Digital gold accounts: golden opportunity or yellow peril?
by Kathleen Lucia, EAU Vice-President

Not so long ago the usefulness of gold as a reserve currency and even as a long-term store of value was questioned. Now, with gold prices reaching all-time highs, the yellow metal is back in fashion. Furthermore, new technology has made gold, once again, a viable international trading currency. It is not a turn of events that the world’s financial regulators are celebrating.

UK daily newspaper, The Guardian, reported on June 30th that mining company Scotgold Resources is ready to reopen Scotland’s only gold mine, Cononish, which has been closed for 10 years. The company expects to excavate at least 154,000 ounces of gold, work that will maintain 60 jobs in the area for the next eight years. It is a sign of the times.

The fundamentals underpinning the gold price are sobering. Some estimates have it that the existing world total of gold mined greatly outstrips unmined reserves, which could be exhausted in 25 years assuming annual demand of around 3,600 tons. But worldwide demand for gold is increasing, according to gold producers’ organisation The World Gold Council, while the rate of world production is falling as ore grades decline. Global output fell to a 10-year low in 2006.

In March this year, the gold price hit a new record high of US$1,011 an ounce as financial markets continued to reel under the impact of the US-led credit crunch. The World Gold Council’s analysts report that gold has been significantly less volatile than other commodities and outperformed equities and bonds in the first quarter of this year. 

The high price has dampened demand for “physical” gold, that is, in bullion, coins or jewelry. But demand for paper holdings, such as in exchange traded funds, has doubled in the 12 months to the end of the first quarter. Similarly, interest has burgeoned in electronic currencies. These are linked directly to stored gold bullion and offer a simple and cost-effective way, not simply of buying and selling gold, but also of using it as money, forming a new kind of gold standard. Any amount of gold can be bought and used to send online payments worldwide. And herein nestles the problem. Digital gold can bypass all financial regulation and government scrutiny. It works by transferring the ownership of gold from one individual to another without moving the gold physically from its various repositories. In effect, it constitutes an alternative financial system. Add to this the increasingly obvious fact that global financial movements of all kinds are now virtually impossible to regulate and it is easier to understand why US regulators appear jittery.

Covert action
In April 2007, the digital currency business E-Gold and a sister company were hauled before a federal grand jury in Washington D.C. on four charges including money laundering, conspiracy and illegally transmitting money. The charges, if proven, carry prison sentences ranging from five to 20 years.

According to the indictment E-gold, said to manage around two million accounts, operated as an alternative payment system for such assorted criminals as credit card scammers, identity fraudsters and even child pornographers. A Justice Department press release quotes Assistant Attorney General Alice S. Fisher of the Criminal Division saying: “This indictment demonstrates that the Department of Justice, in cooperation with its law enforcement partners, will aggressively identify and prosecute those who knowingly enable and profit from transmitting the proceeds of criminal activity, online or offline.”

The indictment was the result of a two and a half year investigation by the U.S. Secret Service Orlando Field Office into an alternative payment system which had largely operated outside of normal banking industry regulations, claims Secret Service Assistant Director for Investigations Michael Stenger, who is quoted as saying: “This system has been exploited for more than 10 years by criminals who operate primarily via the Internet”. And the release quotes Assistant Director James E. Finch, of the FBI’s Cyber Division: “The advent of new electronic currency systems increases the risk that criminals, and possibly terrorists, will exploit these systems to launder money and transfer funds globally to avoid law enforcement scrutiny and circumvent banking regulations and reporting”.

The companies’ owners robustly refute the allegations and the case is ongoing. Whatever the ultimate outcome, it signals the start of a full blown battle by the world’s regulators to gain control over digital finance.

Anonymity worries regulators
The US is not alone in fearing the potential for digital currencies to be used in criminal and, possibly, terrorist activity. In principle, e-money denominated in gold weight is perfectly respectable; it is an option that even the London Gold Exchange offers investors, describing itself as the world’s largest trader in digital gold and silver. What worries regulators is the anonymity with which some of these increasingly popular accounts can be set up and used.

