El Salvador's aspirations to be in the vanguard of the crypto bond market look to be on hold. By Ben Edwards.
When El Salvador’s president Nayib Bukele emerged on a beachfront stage to fireworks and AC/DC’s "You Shook Me All Night Long" blaring out of the speakers last November, he announced plans for the world’s first sovereign bond to be backed by bitcoin.
Speaking at the end of the Latin American Bitcoin and Blockchain Conference at a party on Mizata Beach, a two-hour drive south from the country’s capital San Salvador, Bukele and Samson Mow – who at the time was chief strategy officer at Blockstream and helped design the bonds – said El Salvador would initially issue a US$1bn 10-year deal. Half the proceeds would be used to buy bitcoin and the other half would be used to finance infrastructure that will tap geothermal energy from a volcano to power bitcoin mining activities.
The US$500m of bitcoin would be locked up for five years, after which the country would start selling part of that stash as a dividend for bondholders to supplement the 6.5% annual coupon they would receive for holding the so-called volcano bonds. Mow said he did not see any reason why they would not be able to find US$1bn of demand given the amount of ‘bitcoin whales’ that trade on the Bitfinex crypto exchange, where the bonds are due to be sold. More bonds would follow, he said.
But despite all the fireworks and fanfare – which also included ambitious plans to build a bitcoin-themed city next to another volcano – investors are still waiting. Government officials had signposted a March launch but the country postponed the bond sale, citing market volatility caused by Russia’s war in Ukraine. While emerging market debt issuance has been relatively subdued since the conflict started, developing countries including Angola, Chile and Nigeria have all issued hard currency bonds. Yet, by early May, El Salvador’s volcano bond was still nowhere to be seen.
“The problem is you have very poor communication from the government, so there’s a real issue of credibility for them,” said Nathalie Marshik, head of emerging market sovereign research at Stifel Investment Services.
“They went all guns blazing in November and then came out in December and said they had US$300m in demand. Then, in January, they said they had another US$200m, but then the messaging started getting iffier.”
First, while the country’s finance minister Alejandro Zelaya was meeting bondholders on a trip to Paris, he mentioned that the bonds would be backed by assets owned by the country’s state-owned geothermal company LaGeo – the first time such an arrangement had been mentioned.
When the March launch was scrubbed, some investors started becoming sceptical. Marshik thought perhaps Bukele wanted to wait for April’s Bitcoin 2022 conference in Miami to whip up excitement as he had done at Mazata Beach back in November. But when the Miami event came and went with no new announcements, that scepticism started to solidify. “We were all left thinking that they clearly don’t have the demand,” Marshik said.
Out of line
Part of the issue is that the bonds are not being priced in line with the rest of the country’s sovereign curve. El Salvador’s outstanding dollar bonds are all trading below par, in some cases significantly so. Bonds maturing in 2032, for instance, are currently being quoted at roughly 40 cents on the dollar, according to Refinitiv data.
“The coupon [on the bitcoin bond] is very low for the kind of credit risk that you would be taking on El Salvador,” said Jonathan Masters, a partner at Eversheds Sutherland. “If you’re into emerging market debt, you’re more likely to go for a conventional bond where you get a higher coupon, and if you’re into bitcoin, it makes more sense just to invest in bitcoin.”
Bondholders would only receive half of any bitcoin gains by holding the bond, compared to 100% if they just invested in bitcoin.
“It’s a gimmick, and I question whether it will happen, given they’ve had real difficulty getting it away,” said Masters. “This is a hybrid that is almost the worst of both worlds.”
Emerging market investors are sceptical that El Salvador will be able to find sufficient numbers of bitcoin enthusiasts to support the bond sale because it could mean off-loading some of their bitcoin.
“Because you have to subscribe to the bond in dollars, if you’re long crypto already and you are a believer in crypto finance, as it stands at the moment, you would have to sell your bitcoin for dollars,” said Graham Stock, senior emerging market sovereign strategist at BlueBay Asset Management.
