
The repository cannot sell your bars to someone else, or loan them out.
When you present your warehouse receipt to collect your gold bars, the
repository must give you the exact same bars that you originally placed in
their care.

A deposit institution, on the other hand, exchanges a liability claim for
an asset that you place on deposit. If you deposit ten $100 bills in a
bank, the bank becomes the owner of the $100 bills and you become the
owner of an account balance. The bank owes you $1,000 but they don’t have
to give you the same $100 bills that you deposited. They can give those
bills to someone else and pay you with $1’s, $10’s, or even a $1,000 bill.

The difference, you see, between a claim and a warehouse receipt is that a
claim is generic and a warehouse receipt is specific. Claims are far more
useful than warehouse receipts because they are infinitely divisible. If
you deposit $1,000 in a bank, you can withdraw $10 at a time. With a
warehouse it is all or nothing. You can withdraw the entire gold bar or
nothing at all. A repository will not divide your gold bars for you.

So, e-gold is not a warehouse, because the company cannot distinguish
which account holder owns which piece of gold in reserve. In fact, an
e-gold account is merely a liability of e-gold to pay the account holder x
amount of gold on demand. That means that e-gold is a deposit currency
system for gold. But since the gold reserve is 100% in custody (not loaned
out) e-gold is not a fractional reserve institution. Therefore it is not a
bank.

The contention of Gold Money's lawsuit was basically that James Turk
invented the digital warehouse receipt for gold, therefore e-gold was
infringing the patent.

Even more interestingly than the fact that the suit was dismissed is that
it appears Gold Money is also a deposit currency institution. In fact,
Gold Money uses exactly the same method of accounting for the gold that
e-gold does. Gold Money holders don't know which bar in the Gold Money
reserve belongs to their "holding" because Gold Money doesn't assign bars
to individual holdings. Gold Money holdings are divisible to a fractional
amount of the minimum bar size in the reserve. If it looks like a deposit
institution and it smells like a deposit institution, it probably is one.

The crucial difference between gold currency institutions and banks is
that Gold Currencies do not lend out the gold reserve. A company such as
e-gold maintains a 100% or higher reserve of gold bullion backing the
electronic gold currency they have issued into circulation.

Due to the fact that the business model for gold currency institutions has
some of the properties but lacks others, it is unclear in most countries
whether or not gold currency institutions fall under banking regulations.

Switzerland is the only country so far to actually recognize "e-money" as
a distinct type of institution, not subject to normal banking regulations.
There will undoubtedly be some interesting court cases in the home
jurisdictions of these companies in the future.

Deposits, Bailment, and Withdrawal

When you add gold directly into a digital system such as e-gold or
GoldMoney the process is referred to as bailment. The accounts are
denominated by mass (grams or ounces). When you buy e-gold from an
exchange agent using a different currency, the process is called an
exchange since you are exchanging from a paper currency to a gold
currency.

An exchange agent is also referred to as a market maker or a cambio in the
gold economy.

However, if your market maker accepts cash through a certain bank, it may
be referred to as a “direct cash deposit.” But again, the deposit is being
made into a bank, not the exchange agent, nor the gold currency
institution. (Remember that you are exchanging your paper currency for
gold currency. So the paper currency stays in the bank, and the digital
currency stays in the gold currency institution that your account is
with.)

The term reserve also has a different meaning in the gold economy than it
does for a bank. A bank has a reserve, meaning whatever is left after they
lent out 98% of your deposit. A gold currency operator that uses the term
reserve would mean all of the gold collectively held in trust for the
account holders.

While banks pay an interest rate to depositors for the privilege of
re-investing their money into higher risk vehicles, a gold currency
issuers must charge a storage or maintenance fee to store metal for
account holders. Since the institution is not re-investing the metal into
other investments, it has to charge a fee to cover the costs of
maintaining the security of the bullion vault. (Contrary to the fad, there
are no bullion storage vaults offering free storage and making all of
their profit from advertising.) The storage fee is usually between ˝% and
1.5% per year.

Some gold currency companies may not charge an agio fee, because they make
the vast majority of their revenue from transaction fees or account
maintenance fees. (In the case of e-gold, 98% of the revenue comes from
transaction fees, and less than 2% from agio fees.)