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What is a Commodity Backed Cryptocurrency?

Definition of a Commodity Backed Cryptocurrency

Commodity backed cryptocurrencies are a relatively new addition to the plethora of digital financial instruments available today, but they are already garnering a lot of attention. The Venezuelan government launched its own commodity backed coin, the Petro, in the early months of 2018 and few news outlets have stopped speaking about it ever since. As you might have already guessed, the Petro coin is almost entirely backed by oil reserves, but oil is not the only commodity with which a cryptocurrency can be backed. The Petro, for example, is also apparently backed by gold and diamond reserves as well.

Basic Concept of a Commodity Backed Cryptocurrency

The basic concept behind a commodity backed cryptocurrency is that there is some physical thing of value tied to the digital coin. For example, in the case of the Petro coin, each digital coin is tied to a real barrel of oil that the government has set aside in reserve. By setting up the cryptocurrency in this fashion, an individual’s investment risk in a coin is never greater than their initial investment, minus the price of the barrel of oil. Basically, if the value of the coin falls to zero, you can always trade it for that barrel of oil.

There are, admittedly, a few logistical issues in dealing with the worst case scenario of a commodity backed coin with a value of zero, but the worst case scenario for a commodity backed coin seems to come with a lot more options than the same scenario with a standard digital currency. If Bitcoin, for example, drops to zero in value, there’s nothing that anyone can do in order to recover a portion of their initial investment.

How is the Price of Commodity Backed Cryptocurrencies Determined?

This is something that is still up for a little bit of debate, but the pricing of commodity backed cryptocurrencies is likely to be done in one of three ways. The first way is by simple market forces. In this case, the demand for the coin, and the number of coins available, determine the cost of the asset. The second way is through tying the coin to the value of the underlying commodity. For example, the value of a Petro coin could quite easily be tied to the price of a barrel of oil. Lastly, the price of the coin could be left in the hands of the people, organization, or government that decided to release the currency. This last scenario is a very likely one for a coin like Petro because the Venezuelan government will likely want to balance the demand for their coin with the economic success/needs of their country.

Key Concept Review – Commodity backed cryptocurrencies are tied to a physical item of value like a barrel of oil. If the value of the coin falls to zero, you can always obtain that physical item in exchange for the currency you hold. The price of the coin is determined by either market forces, the price of the physical item, or the organization that released the coin.

Commodity Backed Cryptocurrencies on the Market

Recently there have been more and more commodity backed cryptocurrencies that have made their way into the digital marketplace. Below are some of the most popular new coins that fit this category:

Aramco (ARM) – The ARM is an oil backed cryptocurrency being offered by Aramco, the well known Saudi Arabian oil company. Each ARM coin is backed by a single barrel of oil and Aramco is promising that the price of ARM will increase by at least $0.01 USD every single day. The presale for the Aramco cryptocurrency went live on April 24th, 2018 and you can learn more about the coin from our Aramco ICO article.

Jinbi – The Jinbi is a gold backed cryptocurrency with ties to Switzerland and London. Each Jinbi coin will be backed by a store of actual gold that will be produced and managed by International Precious Metals Limited. The presale for Jinbi gets underway on May 29th, 2018 and you can read more about the coin from our Jinbi ICO article.

El Petro – This currency was mentioned earlier. It is an oil and gold backed cryptocurrency that has been launched by the Venezuelan government. According to President Nicolas Maduro, as of April 26th, more than $3 billion worth of the El Petro has been sold and he is apparently already moving $1 billion worth of it to Venezuela’s central bank for auction. Visit the official El Petro website to learn more about recent developments with this coin.