One of the three main diamond exchanges in the world is based in the Israeli city of Ramat Gan near Tel-Aviv. It is called Israel’s Diamond Exchange and has chosen to launch two cryptocurrencies that will both be partially backed by diamonds. The cryptocurrency called Carat will be available to investors and the general public for purchase in May. The second, dubbed Cut, should be available within the next few weeks, according to the exchange, and will be only available for transactions between traders.
SECURITY TOKENS FUTURE OF CRYPTO
A quarter of both Cut and Carat’s value will be backed by diamonds. The exchange is hoping to tackle the problem of the profitability of the diamond business stemming from the narrow profit margins between rough and polished gems, while providing transparency and efficiency behind transactions.
The concept is not entirely new, and both gold and diamond-backed cryptocurrency make up a share of the growing number of cryptocurrencies, which as of January is around 1,400.
Lex Sokolin, a partner and global director of FinTech strategy at Autonomous Research, said that creating a currency backed by diamonds shows the potential of the crypto economy.
"Let's start with the premise that all assets are going to be tokenized in the future. That means anything physical or digital that can be exchanged will have a digital representation of that object through a token… Tokenizing diamonds is no different, and highlights the potential of the crypto economy," Sokolin said.
Jamie Burke, the CEO and Investor at venture capital firm Outlier Ventures, goes so far as to state that this type of asset-backed cryptocurrency will come to displace the current crypto market of utility tokens.
"I believe this is a classic example of what will become a growing number of Security Tokens. That is where a token's value is linked to an underlying physical asset… In the end this market will over time dwarf the current crypto market which is largely focused on utility tokens which are designed for usage or access to software only," Burke said.
Utility tokens are distributed by a company in the form of user tokens or app coins that represent future access to a company’s product or service. In contrast to a security token, they are not backed by an external, tradeable asset.
Moreover Spiros Margaris, a venture capitalist and global top fintech influencer, said that the novelty of the idea will help attract investors who may previously not have considered cryptocurrency as an option.
"Any new ideas and concepts that come to the cryptocurrency market like the diamond-backed cryptocurrency Carat will help establish the crypto industry and strengthen its mainstream appeal," Margaris said.
EXCHANGE ALLEGES IMMUNITY TO PRICE VOLATILITY
One of the problems that the exchange foresees in tackling is the price volatility that is often associated with cryptocurrencies. Bitcoin, one of the more popular cryptocurrencies on the market, is now in a price dip — 1 bitcoin is currently worth $8,286. That means that bitcoin has lost more than half of its value since mid-December, when on December 17, it peaked at $19,666.
The Cut, which is only available to diamond dealers on a peer-to-peer basis, will have its price determined by an algorithm, as each diamond varies and so each diamond must be priced individually. Both diamond-backed currencies, claims CARATS.IO — the creator of the coins for the exchange — should be immune to price volatility.
Keith Lim, the founder and CEO of technology company Hearti Lab, agrees with the exchange, saying that informing the investor about the source of the value of the currency will curb the volatility that other cryptocurrency on the market can be subject to.
"Such an asset-backed cryptocurrency should minimize price volatility as investors will have a sense of the underlying value," Lim said.
Sokolin believes that because the asset which backs the currency itself does not have any utilitarian value, the coin on which it is based will be subject to as much volatility as other cryptocurrencies.
"Diamonds in particular are interesting because their value is primarily human sentiment, created through marketing the diamond as a precious gem… So to back the value of a cryptocurrency, even fractionally, by something that is valued primarily on sentiment created by marketing and a limited supply seems to me no different than other crypto currencies," Sokolin said.
REGULATORS WILL DISLIKE CUT, CARAT
Another area in which the diamond-backed currencies experts agree will unlikely prove to be different from other cryptocurrencies is its lack of appeal to regulators. Regulators have previously been skeptical about the potential of cryptocurrency and have taken measures to control its exchanges.
According to local media reports, China is set to increase regulations on cryptocurrencies, banning initial coin offerings and cryptocurrency exchanges, measures which are currently being prepared by the People’s Bank of China. This will mean blocking internet trading accounts, shutting down web servers, and forbidding illegal traders from leaving the country.
In nearby Hong Kong, the Securities and Futures Commission issued a statement on Friday, where it stated that following investor complaints claiming they were unable to withdraw cryptocurrencies from their accounts, the commission will clampdown on exchanges that sell cryptocurrency without a license.
For this reason, Lim stated that regulators, despite the benefits that the exchange touts about the security and transparency of its currency, will unlikely respond well to the new diamond-backed cryptocurrency.
"Unfortunately, my view is that regulators will view this diamond backed cryptocurrency the same way as others like Bitcoin. This is because regulators do not understand cryptocurrencies that well, and will hold the same general view on all cryptocurrencies," Lim said.
Some of the risks mentioned by Mersch include the currencies’ volatility, lack of liquidity that does not afford consumers a quick return on investments if they so desire, and on a greater scale could undermine the potential of the traditional financial system and offer states facing sanctions a way to circumvent them and gain access to foreign currency and world markets.
The head of the International Monetary Fund, Christine Lagarde, has also come out against the proliferation of cryptocurrencies, stating at the World Economic Forum in the Swiss city of Davos that their anonymity enables money laundering, and is an issue which without regulation from central banking authorities cannot be resolved.
The Diamond Exchange says that although there has been no talk of how the currency would be regulated, it would still ensure that the fact the currency is asset-backed will eliminate worries about money laundering and problems with transactional speed.
Traders using the Cut will be vetted by the exchange, and each transaction is promised to take place in a matter of minutes. The exchange has promised to make information on the identity of a trader making a transaction available to regulators, upon official request.
Yet, Richard Rofe, the managing director at Arcadia Capital Advisors, stated that the reason regulators may not pay heed to whether the currency is asset-backed or not, rather honing on the fact that it is decentralized.
"No more support as the regulators don’t care if there is backing or not. If they don’t want a decentralized currency they will dislike them all equally," Rofe said.
Cryptocurrencies, which are decentralized, cannot be placed in the traditional financial system as they do not afford a single person or institution the backing of its value. The value of a cryptocurrency is derived from the network of people using it.