El Salvador’s $1B Bitcoin experiment dents its U.S. dollar-based bonds market

El Salvador's $1 billion Bitcoin bond plans sent its dollar-denominated bonds diving. Image by wuestenigel on flickr
El Salvador’s $1 billion Bitcoin bond plans sent its dollar-denominated bonds diving. Image by wuestenigel on flickr

Key Takeaways:

  • El Salvador announced plans to launch world’s first sovereign Bitcoin bond.
  • News of the launch sent the nation’s dollar denominated bonds to a new record low.
  • Meanwhile, BTC prices fell below $56,000 for the first time in more than 5 weeks.

NEW DELHI (CoinChapter.com) — El Salvador, the first nation to adopt Bitcoin (BTC) as a legal tender, recently partnered with digital assets firm Blockstream to raise $1 billion for U.S. dollar-denominated 10-year bonds with a coupon of 6.5%. The country decided to deploy Liquid Network, a sidechain-based settlement network for traders and exchanges, to issue the said debt.

However, after news of the so-called Bitcoin bond hit the wire, El Salvador’s original dollar-denominated bonds went into freefall, hitting an all-time low.

Investors have been guessing whether or not El Salvador President Nayib Bukele’s decision to issue sovereign Bitcoin bonds would mean further souring the country’s relations with the International Monetary Fund (IMF).

Meanwhile, BTC prices slumped below $56,000 for the first time since moving above the price level on Oct 11. The O.G. crypto ended the previous week in a downtrend, falling 9.27%. On Nov 22, Bitcoin prices painted another red candle on the daily chart, losing 5.79% of its value.

BTC/USD daily price chart. Source: TradingView
BTC/USD daily price chart. Source: TradingView

El Salvador’s Bitcoin Bond

El Salvador’s proposed Bitcoin bond would help finance energy and Bitcoin mining infrastructure. The country plans to allocate $500 million to invest in Bitcoin.

Bitcoin and blockchain technologies firm Blockstream is developing a tokenized financial instrument for the Bitcoin bond. Samson Mow, Chief Strategy Officer at Blockstream, shared that the 10-year Bitcoin bond would be US Dollar-denominated, initially offering 6.5% dividends annually.

The BTC purchased using the fund would have a lock-in period of five years. Afterward, El Salvador will start selling its Bitcoin to offer additional dividends to bondholders. The Blockstream CSO predicts an annual percentage yield of 146% based on Blockstream price models.

In detail, Blockstream’s models predict Bitcoin prices to reach $1 million within the next five years. Furthermore, taking out of $500 million worth of Bitcoin from the market for five years would likely cause a supply squeeze that positively affects BTC prices, the Central American country hopes.

Blockstream shared in a blog post that El Salvador’s government plans to create a securities law and ‘grant a license to Bitfinex Securities to process the bond issuance.’. As a result, the El Salvadorian securities exchange could list other Liquid security tokens like the Blockstream Mining Note (BMN) for trading.

The Bitcoin Bond represents the start of a reformation of capital markets, built on Bitcoin and layer-2 technologies like the Liquid Network. Now, investment capital can flow in from around the globe without friction.

Excerpt from Blockstream’s blog post.

El Salvador’s Bitcoin bond would have its dividends dispersed annually, and the threshold for investing in the bond is $100.

Analysts believe that the bond’s high yield promise would attract investors. However, it is important to remember that Bitcoin weakening could lead to losses. There’s also a chance that the bond would attract investors from Wall Street.

Institutional investors tend to overlook certain risks as long as they meet their goals for returns. ‘I can’t buy Bitcoin, but I can buy junk.’ It’s a way to get around mandates in their funds. Technically, you’re not buying Bitcoin, just junk.

Luis Gonzali, co-head of investments at Franklin Templeton Mexico, said

Meanwhile, the bond represents a new method for governments to borrow externally.

Dollar-Denominated Bonds Down

El Salvador’s dollar bonds, due to mature in 2050, fell to 64.4 cents on the U.S. dollar on Nov 22, their lowest ever. The decline followed El Salvador’s announcement of launching a $1 billion Bitcoin bond.

The Central American nation fell out of favor with the International Monetary Fund (IMF) after announcing and then implementing its plans of adopting BTC as a legal tender. Furthermore, the IMF has often been a critic of President Bukele’s policies.

This announcement cements the ‘anything-but-the-IMF’ path. Bonds are falling as the market reassesses possible recovery value lower on unpredictability of policies.

Nathalie Marshik, Managing Director at Stifel Nicolaus & Co., commented

A month after El Salvador adopted Bitcoin as legal tender, credit risk analysis firm Moody’s lowered the country’s long-term, foreign-currency issuer and senior unsecured ratings to Caa1 from B3. A Caa1 rating means an obligation has a poor standing and very high credit risk.

El Salvador's dollar bonds fall to an all-time low. Source: Bloomberg
El Salvador’s dollar bonds fall to an all-time low. Source: Bloomberg

As a result, El Salvador’s debt is in the distressed category, with investors looking for extra yields to hold El Salvador’s dollar bonds. The country has an upcoming payment to external creditors due in Jan 2022. Incoming funds from the Bitcoin bond could offer the government some breathing room.

The IMF Report

The Salvadorian government approached the IMF for a loan of $1.3 billion. On Nov 22, the IMF issued a concluding statement regarding El Salvador’s request. In detail, a concluding statement describes the preliminary findings of IMF at the end of an official visit to a member country.

IMF’s report noted El Salvador’s quick rebound from the pandemic. However, public debt and rising fiscal deficit are putting a strain on the country’s already stressed resources. The report also noted El Salvador’s Bitcoin policies.

The IMF lauded the country’s efforts to increase financial inclusion and took note of Bitcoin’s risks. The report noted that Bitcoin’s use as a legal tender is a risk to consumer protection, given the crypto’s volatility.

Staff recommends narrowing the scope of the Bitcoin law and urges strengthening the regulation and supervision of the new payment ecosystem. […] Risks arising from Bitcoin as a legal tender, the new payments ecosystem and trading in Bitcoin should be addressed.

Excerpt from IMF’s El Salvador Concluding Statement.

The IMF report also noted that a well-defined fiscal consolidation strategy would help in restoring fiscal sustainability.

At the time of writing, BTC was trading at $56,143, down 0.35% on the day.

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