Unlike fiat currencies that have paper cash and coins as legal tender, typical cryptocurrencies are not backed by anything tangible.
It's not hard to see why most people struggle to understand how a currency backed by nothing can have real value.
Cryptocurrencies are known for their polarizing price fluctuations, and their volatility stems from the fact that they are not tied to any asset.
Despite this shortcoming, cryptocurrencies have an edge over traditional currencies because they are divisible, fungible, transferable, decentralized and scarce.
So, what happens when we hitch cryptocurrencies to a tangible asset?
Welcome to the buzzing world of asset backed cryptocurrencies.
What are asset backed cryptocurrencies?
Asset backed cryptocurrencies are digital coins that are tied to an existing asset of real value.
When the price of the token goes down, the investor can choose to either cash out or retain the underpinned asset.
This way, asset backed cryptocurrencies overcome one of the biggest flaws associated with first generation cryptocurrencies; price volatility.
Tying a digital coin to a tangible asset gives token holders the peace of mind as they are certain that the price of their token is as stable as the underlying asset, which they can cash out when the worst happens.
It's a great way of safeguarding the coin from excessive speculation.
Hitching a digital coin to an asset seems rather straightforward, only that it's not. Essentially, there are third party custodians who store and manage the underpinned asset.
The introduction of a trusted, centralized third party seems to go against the true spirit of decentralization that's associated with blockchain technology.
How do stable coins play a part?
Stablecoins are arguably the most popular asset backed cryptocurrencies.
These are digital currencies pegged to an asset.
They have a collateralized store of value that backs its price.
The result is a non speculative currency that's stable enough to be used as a means of exchange and store of value.
Stable coins bring to the table the best of both worlds; liquidity of fiat currencies and the transparency, fungibility and decentralization of digital currencies.
Users of stablecoins have the advantage of getting their reserve of fiat currencies whenever the price of a stablecoin plummets.
Stablecoins like Tether have in the recent past stood strong against price fluctuations, and experts are hopeful of using this concept to put an end to price volatility that has dogged the cryptocurrency industry for years.
Gold backed cryptocurrency
Away from the stablecoins, a new generation of asset backed cryptocurrencies is gaining traction; gold backed digital currencies.
As the name suggests, these are digital currencies whose price is tied to the value of physical gold.
The gold in this case is stored by a trusted third party and can be traded in a digital exchange.
The whole concept of hitching a digital currency to the value of a physical asset like gold is popularly known as tokenization.
The idea itself is compelling because of the traceability and transparency of the blockchain technology.
With tokenization, it's easier to trace your gold than it is when you buy the physical gold.
Furthermore, you enjoy the liquidity that comes with tokenization as redeeming your token is easy and quick, given that the token is traded in a number of digital exchanges.
While gold backed currencies are all the rage, they have a flaw of their own; the cryptocurrency company issuing the token doesn't have to account for all the underlying assets as they are managed by a third party.
However, it's worth mentioning that gold backed cryptocurrencies present a good value proposition for investors as the minimum price of the token is designed to equal the prevailing rate of gold.
Because of these benefits, gold backed cryptocurrencies are becoming more popular than first generation cryptocurrencies.
Digix Gold token is among the most popular gold tokenization projects in the cryptocurrency industry. Trading as DGX, each token is backed by physical gold, with one token being equal to 99.99% LBMA gold.
The underlying gold is stored in a secure vault in Singapore. Token holders have the option of having their gold bars sent over mail, or making the trip to Singapore when they choose to redeem their tokens.
When it comes to investing in gold, you're better off buying a gold backed cryptocurrency than buying physical gold.
Gold backed tokens like DGX are based on a transparent blockchain that makes it easier for you to trace your gold.
Additionally, DGX tokens are more liquid than physical gold because they are traded in cryptocurrency exchanges.
Onegram, a Dubai based company is also tokenizing gold. It's the first Sharia compliant digital currency.
Sharia law prohibits Muslims from speculative investment like cryptocurrencies.
Before the inception of Onegram, cryptocurrency investing in Gulf nations was prohibited, but Onegram is changing all this. Each OGC token is tied to a gram of gold.
The company plans to reinvest 70% of transaction fees into gold. Their plan is to grow the amount of gold as the number of OGC tokens remains constant.
In the end, Onegram provides a private investment option for Muslims.
This is a Switzerland based stablecoin that's backed by physical gold.
Each of the ERC20 standard Ekon token is equal to a gram of gold 999.
Ekon promises an audit every 90 days to verify the number of gold bars in its vaults.
With Ekon, you can only 'withdraw' your gold and not the corresponding monetary value.
The company claims that Ekon is not a security token and is only allowed by regulators to redeem tokens for gold.
Oil based cryptocurrency
The first oil backed cryptocurrency was announced by Venezuelan President Nicolas Maduro in December 2017.
