Why do you always end up paying more when buying gold on-chain?

Author: Yuki is short, so is life

Compiled by: Shenchao TechFlow

Tokenized gold has attracted a large number of crypto users into the real world asset (RWA) space, but at what cost?

Figure: Comparison of Binance PAXG Price and Spot Gold Price

The following is a simple price chart comparing the price trends of one of the tokenized gold solutions - PAXG (blue line) against spot gold (yellow line). Each token represents one ounce of spot gold. However, during the displayed time period, almost all buyers of PAXG paid a premium over the spot price.

Chart: Premium of PAXG and XAUT compared to spot gold

The original intention of tokenizing real-world assets (RWA) is to allow users to acquire real assets at a lower cost. However, tokenized gold, which accounts for about 84% of the total market value of tokenized commodities, has failed to achieve this goal. The premium on tokenized gold can easily be mistaken as being driven by demand, but in reality, this premium stems from inherent structural frictions in the design of these token issuance models.

Minting and Redemption Fees

The premium of any tokenized product compared to its underlying asset is mainly driven by the minting and redemption fees. The minting and redemption fees effectively set a “premium range” for the price of the tokenized product relative to the underlying asset.

Assuming you are a market maker for XAUt or PAXG. The price of gold has risen strongly, resulting in a significant increase in the inflow of tokenized gold. So, at what price would you sell XAUt or PAXG? To break even, you need to sell at no less than the cost price at which you acquired these tokens as inventory, and this cost price is defined by the minting fees of the tokens, effectively setting a soft cap on the token price.

Under the same logic, tokenized gold may also trade at a discount. Suppose there is a capital outflow from tokenized gold. As a market maker, you would only buy XAUt or PAXG at a price lower than what you could obtain by redeeming these tokens from Tether or Paxos. Just as minting fees limit the upside price potential, redemption fees also limit the downside price potential.

Figure: Premium Range Driven by Minting/Redeeming Fees

The higher the fees, the wider the premium range, and the more likely the token price is to deviate from its fair value. As of the time of writing this article, Tether charges a 0.25% fee for the minting and redemption of XAUt, while Paxos has a fee structure that varies based on the scale of minting and redemption: a 1% fee for 2-25 PAXG, and only a 0.125% fee for scales exceeding 800 tokens.

Considering the expenses and operational costs required for tokenizing physical gold, one might think that the minting and redemption fees charged by Paxos and Tether are reasonable. However, it is evident that reducing the minting and redemption fees would decrease the tracking error of tokenized real-world assets (RWA), ultimately enhancing cost efficiency for end investors.

structural friction

The minting and redemption fees only set a “soft” upper and lower limit for the price of tokenized gold. Other frictions related to the primary issuance model of the tokens may also significantly widen the premium range of tokenized gold prices.

For example, Tether Gold requires a minimum scale of 50 XAUt (approximately $200,000) at the time of minting, and a minimum scale of 430 XAUt (approximately $1.7 million) at the time of redemption. This scale limitation poses a significant barrier for market makers, forcing them to hold inventory for long periods and incur substantial opportunity costs.

Another major challenge in the current tokenized gold market is the settlement delays during the minting and redemption processes. When redeeming PAXG, Paxos indicates that the user account balance updates may take several business days, resulting in funds being locked and generating significant opportunity costs.

These frictions collectively hinder active participation from market makers unless there is sufficient profit margin. This ultimately leads to the prices of tokenized gold assets deviating more significantly from their fair value, even exceeding the upper and lower limits set by minting and redemption fees.

Tokenized gold has demonstrated that real-world assets (RWA) can attract capital, but it also exposes the limitations of the current tokenization models. On-chain gold transactions have premiums and slow redemption cycles. These barriers effectively act as an indirect tax. If tokenized assets are to achieve scalable development, users should not be penalized for choosing on-chain solutions.

Liquidity, redemption efficiency, and price consistency must complement each other rather than compromise. This situation must change.