Digital gold: A convenient investment method or a Ponzi scheme in making?

The digital wave in gold is at a nascent stage, with about two tonnes of gold held at vaults on an outstanding basis, although the total number of customers using the digital mode to buy gold is estimated at about 80 million. This is due to the fungibility that the product offers and that there are no storage hassles. It is an interesting time and digital should be the way forward but it can’t be on a regulatory infrastructure that is hanging on a loose thread. Digital gold could, in fact, become the biggest Ponzi scheme in India if a self-regulatory mechanism is not framed right away.

Buying gold digitally is not just the easiest but also the most economical way to buy gold, with prices varying between 1.5 per cent and 2.5 per cent over the landed price, as against 4-5 per cent if one were to buy from a retail store. What’s more, digital gold has nil storage cost and it is as fungible as having physical gold. This means one could sell it anytime, or even use it as a collateral. It is estimated that there are 80 million customers (there could be an overlap, as there would be users transacting through multiple apps) who have transacted on various platforms and together have custody of nearly two tonnes of gold.

In many of the transactions where customers have bought or sold gold, they have apparently received cashback redemption from the payment app facilitating the purchase. The cashback received is used for purchasing and selling gold instantly, in the process monetising the cashback points earned by the customer into currency. As a result, the total transaction looks proportionately large. Moreover, these are the customers of the payment app, not of the agency (the issuer) owning gold. So, to get a true assessment of the market, it would rather make sense to look at gold held in the vaults on a monthly or annual outstanding basis instead of the total number of customers who transacted.

Are customers protected?

Upon payment, the buyer is immediately allocated gold in the vault managed by the issuer. The trustee or the insurer of the issuer acts as a guarantor to the vault, thereby shielding the customer from any risk of default by the issuer. However, such practices are not mandatory; they are basically the best governance practices that these firms want to operate in.

Some legal issues remain in the Indian context. Do you know that these firms managing your gold are under the shop & establishment Act? If the issuer defaults, where do you run to? One can only imagine the public taking to the streets and protesting, as these entities at present are completely outside of any regulator’s remit.

In Re Goldcorp Exchange Ltd, a case from New Zealand before the Privy Council in the UK (the UK Supreme court) dealt with the ownership of the purchased gold. Goldcorp Exchange Ltd used to sell gold coins and gold ingots to customers. The customers were given certificates for their purchase and ownership. The company charged its customers for storage and insurance. A certificate holder could surrender his certificate and get a delivery of the gold in 7 days or sell to another buyer on the prevailing market price. The practice essentially took away the inconvenience of storing gold. On a sale, the gold was not appropriated to the buyer. The company promised to maintain an adequate stock to be able to deliver whenever called upon by the customer. The company later went into liquidation and there was a dispute over whether the gold was owned by the company or its customers. The Privy Council ruled that as the gold for the customer was not ascertained, the ownership continued to be with the company.

It is also important to ask who regulates these accounts in which grammes of gold are held? What stops it from becoming the ground for making unauthorised payments?

What are the entry barriers to the business? Upon evaluating the entry barriers on various parameters, it appears to be high if one wants to run a sustainable model; for fly-by-night operators, it is as easy as setting up a paan shop.

Let us look at a scenario. A firm creates an online portal, reaches out to customers and “persuades” them to purchase a gramme of gold. The transaction could be for cash against delivery and the portal owner would not collect payment from the buyer. Thus, in the process, the customer gets his gold, all transaction in books are legitimate. Any check at the unit would show the billings to be in order. Issuer could always show cash as being under circulation, and after some time the company could be shut down. That becomes the legitimate way of managing the “cash transfers” without the hassle of managing cash.

On similar lines, one could reach out to rural areas or Tier-III towns by identifying agents who are influencers. Like chit funds, people in these places could be easily convinced to buy gold through such platforms, and the whole process of authentication could be so convincing — with alerts on mobile — that it would be surprising if people did not fall for the trap. Further, such deposits might get promoted by issuers as part of government-driven gold monetisation scheme, by giving an interest of 2.5 per cent for buying gold through a portal and making them believe it is held in a vault.  

The solution

The same model might be replicated for silver, too. What is the recourse then?

First, one has to create a gold grammes account, to be managed through a depository participant — the equivalent of a demat account. Any issuer of digital gold should be a member of this depository and every consumer should be able to manage such trade only through a precious gramme account. Also, this fits into the gold monetisation scheme, as the consumer could transfer these directly to a bank for earning interest on deposits. If regulated, nuggets and bars would be standardised material and the cost of managing it would be minimal for banks.

Secondly, there has to be a process to link the grammes account with the issuer, so that it recognises which issuers are registered entities.

Thirdly, these schemes are in no way less than mopping deposits by unregulated entities, though these are not cash but in gold, which is just as good. The Ministry of Corporate Affairs, with inputs from the Reserve Bank of India (RBI), should ideally take the responsibility of framing a guideline regarding the payment, standard of gold, custody, information disclosure mechanism and governance structure of such entities. The regulatory framework needs to be defined.

In the current scenario, without some oversight, the proliferation could be so high that the number of operators could become as many as the number of jewellers in country, eventually taking it to a point of no return. Do we need to wait until we reach that point of no recourse?

Arvind Sahay is professor of marketing and International Business at IIM Ahmedabad and Chairperson of India Gold Policy Centre; Sudheesh Nambiath is head of India Gold Policy Centre at IIM-A