That could also potentially put downward pressure on the price of bitcoin, Stock says.
“There’s no internal consistency in what they’re trying to do,” he said. “The hope for us as emerging market investors was that it would prove a new pool of liquidity that first El Salvador and then others could access, but there’s no sign of that happening.”
For Marshik, the bond sale is a diversionary tactic to take the spotlight away from the more serious problems the country is facing, such as its fiscal woes, creeping authoritarianism and gang violence.
“Bitcoin has always been a sideshow – this is fairy dust to distract us from the key economic issues and the fact that they don’t generate enough dollars to pay back their debt and that they’re not doing the fiscal adjustment that they need to do,” she said.
The bitcoin bond plan has also weighed on the country’s existing debt, which had already been under pressure since Bukele said he was going to make bitcoin legal tender in the country. Before the bond announcement in November, its debt maturing in 2032 was trading at 72 cents on the dollar. Bonds maturing in 2050 also dropped from just under 66 cents to 36 cents.
El Salvador has an US$800m bond maturing at the start of next year, which was trading at just under 78 cents on the dollar in May. Investors are currently bending towards that bond being repaid.
“They have the ability to repay that bond, so it’s more of a decision that Bukele has to take about whether he is going to pay or not,” said Carlos de Sousa, a fund manager and emerging market debt strategist at Vontobel Asset Management.
“My view is that he doesn’t want to have an economic crisis before the 2024 elections and, therefore, most likely he will decide to pay, but I don’t have a super-high conviction on that, so, therefore, we’re not invested in that bond.”
Eventually, however, El Salvador will have to restructure – hence why the rest of the bonds are trading so low, said de Sousa.
El Salvador last year asked the IMF for a US$1.3bn loan, though little progress has been made on a programme, in part because the IMF urged the country to ditch bitcoin as legal tender– something Bukele is unlikely to do.
Fitch warned last October that El Salvador’s 2022 budget underestimates the size of the country’s fiscal deficit and financing needs due to optimistic revenue assumptions, adding that an IMF deal is uncertain.
Bitcoin is unlikely to be the major sticking point though, according to de Sousa.
“The main obstacle is that an IMF programme requires a lot of transparency, better governance and it requires imposing a fiscal adjustment,” he said de Sousa. “The fact that they legalised bitcoin makes things a little bit more difficult, but that’s not an impediment.”
Some asset managers are watching on with interest. Matthew Sigel, head of digital assets research at VanEck, is still optimistic El Salvador will issue the bond and is bullish about the prospects for emerging market countries more broadly to tap crypto markets to reduce their dependence on dollar debt.
“We’re intrigued by this offering,” Sigel said. “Bitcoin enables sovereign nations like El Salvador who have relinquished their monetary policy to the United States for many decades to regain some control and to invite innovation.”
Crypto watchers believe there is sufficient demand among crypto investors to get El Salvador’s bitcoin-backed bond over the line but it is being held up because of regulatory delays and because the bond prospectus has not been released.
“We believe there is interest from crypto investors, which include crypto native funds as well as other investors,” said Paolo Ardoino, chief technology officer at Bitfinex. “Rules on the issuance and trading of such assets are still evolving and, as such, are a consideration for some investors. The issuer also needs to present its key information document before investors can make any firm commitments.”
He said that given the market capitalisation of the digital token space has grown to more than US$2trn, there is considerable capital available to support these types of investments.
Others are less convinced that crypto investors are ready to diversify en masse into fixed income-related issuance.
“The sovereign debt market is dominated by institutional investors not by retail investors, and the crypto community is dominated by retail investors,” said de Sousa.
“So, it’s not only a completely different kind of instrument, it’s a different kind of investor base. So, you need to come up with different ideas to be able to appeal to that market, which wants to make a quick buck. El Salvador hasn’t been able to do that.”
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