Dubbed 'Petro', it's tied to the country's vast oil and mineral reserves.
Petro was Venezuela's answer to hyperinflation that came about after the prices of oil plummeted to record lows in 2014. The country's national currency, the Bolivar, took a massive hit.
It's yet to recover.
With runaway inflation, Venezuelas economy tanked and the country struggled to get international financing.
As hyperinflation kicked in, a new currency, the Sovereign Bolivar, was created and tied to the Petro. Each Petro token is equal to a barrel of oil, making it more stable than typical cryptocurrencies that aren't tied to anything.
The Petro was created to help Venezuela regain access to international finance and circumvent US sanctions.
In a surprise to some, Petro failed to appeal to the masses.
At launch, it was called out as a scam as glaring inconsistencies spoiled its party. For instance, it's white paper failed to explain exactly how one could redeem his token for a barrel of oil.
Although the execution of its whitepaper was flawed, Petro was a first of its kind, being tied to a commodity and backed by a government.
In case it succeeds as a digital currency, it could pave the way for more government-issued cryptocurrencies.
Security/business backed cryptocurrency
If you don't fancy a fiat, gold or oil backed cryptocurrency, a security backed cryptocurrency could be worth looking at.
Basically, securities function in a similar way as traditional stocks.
Some blockchain startups are tokenizing the traditional securities industry by creating cryptographic tokens that not only represent ownership, but also generates "passive income" or dividends for token holders.
Tokenizing the securities industry gives it the much needed liquidity that was lacking in this industry.
With more bankers and institutional investors embracing tokenized securities, it's easy to see why this class of cryptoassets is gaining popularity.
Tokenized securities allow for fast, secure and cost-effective trading, even as it brings more liquidity and automation to the securities industry.
The fact the these kind of cryptoassets are heavily regulated makes investors gain trust with digital securities.
Polymath is a blockchain startup that's tokenizing the securities industry.
It's smart contracts-based platform allows developers to create and launch legal Security Token Offering.
Polymath connects blockchain investors with smart contract developers, KYC providers and other actors in the development chain, effectively eliminating middlemen.
The Gibraltar Blockchain Exchange is a subsidiary of the GSX Group, the owners of the Gibraltar Stock Exchange
Their main goal is to provide a world class token sale and ICO platform based on the blockchain. They also plan to provide a high quality crypto-exchange and a marketplace for token traders, developers and investors.
Over and above this, they are building the first tokenized securities exchange in the world.
Their native digital currency, the RTK, is a utility token that you can use when listing an ICO on the GBX platform.
Unlike most exchanges that are unregulated, GBX conforms to all government regulations.
If all goes as the team hopes, GBX could be a gamechanger in the tokenized securities industry as it is the first regulated exchange.
Other notable asset backed cryptocurrencies
Gold, diamonds, securities and fiat seem to be the most popular assets for backing up cryptocurrencies, but they are not the only ones.
Anything of value can back up digital currencies, but blockchain startups are keen on utilizing traditional asset classes.
In the recent past, a number of ICOs have emerged with a purpose of tokenizing the diamond and the real estate industries.
The two industries are known to have problems with divisibility and fungibility among other shortcomings.
Because the blockchain is decentralized and traceable, it's emerging as the best suited piece of technology that could revolutionize the two industries, opening them up for mass adoption.
The Cedex blockchain project seeks to tokenize the diamonds industry. They are building a blockchain based diamond exchange.
Understandably, the diamonds industry has many challenges that could be addressed by a blockchain.
These include; low liquidity, indivisibility, lack of standardization and transparency.
Cedex's machine learning algorithm solves the transparency and standardization problem.
Cedex's goal is to make diamonds a publicly tradeable asset. By so doing, they will be unlocking a multi billion dollar investment market.
In the real estate industry, ATLANT is making a name. The industry is also dogged by lack of transparency and is crowded by middlemen.
Atlant token holders earn a passive income by owning pieces of real estate. The company is not just tokenizing the industry, but also revolutionizing the global P2P rental business.
It also reduces rates for both the tenants and the lessors, and cuts the possibility of fake reviews.
The company helps users to 'invest, rent and trade' in real estate. Through Atlant, many people have been able to invest in the real estate sector.
PROPY's is another project to create a unified property store for the global real estate industry.
Through PROPY, home buyers can purchase property internationally without worrying about jurisdictions or title deeds.
REAL is another blockchain offshoot that's keen on transforming the real estate industry. Their goal is to eliminate third parties, to improve liquidity and transparency.
The REAL token gives users the much needed economic rights to participate in the global real estate industry. They also earn a passive income.
All in all, there are dozens of projects that are tokenizing traditional industries that had entry barriers, low liquidity and transparency.
With more ICOs in the pipeline, we expect to see more asset backed cryptocurrencies coming up with innovative ideas.
With this innovation, the blockchain would finally have a real impact in many traditional industries that were a reserved for a few.