Will anyone invest in El Salvador’s $ 1 billion Bitcoin Bond?
President Bukele plans to build the world’s first “Bitcoin City” using bitcoin-backed bonds, which will be based on big bets on the future of cryptocurrency.
On November 20, in his characteristic heterodox fashion, Salvadoran President Nayib Bukele unveiled his government’s latest plan: to build the world’s first “Bitcoin city”.
The circular city – laid out like a coin – will be built at the base of the Conchagua volcano in the eastern region of La Union, where geothermal energy from the volcano is expected to fuel bitcoin mining.
The city plans to have everything from an airport to housing to commercial real estate, and other than a 10 percent sales tax, there will be no income, capital gains, property. , salaries or municipal taxes.
According to Bukele, the idea is to create a city that would serve as a shining example of what is possible in the 21st century, specifically having reference the need for nations and rulers to build modern versions of Alexandria.
But why is it called Bitcoin City? This is not because bitcoin will be legal tender – this is already the case in all the cities of El Salvador – but because it is partially financed by a new financial instrument: the “Bitcoin Bonds”.
The idea is this: the Salvadoran government will issue a symbolic billion dollar bond that will offer a 6.5% yield to investors. About $ 500 million will go towards building the city’s infrastructure and mining bitcoin, and the remaining $ 500 million from the bond offering will go towards buying more bitcoin.
Developed by Blockstream on the Liquid Network, the bonds will be denominated in US dollars over 10 years. After a five-year lock-in period, El Salvador will begin selling its cryptocurrency holdings and paying an additional dividend to bondholders.
The annualized return to investors is estimated at 146% by year 10, according to Blockstream’s optimistic projection of a bitcoin price reaching $ 1 million. This is compared to the benchmark 10-year yield on outstanding El Salvador government bonds which currently stands at 13%.
Samson Mow, Chief Strategy Officer of Blockstream noted he expected other countries to follow suit and assumed the move would absorb enough bitcoin to increase its value. This would allow El Salvador to repay the deposit with the profits made by reselling the bitcoin.
The crypto exchange Bitfinex was named as the bond’s bookrunner, and Mow said it would be sold in $ 100 installments to “democratize access to the bond.”
Bukele said the government plans to issue the bitcoin-backed bond sometime in 2022.
“An act of desperation”?
Some observers have questioned the move, saying the new offering may struggle to attract investors because the bond would pay interest at a lower rate than the country’s conventional dollar bonds.
Marc Chandler, managing director of Bannockburn Global Forex, called the move an “act of desperation” and believes it is a ploy to get lower interest rates.
“He’s trying to get a lower return from the bitcoin wrinkle,” he told TRT World. “It’s not a bitcoin bond, it’s a dollar bond.”
Credit rating agencies have also not welcomed El Salvador’s bitcoin bet.
After the country adopted bitcoin as legal tender in June, Moody’s downgraded the long-term rating of the issuer in the foreign currency of the Central American country and senior unsecured ratings of B3 to Caa1, a “junk-grade” credit rating – or bonds deemed to be subject to very high credit risk. raised.
Lyn Alden told TRT World that the announcement of the bitcoin-backed bond issue is unlikely to change the negative outlook for rating agencies and financial institutions.
“This bond sale looks very risky for institutions that are not particularly bullish on bitcoin fundamentals, and is primarily attractive to investors who are bullish on bitcoin,” said Alden, founder of Lyn Alden Investment Strategy, a consulting firm that provides services to both retail and institutional investors.
“Even for Bitcoin bulls, there is significant counterparty risk with this bond.”
Chandler doubts the retail investment community is showing any interest, and that any country will follow El Salvador’s lead, just as he doubted corporate treasurers would follow Tesla when he bought $ 1.5 billion. bitcoin earlier this year.
“It’s a bet on the future of the price of bitcoin,” Chandler continued, pointing out that given questions about the intrinsic value of the world’s largest cryptocurrency, it’s actually a “crapshoot”.
“If bitcoin appreciates, the investor can make more money than the current higher yielding dollar debt,” he says, but adds that this still would not solve the current economic and development challenges of the country.
Best and worst case scenarios
While crypto enthusiasts are probably the most attracted investors to bitcoin bond, why not just buy bitcoin directly instead of taking risks through a struggling emerging market?
Alden agrees that buying bitcoin directly is a better strategy, but points out that there are certain pools of capital that have mandates – like holding bonds or stocks – and have no way of expressing interest. for bitcoin within their fund.
“If someone manages a pool of capital like this and is very bullish on bitcoin, then any reasonable bitcoin-related action or obligation can be very attractive to them as a security.”
Additionally, some might want to invest to contribute to the larger cause of bitcoin development in the country.
“There may be passionate bitcoin investors who are willing to risk capital here for the benefit of El Salvador and the intangible benefits it can add to the Bitcoin network if the project is successful in the long run,” Alden said.
She believes that a scenario in which this move would bear fruit would mean that the price of bitcoin would perform well against the dollar over the next 5-10 years, and that El Salvador would be able to profitably mine additional bitcoins.
Increasing income from tourism and foreign investment by attracting bitcoin investors would be another key to success – and so far it seems to be working, with many wealthy and prominent investors visiting El Salvador on a regular basis.
“They are positioning themselves as a Bitcoin hub, which could definitely work well,” Alden said.
For Francisco Dominguez, one of more than two million Salvadorans living in the United States, a city marked by the future of bitcoin remains a very risky proposition.
“I don’t know how the Salvadoran people might feel about this if – and when – we hit a bear market,” he told TRT World. “Things are moving so quickly and there is a lot of excitement around bitcoin and how it can bring financial freedom, but I wonder if the government understands the risk of volatility and is doing enough to educate. people about it. “
While supporting Bukele’s foray into legal tender bitcoin, Dominguez is wary of the need for an additional bet like Bitcoin City in a country plagued by so many other pressing issues.
And if things go wrong, the “repercussions could be extreme,” he worries. “It would be a public relations nightmare for the government if bitcoin takes a dip. What happens then?”
Alden predicted some variables that could sink Bitcoin City, including mining infrastructure issues that make it unprofitable, or not being able to maintain international interest in the project.
Being so dependent on a man’s vision poses another notable risk. “They could have a deterioration in governance, like President Bukele turning into a dictator over time, or making bad governance decisions,” Alden warns – or more simply, a scenario where a new president comes along who “s’ opposes the project and reverses the course in a destructive way.
At the moment, questions remain as to when exactly the government plans to buy $ 500 million worth of bitcoin, in addition to the legal rights of potential buyers.
It is also unclear what would happen to the new obligations if the country defaulted on its existing traditional obligations. The next maturity of government bonds is a repayment of $ 800 million due in January 2023.
Source: TRT World