During the last event of “Bitcoin Week'', "Feel the Bit", in El Salvador last November 20th, President Nayib Bukele announced a project for the first El Salvador bitcoin bond issue, nicknamed ESBB1.
The project is quite convoluted, having financial, technological, and practical implications. We will cover all of these, but I will try to focus more on the economic and technical aspects of this, leaving the discussion of the details of the Bitcoin City part of the citizenship project to other threads.
1. The MasterplanEl Salvador, the only country in which bitcoin is a legal tender, announced a debt issuance to raise capital in order to "accelerate hyperbitcoinization and bring about a new financial system on top of Bitcoin," according to a blog post by Blockstream. Half of the Proceeds of the bonds will be used to build a new city, nicknamed “Bitcoin City”, in the Gulf of Fonseca, in the immediate vicinity of an active volcano, whose geothermal energy will be used not only to power the city itself but also to mine bitcoins. The city would have no income, property, capital gain or labour taxes but would be financed only by a 10% sales tax.
As only half of the capital will be used to build this “bitcoin infrastructure”, the other half of the bond sale proceeds will be used to pay a special “bitcoin dividend” to the bondholders, which would significantly raise the final bond yield. The plan is to use such capital to buy bitcoins on the market, hodl them for five years, and then subsequently return part of the appreciation of those to the investor across the last five years of the bonds in the form of an annual coupon payment financed by the sell of a corresponding amount of those bitcoins.
Thirdly, the investor who buys more than 100,000 USD of the bond would have the possibility to apply for El Salvador citizenship.
The bond is meant to be fully tokenised in a wholly digital form developed with Blockstream. This would allow the decentralised exchange of the bond using the Liquid sidechain. The bond purchase will be possible in USD, BTC, and USDT, and, given the unique digital feature, the minimum purchase amount would be 100 USD only. This feature will help “democratise access to the bond”.
If you want to discuss the masterplan of El Salvador and the construction of the Bitcoin City, I suggest you this thread:
First Bitcoin City
2. The Bond details Few details have emerged so far. The only details are those revealed at such a conference and a few later interviews with Bitcoin entrepreneur Samson Mow, as President Nayib Bukele didn’t attend a press conference meant to give out more details.
The termsheet of the bond was published on a presentation slide and reads as follows:
According to the Termsheet
- The bond will be issued in January 2022. It will be US dollar-denominated (USD is legal tender in El Salvador) and with a potential size of 1 billion.
- The bond will mature in 10 years, or January 2032 and will pay an annual coupon of 6.5%.
- After the first five years, the bond will start selling an equal amount of bitcoin each quarter. The sale has been spread over multiple quarters to minimise market impact.
- After the initial bitcoin purchase has been covered, the bond will start paying an additional “bitcoin dividend”. The bond will pay an additional coupon determined as the 50% of the potential bitcoin gain from selling the 20% of the bitcoin held by the bond. If the proceeds of such a sale produce a profit, this will be shared in equal parts with the investor.
- Remember that the bond will use only 50% of the funds to buy bitcoin. So the “bitcoin dividend” will pay to the investor 50% of the gain on that 50% investment.
In the following example, you can see all the cash flow of the bond, according to the bitcoin price in the second row:
Spreadsheet Blockstream, a Canadian blockchain solutions company, helped El Salvador to structure the bond, working in close connection over the last few months. In addition, the government is going to issue a few particular laws for Bitfinex actually to sell the bond:
El Salvador also aims to create a government securities law and grant Bitfinex Securities licenses to process the bond issuance. This could pave the way for other Liquid security tokens like the Blockstream Mining Note (BMN) or Exordium (EXO) token to be listed on a regulated El Salvadorian securities exchange.
This will probably take some time; providing the issuer and the operation arrangements with a legal framework within which to operate is an incredibly demanding task. But, above all, this one is the first experiment with so many aspects to consider.
To my knowledge, this bond will be the first fully-fledged digital bond in the world. The bond will be traded on Blockstream AMP, a platform used to issue, trade, and manage digital assets issued on the Liquid Network. The trading activity would be entirely digital, 24/7 (weekends and bank holidays included then) over a blockchain (albeit a permissioned one) on a fully digital form: not only the bond part of the trade will be digital, but also the “purchase “ part will be fully digital, through either fiat, BTC or stablecoins. This would drive costs down for both the issuer and the investors.
