Gold, War, and Perpetual Prediction Markets

Onchain Real World Assets (RWAs) like gold, oil, or copper can serve as early indicators and prediction markets for traditional assets. The combination of both spot and perpetual contracts on RWAs opens up new strategies for predicting sentiment, event-based trading, and for executing cross-asset arbitrage strategies.

In this article, we explore the the interplay between gold, conflict, and prediction markets through the events surrounding PAXG, a tokenized version of gold, during the events of April 2024 and November 2022.

PAXG Premium as a Bellwether During the April 2024 Middle East Crisis

Gold has historically been a safe-haven asset during times of war and economic instability. The intersection of gold and financial prediction markets offers interesting insights to the broader market sentiment.

During the recent crisis in the Middle East over the weekend of April 13-15, 2024, PAXG, the leading tokenized gold product, traded at a remarkable 20% premium compared to the spot price of gold (XAU), spiking past $2,850. This phenomenon can be attributed to several factors:

  • Traders cycled out of risk-on crypto assets into PAXG as an onchain safe haven.
  • Demand for PAXG spiked as it was the only liquid public market for gold available over the weekend.

While spreads declined after markets reopened Sunday evening, PAXG continued to mostly trade at a small premium for several weeks following the crisis.

Markets didn’t converge to pre-shock spreads for several weeks after the initial weekend spike. One likely explanation is that by then a premium had been priced in for the flexibility to trade in and out of gold positions over subsequent weekends – a valuable option during times of prolonged uncertainty with potential repeated flights to safety.

This contrasts with the slight discount at which PAXG typically trades relative to XAU.

A straightforward conclusion from looking at this April’s events is that PAXG acts as a safe haven asset during times of economic uncertainty, in particular when the underlying market is inaccessible.

FTX Collapse and the PAXG Discount Anomaly

The last time PAXG volumes were as high as during the April’s Middle East crisis was during another period of extreme uncertainty: the FTX collapse in November 2022. This adds as confirmatory evidence for our intuition around PAXG acting as a stand-in for investor retreat to safety during market panics.

However, PAXG traded at a discount to XAU during this period. Over an 11-day window from Nov 7-18, PAXG saw an XAU premium (i.e. PAXG discount). This contrasts with April 2024 during the Middle East crisis, where PAXG traded at a premium.

The most likely explanation for the FTX PAXG discount is that overall outflows from the crypto market (precipitated by the collapse and fear of the entire market failing) eclipsed any onchain demand for safety. The perception at the time was that the safest move was to exit crypto altogether.

A critical factor worth mentioning is Alameda’s PAXG holdings. At the time a major holder of PAXG, Alameda began dumping its holdings as news spread of its balance sheet issues. This market dynamic from a single large holder also likely had a strong influence on price suppression, potentially accounting for the majority of the disparity between price action during the Middle East vs. FTX crisis.

Except for cases of extreme panic where many believe the entire crypto industry may fail, PAXG indeed behaves like a safe haven asset for crypto-natives.

Analysis of PAXG Premiums and Volatility Across Periods of Uncertainty

Expanding the analysis to focus volatility, with a focus on periods of market uncertainty, PAXG on average has slightly higher intra-day vol than XAU:

During the two periods under analysis (ME 2024 and FTX 2022), that volatility differential blows out, in particular over weekend.

Importantly, it tracks closely with the spikes in volume over the weekend. PAXG volatility was highest on Saturday and Sunday when volume was highest:

More specifically, it peaked on Sunday – where end of day coincides with gold market reopen (5pm ET). In this sense, PAXG’s tokenized version of gold acts almost as a prediction market for gold’s Sunday market open price.

Onchain RWAs as Prediction Markets

A core set of onchain RWAs (Real World Assets) can act as a shorthand way for crypto-natives to express simplified versions of broader market views. For example, where gold is typically seen as a safe haven, copper can be seen as an indicator of GDP bullishness, and oil as a signal of energy demand and/or geopolitical instability.

The discount/premium, volume, and volatility dynamics of these onchain RWA markets turn them into prediction markets for the underlying asset. Given that access is unrestricted (unlike artificial demand suppression in traditional markets) and that trading can occur 24/7, onchain RWA markets may also serve as early warning signals for the underlying asset.

Some potential consequences as more traditional assets get tokenized and become tradable 24/7:

  • Crypto-native assets absorb less volatility from catalytic events outside traditional market hours, as investors can express views through the tokenized versions of traditional assets rather than crypto serving as a catch-all risk proxy.
  • Tokenized assets become a bellwether for the underlying markets, though selection bias of different risk appetites may exist initially.
  • Potential reduction in volatility of underlying markets upon reopening, as the tokenized markets provide a predictive signal.
  • New arbitrage opportunities arise, such as speculating on PAXG depegging (to the upside) over a weekend while remaining neutral on the price of gold through a short XAU/USD perp on Ostium Labs and a long PAXG/USDT position.
  • Similar to how funding rates in crypto markets are a good indication of overall sentiment, funding rates across RWA perps can become indicator of where underlying assets are likely to move.

A majority of these assets don’t yet exist in tokenized form, meaning the only outlet for market demand is perpetuals on platforms like Ostium. Perpetuals that use an off-chain spot index as a reference price scalably open up a vast set of assets for onchain trading, far more rapidly and through integration with more crypto-native primitives than tokenization.

The PAXG premium and volatility dynamics during recent periods of uncertainty demonstrate the potential for onchain RWAs to serve as early indicators and prediction markets for traditional assets as the market grows and matures. The combination of both spot and perpetual contracts on RWAs opens up a new design space, in particular basis trade arbitrage across both on- and off-chain spot and perp markets. We are likely only at the beginning of a broader market expansion as TradFi and DeFi hurdle towards convergence.