Government bond issuances are typically met with little fanfare — but that was not the case when El Salvador president Nayib Bukele announced plans for a $1bn bitcoin-backed bond, at a launch party last November.
Through smoke, fireworks, and neon lights, a jumbotron screen flashed images of a volcano erupting and spewing forth Bitcoin to the soundtrack of AC/DC’s “You Shook Me All Night Long”.
The so-called “volcano bond”, which was set to be issued last week as FTfm went to press, has been marketed with a 6.5 per cent coupon and a “bitcoin dividend” of 50 per cent of the gain in the price of the cryptocurrency after five years. Half of the $1bn expected proceeds from the issuance will go toward the construction of “bitcoin city”, a development close to the Honduran border dedicated to bitcoin mining and powered by geothermal energy from a nearby volcano. Meanwhile, the other $500mn will be invested directly in bitcoin.
For many market observers, the scheme shows El Salvador’s wayward drift from the discipline of traditional sovereign debt markets. Others, however, see it as a sign of cryptocurrencies moving rapidly into mainstream global financing.
Earlier this month, emerging market debt traders sat in on a call with Salvadoran finance minister Alejandro Zelaya to discuss the security. “Much to our surprise, [Zelaya] said he had demand for up to $1.5bn for the bitcoin bonds”, says Kevin Daly, a portfolio manager at investment firm Abrdn. Even so, he views the issuance as a mis-step.
Rating agency Fitch has also added its voice to a growing chorus of warnings. It recently downgraded El Salvador’s sovereign credit rating to CCC from B-, citing its use of bitcoin as legal tender as an impediment to a possible $1.3bn financing package from the IMF.
But Salvadoreans are not alone in experimenting with digital currencies. According to blockchain research company Chainanalysis, Latin America along with south and south-east Asia account for the bulk of web traffic on cryptocurrency platforms — with Vietnam, India and Pakistan topping the index of global adoption.
“El Salvador is a case study for other developing countries that are reliant on the World Bank and the IMF for financing”, says Meltem Demirors, chief strategy officer at digital asset manager CoinShares.
Bitcoin advocates see the greatest opportunities for adoption in nations with unstable fiat currencies or dependence on remittances from overseas. While investors in developed market countries treat bitcoin as a speculative asset, this runs counter to how cryptocurrencies are used in emerging market countries, where the focus is on transacting.
“Our largest, most lucrative export is our people: they make more money for us than any commodity”, explains Lord Fusitu’a, a Tongan nobleman and former MP, who is seeking to introduce a bill that could make bitcoin legal tender in Tonga as early as February 2023.
Tonga is one of the most remittance-dependent countries in the world, according to the World Bank. Remittances accounted for 39 per cent of its GDP in 2020, but these receipts incurred an average transaction cost of about 10 per cent.
Taking inspiration from Bukele’s backing of cryptocurrencies — 60 per cent of Salvadoreans have digital wallets in a country where fewer than a quarter of the population have bank accounts — Lord Fusitu’a expects to be able to cut remittance fees by switching to bitcoin.
As of October 2021, only 4 per cent of Salvadoreans used bitcoin in remittance transactions, a poll by the Central American University found. However, the government hopes the Lightning Network — a payment protocol designed to solve bitcoin’s scalability problem — will deliver faster transactions and further reduce costs, which are currently a hurdle.
Mark Yusko, chief executive officer at asset management firm Morgan Creek Capital, identifies El Salvador’s more autocratic government and untapped, or stranded, energy resources as characteristics that may lend themselves to early bitcoin adoption, more widely. For example, in Paraguay, the senate recently approved a bill to enable cryptocurrency mining — an energy-intensive activity — to make greater use of its abundant hydroelectric capacity. The South American country consumes only a third of the energy it produces.
However, fixed income analysts are sceptical about other emerging market countries following El Salvador into bitcoin bonds.
“There are broader checks and balances elsewhere in Latin America that would discourage against any fast-track process to adopt Bitcoin like what we saw in El Salvador”, says Siobhan Morden, a managing director at Amherst Pierpont Securities.
She adds that other governments in the region were probably unnerved by recent warnings in an IMF review of the central American country, in January. It claimed that adoption of the cryptocurrency “entails large risks for financial and market integrity” and recommended that El Salvador immediately scrapped bitcoin’s legal tender status.
But the prospects of similar issuances of crypto-based sovereign bonds are more likely to hinge on the success or failure of this first offering. Paolo Ardoino, chief technology officer at cryptocurrency exchange Bitfinex Securities, which is working on the volcano bond launch, says this may be measured through “subscription, diversification of the investor base, and post-issuance trading”.
Representatives from investment consulting firms Meketa Investment Group and NEPC say that uptake among institutional investors, including pensions and endowments, is likely to be muted. Instead, they predict retail investors and cryptocurrency enthusiasts will buy the lion’s share.
Restrictive investment policies prevent most institutions from holding bitcoin directly. But some investors have some small exposures through their stakes in hedge fund and venture capital strategies or certain publicly traded stocks, such as Microstrategy and Tesla. The decision of large custodial banks BNY Mellon and State Street to form the cryptocurrency trading platform Pure Digital in 2021 could also expand the base of interested institutional investors, says Meketa research consultant Alison Adams.
For now, El Salvador is “still muddling through”, says Abrdn’s Daly, who also notes the principle of volcano bond is not government-guaranteed — and is therefore sectioned off from the country’s conventional sovereign debt. “A default [on the country’s $800mn eurobond that matures in January 2023] would create more problems for the government a year ahead of the election,” he points out, “and that’s not what Bukele needs or wants”.
“The jury is very much out”, Daly adds. “If they manage to print a billion dollars, we’re all going to shake our heads in amazement.”
Source: Financial Times