The actual trading would be done with the interface of Bitfinex, which will provide onboarding, a matching engine, and order processing of the orders and trades.
In this
spreadsheet , you can find a copy of the termsheet.
3. El Salvador as an issuer in traditional financeEl Salvador has a poor financial situation. The country has a CCC+ rating. Essentially, their financial stability is rated as “junk”.
This condition precluded the country from accessing traditional financial markets, as many money managers cannot buy Junk Bonds and those who can require high premiums to do so.
El Salvador has a few outstanding bonds:
As you can see, there are only 12 bonds maturing from 2023 up to 2052. Remember that the US has over a few hundred available bonds to construct the same bond curve.
The yield curve is as follows:
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| El Salvador Yield Curve: it's inverted; shorter maturities require higher yield.
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This graph plots the maturity date of each El Salvador bond, coupling each maturity with the associated yield: the resulting line is called the "Yield Curve" and plots the line we would like to use to exchange capital in time. Usually, those slopes are tilted upwards. Whatever the issuer, if I lend the money, I want to receive a higher premium for letting someone use such for a long time because of the credit risk. Credit risk, which represents the risk of the borrower not returning the funds, ideally increases with time.
Shorter maturities require higher yields; this is quite common across distressed issuers. Basically, the idea is the following: if you manage to navigate through the immediate difficulties, later things will probably be much better, so a lower premium will be required. This produces these weird "inverse" yield curves you don't usually see amongst more credit-worthy issuers.
Since the introduction of the Bitcoin Law and the subsequent friction with the IMF, El Salvador bonds have been losing premium constantly, with yields going north (remember that if the price of a bond falls, the implied yields grow, an inverse relation).
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| El Salvador Sovereign Yield Curve compared to what it was three months ago.
A big shift upwards. The current curve should be comparable with the above one in Google Sheets. | El Salvador 10Y yield during last months: up from 12.50% to 16.00%. |
ESBB1 would be somewhat depressed in terms of yield, considering the bonds in the curve. However, just remember that this would include the lower amount of bitcoin; in case of a good underlying bitcoin appreciation, the final yield would be better.
4. How this bond compares to traditional investment Since the conference, the Bitcoin community cheered at the bond announcement, as it is seen as a way to help the hyperbitcoinisation in El Salvador. Of course, Bitcoin City symbolised this, but the bond carries another light financially.
To cut a long story short: this bond is a financial disaster.
An excellent analysis of this concept from a
Bloomberg article. Basically, buying an El Salvador Bond and using the residual amount to buy bitcoin currently produces a superior result. And this holds true in pretty much every possible future scenario. Even in a very unpredictable scenario of bitcoin going to zero, the payoff would be better for the traditional finance bond. In an environment where bitcoin would go to zero, we are left wondering why we should buy a Volcano Bond in the first place.
I ran a few computations in the spreadsheet. Even in the ultra-bullish case illustrated by Samson Mow, the Volcano Bond is inferior to the strategy of buying a traditional bond and investing the change left after the bond purchase in bitcoin.
Summarising what is written in the article, instead of buying the bitcoin bond, a superior strategy would be to buy a regular bond instead, for example, the EL SAVL 2032 with an annual 8.5% coupon, trading at 65 cents. This would imply a cash flow of 65,000 USD. This would leave the possibility to invest the residual 35,000 USD into bitcoin. The combined investments would be superior to the bitcoin bond in any state of the world.
So why on Earth should anyone buy a Vulcano bond if we just demonstrated that it is an inferior choice?
Well, the reason is always the same: not every investor has access to physical bitcoins.
This is the very reason why there is a market for vehicles like GBTC, future-based ETF, or even Microstrategy, or vaguely Bitcoin-related companies that get purchased by investors in the desperate willingness to gain bitcoin exposure.
Many money managers have constraints on what they can buy as investments. And many of those can not simply buy physical bitcoins, or even if they could theoretically buy the thing; then they would have compliance, custodial, fiscal, or accounting problems.
