Mining remains capital intensive due to the sizable upfront, and ongoing, investment. Whether funded through sales of forward production, or via backers willing to underwrite the initial outlay, the cost of production remains high. 

Estimates vary by country, and accuracy is uncertain, but the cost of bringing an ounce of gold to market is estimated as low as $700 in Peru but as high as $1,400 in South Africa. It is unsurprising that changes in the spot market price have a significant impact on profitability. 

Debt and equity issuance emerged as a primary source of funding before streaming and royalties, introduced in the mid-1980s, added further options. Streaming enabled miners to sacrifice a percentage of future production, often sold at a large discount, in exchange for upfront financing. Royalty financing, in contrast, being based on a percentage share of revenue from the overall project. With any financing option, the mining company swaps revenue for funding. 

As Web3 has grown exponentially, the creative use of blockchain-based tokens has been tackling the cost and efficiency of doing business. Web3 potentially offers mine operators (suppliers) a method to access new investor capital, whilst retaining a greater percentage of revenue. 

Using blockchains, cryptocurrencies and NFTs, Web3 gives power back to the users (buyers) in the form of ownership. As tokenisation, an embedded feature within the Web3 concept, offers a way to overcome traditional challenges of owning physical metals and streamline their trading and exchange. It offers a new route for metal suppliers and buyers to serve their respective needs.

The first step is to establish clarity on the language used. It is crucial for any offering.

A security token, will grant ownership rights on the underlying assets, cash flow distribution and may include governance rights. Similar to equity they can be used to allocate a share of returns, and risk, amongst investors. This structure could suit a mining operation due to start or where uncertainty exists, perhaps around the size of reserves. 

A tokenised asset is mostly the representation of an asset that already exists. In this case it could be pre or post-refinement metal, held in secure storage. While the token may include rights, such as redemption, issuers may position the tokenized asset outside of the classification as a regulated security.

The definition of what the token represents has been a hot topic in Web3. Ripple, an integrated currency exchange and payments platform, has had one of the most high-profile cases having been subject to enforcement action by the SEC, the US regulator. The allegations centre on Ripple's XRP token being a security - a regulated asset and therefore subject to regulated distribution. The case rumbles on.

Both securities tokens or tokenised assets have their use cases but also different implications. Which token to use often depends on what is being tokenised. 

Demand 

Investors in precious metals, particularly gold, still view the asset class as essential for a diversified portfolio. Appealing to both institutional and retail investors, the precious metals market is set for a $403 billion valuation by 2028. 

Retail investors keen to own precious metals have often sought exchange-traded funds (ETFs), such as the iShares Gold Strategy ETF, for exposure. Through these products, investors acquire a proportionate share of the underlying fund holding a pool of assets. Investors never truly own the asset as an ETF cannot be redeemed. Even if that were possible, there are numerous disadvantages to trading and using physical metals. 

In retail markets, metals are typically bought at discount to spot market prices and sold at a premium. With one gram, over $90, commonly the minimum tradable size, prices can vary significantly. Online retailer JM Bullion offers customers a more than 5% difference between its buy and sell prices for gold. Palladium's split is over 8% wide. This difference, or spread, varies but is likely much bigger in physical and smaller stores.

Further complications arise beyond this. Ownership can be challenged, resulting in import tariffs or confiscation, should the travel without the appropriate declaration of the assets. Whilst transporting physical metals attracts a high risk of theft. 

Bridging the gap

So the challenge becomes much clearer. Miners want to maximise operating profits by securing the highest sale price for their metals, whilst minimising funding costs of extraction. Retail investors want to hold metals in their portfolio but true ownership is often not available, nor feasible. 

If miners could directly connect with a wider pool of buyers and investors, including retail. The potential to improve upon the price at which they sell metals for operational financing could greatly improve. Market forces from simply having more buyers can begin to reduce the discounts offered to financiers, such as streamers. End users like computer or car manufacturers could enter the value chain earlier and secure access to metals to better withstand supply disruptions.

By creating a security token with a claim over unextracted reserves, miners could effectively pre-fund their cost of production. Alternatively, they could tokenise their warehoused ore, increasing their funding as they extract more from the ground.

Tokenisation can solve customer challenges too. Proof of physical asset ownership resides in a digital wallet secured by private keys, the equivalent of a pin number. This facilitates an easy transportation of ownership, and through the blockchain, an irrefutable digital record of ownership down to a metal's serial number. Owners can then trade and borrow against the value of their metal holding, even buying as low as $1 units.

Practicalities

Several practicalities exist around tokenised metals to ensure the benefits are fully realised. 

Multiple stages exist within the value chain. Miners would need to consider what they plan to tokenise and ensure it does not divert their attention from their core business.

In order to sell or redeem physical metals, an approved dealer network would be required. A tokenised offering becomes unappealing if accessing the metals is unduly onerous. The implication is that any tokenised solution must easily integrate into existing global metals networks. Measurement and validation of reserves are critical for the integrity of token value. Without this any bad actor could issue a token without verifiable assets. 

Within the Web3 industry, independent pricing oracles (sources) such as Chainlink and Supra Orales are utilised for this function. Through APIs they can receive confirmation, from custodians, of any assets held in custody. This provides confidence that the tokens are backed by the metals upon which they derive their value.

A security token may bring a regulated asset to market, with producers subject to licensing and regulatory scrutiny. Whereas a tokenised asset is unregulated and unprotected in law, though many providers do voluntarily enter into regulatory oversight. Both routes hold their own appeal.

Many challenges in tokenising metals are being tackled. Currently, investors and retail users are now able to seamlessly use gold-backed cards like Kinesis Money via the card networks of Mastercard and Visa. Further innovation from blockchain is on the way, there is no reason it cannot be further into the value chain.

Gus Anyim is a consultant at the intersection of Fintech and Web3, supporting projects that tokenize precious metals.