Canada's financial regulator, the Financial Transactions and Reports Analysis Centre of Canada, FINTRAC, found Digital Precious Metals Operators "have achieved critical mass on the web." The regulator warns: “As financial institutions and non-financial businesses increasingly deter money laundering and terrorism financing, adaptable and technology-savvy criminals and terrorist financiers will likely see other unregulated, exploitable avenues to further their nefarious purposes. Digital precious metals may become one of them.

FINTRAC fears that user anonymity and a network of exchange services, some of which accept cash deposits to fund DPM accounts are an obvious attraction to criminals, who can cash in and cash out of their DPM accounts without using the same exchange service and maintaining anonymity throughout the transaction process. Furthermore, the latest innovation, digital gold ATM cards, could make the process even easier. Canada is introducing regulations to tighten up customer identification, record keeping and reporting across the financial services industry.

Nearly two years ago, in October 2006, similar concerns were raised by the Financial Action Task Force (FATF), set up by the G7 (industrialized) nations to combat money laundering and terrorist financing. FATF observed: "Transactions involving digital precious metals have immediate finality, which may appeal to on-line merchants that must pay high credit card fees due to high fraud rates. Some precious metals dealers also allow users to maintain anonymous accounts. These traits are concerning to U.S. federal law enforcement agencies”. So is the fact that gold is traded online and the internet payment system is now thought to hold approximately 2.5 tonnes of gold.

FATF identify the following risks posed by digital precious metals:


And FATF suggests the following correctives:


But there are powerful interests at stake here. Although the gold market in itself is small compared with other metals markets, the digital precious metals market is big and growing. Already, the e-gold system is estimated by some industry analysts to contain more gold than 27 gold-holding nations and every year, more than 10 million payments worth over $1 billion are processed. The industry has been quietly maturing since around the turn of the century and has formed two trade bodies to protect its interests, the GDCA (Global Digital Currency Association), and EcMA (Electronic Currency Merchants Association). Members see nothing sinister in the advantages of digital currencies, which they present, unabashedly, as:


Extreme prejudice There is little common ground here between regulators and those in the e-gold business that they are so anxious to regulate. The trade associations are lobbying hard for self-regulation to be given a chance. But the extreme prejudice of the United States is already clear and E-Gold may well be the first of many to feel the weight of it. The effect may be to make many companies re-think their approaches to the “know your customer” principle. Many may well take the view that, in the post 9/11 world, accountholders’ privacy is simply not worth defending.

In a sense, the global finance genie is too far out of the bottle. FINTRAC put its finger on it in saying, rather wordily, that criminals are likely always to stay a jump ahead of lawmakers and enforcers. Equally, successive financial crises have pointed up the difficulty regulators have in staying on top of their task and not just in foiling criminal activity. One most recent and obvious example is the failure of US regulators to head off the sub-prime mortgage disaster that had been widely predicted for some years. Another is the European Union’s ongoing struggle in achieving the freedom for financial services companies to operate across borders without protectionist interference from member states. (A problem still for most forms of trade and industry in Europe).

At the same time, the financial services industry complains that weighty regulation is actually stifling legitimate business – the Sarbanes Oxley legislation hurried in by the United States government in the wake of the Enron scandal is a case in point. It caused a sharp drop in listings on the New York Stock Exchange and forced regulators to soften their stance. Similar complaint is made about the complex regulation issuing from the EU in recent years, but it is unlikely that governments will listen.

While no amount of regulation will alter the fact that large amounts of money can traverse the globe at the click of a mouse, governments will act to preserve their power and their revenue base, even at the risk of trussing and immobilizing the golden goose. And it could well be that providers of e-currency accounts will be forced to become ‘banks’ and be subject to banking rules. E-currency firms had better start swotting now. And those who cherish their privacy may be deprived of some more.