Minacoin's plan for a gold-backed crypto-currency is about as solid as swiss cheese

By Michael Carney , written on May 6, 2014

From The News Desk

For those who have struggled to wrap their heads around the stratospheric rise in value – and subsequent fall, and rise, and fall – of the various crypto-currencies, you’re not alone. It’s seemingly counterintuitive that a few bits of data can somehow be worth hundreds of dollars and challenge the millenium-old role of government backed currencies (or at least aspire to).

Toronto-based financial services company Mina Financial appears to agree and wants to put a bit more meat on those crypto-currency bones. Today, the company announced the world’s first asset-backed crypto-currency. Minacoin will be backed by physical gold bullion, held in reserve to support its value.

How very analog of them. It’s also an idea that seems to be half-baked, at best.

At least 90 percent of the system’s total net assets will be stored in physical bullion, the company claims, while up to 10 percent may be stored in more liquid gold-linked assets like ETFs. The company’s goal is to take advantage of the many benefits of crypto-currencies, such as their portability, their (relative) security, and low cost transferability. But with gold backing, Minacoin’s value should be far less volatile than its crypto-currency brethren Bitcoin, Litecoin, Dogecoin, and so on. Gold ETFs, for example, typically fluctuate less than 1 percent from the value of their underlying reserves, the company notes.

Unlike bitcoin, all the Minacoins that will ever exist – 21 million – have already been mined. All unsold coins are held in the same express trust which manages the company’s bullion reserves, and to which each Mina purchaser will be added as a “discretionary beneficiary.” But despite this status, Minacoin holders are not permitted to withdraw the gold itself, but must rather sell their virtual-currency and take payout via fiat cash.

This is the part of the story where things get dicey. The 21 million Minacoins are backed by two 400-ounce gold bars. With a value of $1,050,000 USD, Minacoin's value is pegged initially at $0.05 per coin. This presents a slight problem. Given the liquidity issues that bitcoin has demonstrated with a system valued at more than $6 billion, Minacoin is akin to a school project. It’s not like gold is going to appreciate 10,000-time, which is what it would take to make the system worth $10 billion.

Mina Financial could presumably issue future Minacoins backed by additional gold bars, meaning it may be most effective to view this as “Minacoin Trust I.” But as explained, 21 million Minacoins doesn’t amount to much. The plan is to soft-launch today and gauge demand by opening up Minacoin pre-orders, with a proper launch coming in June. At just two months away, and with plenty of holes in this story, this seems like a recipe for disaster.

This whole process makes Minacoins a bit like a cryptographic, digital share of gold. Mina acknowledges as much, saying that Minacoins offer a safe and quick way to use gold as a peer-to-peer payment mechanism. The thing is, this is an idea that has been tried before, with mixed results.

E-Gold was one of the original digital currencies, and was backed by precious metals held in London bank vaults. But when the currency caught on with criminals and became a haven for money laundering, regulators quickly moved in to shut it down. E-Gold’s failure was as much a lack of “know-your customer” (KYC) controls, as anything, but it illustrates just how challenging such a model can be. Alarmingly, Minacoin has said that it does not believe it will be required to collect customer identity information.

This aside, Minacoin raises further questions by flying in the face of the primary value proposition (and the ideological underpinning) of most crypto-currencies: the lack of a central authority. It’s fair to say that a company responsible for storing the millions of dollars worth of hard assets underlying an entire currency is about as central a point of failure as you can create. When the US dollar was backed by gold, the government had a massive military and facilities like Fort Knox to protect its reserves. Today, it uses that military, among other tools, to enforce the dollar’s role as the global reserve currency.

What resources will Mina Financial have to secure its reserves and how trustworthy and competent is its leadership? While the company professes a commitment to transparency and regulatory compliance, perhaps this biggest show of good faith is the fact that it’s retained accounting giant KPMG as an external auditor.

Mina Financial will collect an 0.8 percent monthly management fee for its role in securing the reserves and converting coins upon request. The company was co-founded by Melvin Ng and David Gallo. Previously, Ng ran CADBitcoin, a now defunct Canadian bitcoin exchange which had its accounts frozen in 2013 for failure to comply with national money service regulations. This should concern anyone wondering about Mina Financial’s trustworthiness and level of competence. Gallo, on the other hand, owns and operates 7L Networks, an 11-year-old data center and hosting company.

But all these red flags aside, the real question underlying Minacoin is, what problem does it solve? Consumers who want to store value can just buy gold or gold-linked ETFs. Do they really need a way to use these assets to buy groceries?

By the same token, consumers who are looking for ways to transport and transfer wealth more efficiently than carrying around gold bars or stacks of US greenbacks, already have bitcoin. Yes bitcoin is volatile today, but that is more a result of the relatively small transaction volume and monetary value of the entire system, both of which should change over time as more and larger users come into the system.

It seems that in its efforts to solve these non-problems, Minacoin has potentially created a host of others. Better to keep your savings elsewhere until this one plays out a bit further.