So yes, many suboptimal investment vehicles exist for this very right reason.
The problem with this particular bond is that I find it very difficult for an investment manager who cannot buy bitcoin to buy a Junk Bond not traded on a traditional financial market. Many managers have a threshold for the creditworthiness of the debt issuers, and for sure, the rating of El Salvador is well below this threshold, sitting at CCC+.
Also, a problem is the nature of the digital bond, where there is no centralised venue for trading, which could spell issues for many investors.
5. How this bond is innovating the financial system There is a fascinating detail about the bond. This is the first fully digital bond in the world. Many experiments have been done, but this is the first time a sovereign entity has issued a digital bond that can also be transacted with digital assets, namely BTC and USDT. Blockstream, which by the way, is an unlisted Canadian firm, issued a similar bond, but I guess the scale is so different.
There is an exciting part about this in the Stephan Livera podcast:
Stephan Livera:
True, true. So yeah, you’ve got to think about that also. And so I guess then, in terms of operationally, is it going to be essentially trading, like do you have to become a customer at Bitfinex to get the bond? Or how would you actually buy it?
Samson Mow:
Right. So Bitfinex is going to be the initial exchange that is releasing the bond. So they will be getting the first license, allowing them to issue this security. So I think anyone that wants the first bond would go through Bitfinex to buy it, but once you have it — so let’s take one step back — these bonds are issued as a token on the Liquid network, and they do have a permissioned part, and that’s done with Blockstream AMP, our asset management platform. So it’s effectively a two-of-two multisig. So you would go to Bitfinex, do your KYC, you would be added to the AMP allowlist, and then if you and I are both on the AMP allowlist, then we can withdraw it to any wallet that supports Liquid in AMP assets. And we can OTC trade it back and forth with one another, just like the Blockchain Mining Note. So there’s a Telegram channel and people are already trading the BMN OTC daily. But there is no marketplace. There’s no secondary exchange marketplace, but they can freely trade that. And that would be the same case for any bondholder. So you could trade it and buy and sell it with any other bondholder.
So here we have a fully digital, decentralised OTC trading environment. This is the future of traditional markets. But I guess a few institutional players are already ready for that.
This is true not only from a technological point of view, as implementing this should be trivial, but above all, from a compliance and regulation point of view.
Just remember that even if these bonds can be traded in a decentralised way, they are not decentralised at all. There is a central registrar anyway.
Again on the SLP:
Stephan Livera:
You could withdraw the token of this bond to your Blockstream Jade and have it on that. And so actually, I’m curious then as well, like how would it work if, as an example, let’s say you lost the seed words for your Blockstream Jade—how would that aspect of it work? Is there a central registrar of it? Is that what AMP is providing here?
Samson Mow:
Yes, effectively. So AMP would allow the service to blacklist those tokens because they’re lost now. And because it is—like, this is not decentralised, right? We should not pretend like these bonds are decentralised. They’re not. They are a security, and that’s why you have to KYC, and you have to be added to a whitelist to be able to trade them and withdraw from the exchange, of course. So what would happen is the service would blacklist those old tokens and then issue new ones for you. So the net circulating supply would not change because some of the tokens are now out of circulation, but there is a way to get them back. And we’ve had that with EXO for Infinite Fleet. Someone lost their keys, actually. So they’re going actually to get new tokens from STOCKR. So there is recourse if you lose your key—it is not Bitcoin. It’s a bond tokenised with Bitcoin in it.
This is crucial.
The failure to understand that centralisation of the asset control and the centralisation of the exchange are two separate concepts is a classic error many legacy financial institutions make daily while speaking of "blockchain" and "decentralised assets".
In addition to that, another crucial aspect is the technology behind it. All your favourite digital assets, NFT, tokens or whatever thing you are interested in is based on some shitty blockchain, namely ETH. Not this one. The technology here is 100% Bitcoin. Liquid is a Bitcoin Sidechain. All this is being made with "traditional, slow, polluting" Bitcoin technology.
Also, this is a significant selling point for the bond and, for sure, an actual use case test for Liquid to become the backbone of the new financial market.
6. further resources
Fillippone "everything you wanted to know about.." threads:
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