One of the ongoing themes which we write about in our blog is how money is currently being redefined by competing sovereign nations and groups who appear to have lost faith in the fiat currency system dominated by the U.S. dollar. As we monitor headline news, we occasionally see some stories which are groundbreaking and worthy of your attention. The most fascinating story which we ran across this past week was the launch of Bitcoin Volcano Bonds which we will discuss in this article.
Earlier this year upon the outbreak of the war in the Ukraine, Russia responded to Western sanctions by backing their currency with hard assets. You can read our earlier analysis of these events here:
What Effect Will De-Dollarization Have
Why Putin is throwing B.R.I.C.S at The U.S. Dollar
The Most Empowering Trading Question: Who is Winning?
Adding fuel to this distrust in Western fiat is the reality that the B.R.I.C.S nations, (Brazil, Russia, India, China, and South Africa) are all in the process of also creating a hard asset currency that will compete alongside the U.S. dollar to settle trade between nations. These nations have joined in unity against the Petrodollar. The petrodollar is a term used to describe the US dollar that is used to purchase oil. The petrodollar system was created in the 1970s, when the US and Saudi Arabia struck a deal: the US would provide military protection for Saudi Arabia, and in return, Saudi Arabia would only sell oil in US dollars. This arrangement helped to cement the dollar’s status as the world’s primary reserve currency, and it also had a significant impact on global trade. Because most countries need to purchase oil, they must also hold large reserves of US dollars. As a result, the demand for dollars increased, driving up its value. The petrodollar system has been credited with spurring America’s economic growth in the latter half of the 20th century, but it has also been criticized for giving the US an unfair advantage in global trade.
This geo-political strategy was very smart on the part of the United States. Before August 15, 1971, the U.S. Dollar could be exchanged for gold. But when that stopped, leaders got worried that people wouldn’t want U.S. Dollars anymore. So, they required that the U.S. dollar be used for all oil transactions. This created the illusion that oil and dollars were equivalents. For a long time, this worked well, but eventually many countries realized they were completely dependent on the U.S. dollar and couldn’t do anything about it. Wars have been fought over this in recent years.
Today a similar challenge is rising from the tiny country of El Salvador. In July 2021, El Salvador made Bitcoin legal tender. While El Salvador is a small nation, this act has been viewed by fans and critics alike as sovereign nations attempt to break free from the grip of institutions like the International Monetary Fund and The World Bank.
El Salvador has ended up in the financial headlines once again with its plan to adopt Bitcoin Treasury Bonds also referred to as Volcano Bonds. This is among the most consequential developments that has ever occurred in the world of debt financing. To understand its ramifications let’s quickly review how traditional debt financing of the government or corporations operate.
A U.S. Treasury Bond is a federal debt instrument issued by the government and sold through auction. They are regarded as one of the safest investments because they are backed by the full faith and credit of the United States government. Treasury bonds have a wide variety of terms for maturity, ranging from one month to 30 years. The most common bond terms are 2, 5, and 10 years. When you purchase a treasury bond, you are lending money to the U.S. government for a set period. In return, the government agrees to pay you interest at a fixed rate for the life of the bond, as well as repay the principal amount of your investment when the bond matures. While treasury bonds may not offer the highest return on investment, they provide stability and security for investors looking for a safe place to park their money. You can purchase Treasury bonds from us directly or through a bank, broker, or dealer. You can also buy bonds through the Treasury Department’s website at www.treasurydirect.gov.
Because of Inflation though, U.S. Treasuries are no longer attractive investments. If Inflation is running at close to 8% per year and the 10-year U.S. Treasury is only yielding 3.62%. The result for investors is a negative real rate of return. This is illustrated in the chart below which is created by the St. Louis Federal Reserve Bank.
If you study the red circles above, you will equate them to the periods of high runaway inflation that occurred in the United States. There were also moments of high innovation in debt financing and restructuring.
The amazing thing about FREE MARKETS is that their very purpose is to find solutions to problems that exist in society and attempt to resolve them.
An example of this is the creation of the junk bond market. Junk bonds were invented by Michael Milken, a financier who worked for the investment bank Drexel Burnham Lambert in the 1970s and 1980s. The purpose of junk bonds is to finance high-risk, high-yield investments that might otherwise be considered too risky for traditional lenders. Junk bonds are typically issued by companies with poor credit ratings and are often used to finance leveraged buyouts, hostile takeovers, and other speculative activities. Junk bonds typically pay higher interest rates than other debt instruments, reflecting the higher risk of default. However, junk bonds can also offer investors the potential for high returns if the underlying investment is successful. Companies who needed financing to survive during high periods of inflation in the economy were turned away by Blue Chip banks and broker-dealers. It was the creation of the junk bond market that allowed these companies to finance their operations and simultaneously offer significantly higher yield to investors. While the junk bond market initially benefited several small and medium-sized businesses, it eventually became dominated by large corporations. These corporations were able to use junk bonds to finance a variety of activities, including mergers and acquisitions, share repurchases, and dividend payments. As a result, the junk bond market played an important role in fueling the growth of some of the world’s largest corporations.
Today the most innovative developments in finance are happening in the crypto and bitcoin industries. These innovations challenge the status quo and result in huge volatility in the underlying assets.
Bitcoin volcano bonds are a form of government bond issued in El Salvador and backed by bitcoin. The idea was proposed by Jack Mallers, CEO of Strike Global, to provide reliable government financing while also generating investment opportunities in the cryptocurrency space. To issue the bonds, El Salvador has partnered with the Lightning network to enable investors to securely transfer funds via digital assets such as Bitcoin. Additionally, each bond is denominated in either US dollars or bitcoin, giving investors flexibility when it comes to how they want to purchase and hold their investments. El Salvador benefits from offering this asset due to its potential for greater liquidity and transparency compared to traditional currency-backed bonds. The goal of introducing these bonds is to improve investor confidence and stimulate economic growth within the nation. Now that El Salvador is in process to approve its first Bitcoin volcano bond offering, other nations will likely follow suit – representing an exciting new opportunity for those seeking alternative financial products. Ultimately, Bitcoin volcano bonds demonstrate yet another application of blockchain technology in the world of finance. With continued innovation, we can expect new forms of asset issuance and management in the years to come. This could have a wide-reaching transformative effect on global markets as we know them today.
In 2021, the President of El Salvador, Nayib Bukele made an audacious announcement. He created a compelling vision of how El Salvador would become the financial center of the world by revolutionizing the treasury bond market.
The plan is currently pending in El Salvador’s Congress and hopeful to launch in the 1st quarter of 2023.
As you read these details be aware that bitcoin is down 70% from its highs one year ago. Yet despite this drop its performance over the past decade still makes it the top-performing financial asset of all time.
Here are the plans:
El Salvador will issue $1 billion in 10-year bonds with a 6.5% coupon. This will all be enacted through the Liquid Network which is a 2nd layer network built on top of the bitcoin ecosystem that permits the issuance of tokenized securities like Treasury bonds.
In the past, sovereign nations would usually only have three choices at financing.
- They would go to a Wall Street Bank and issue debt and pay the middleman a huge fee for marketing the transaction.
- They would borrow money from the International Monetary Fund or World bank and be subject to whatever terms and conditions they would require.
- They would borrow directly from another sovereign nation directly and pledge critical infrastructure as part of their collateral.
By using the Bitcoin Liquid Network, El Salvador bypasses all of the middlemen who in the past were the gatekeepers of modern finance. By doing so it changes the ways and means of Treasury financing moving forward.
What El Salvador plans to do is raise $1 billion in financing. They will use $500 million to purchase bitcoin and back the treasury offering with the world’s leading cryptocurrency. The remaining $500 million will be used to build geothermal energy electric plants to mine bitcoin as well as to manage the 6.5% coupon on this debt instrument.
The plan is that El Salvador will buy $500 million worth of bitcoin and lock it up for 5 years. After 5 years, El Salvador will sell enough bitcoin to recoup the initial $500 million purchase. All the remaining Bitcoin will be shared equally with all of the bondholders until maturity.
In 2028, after the initial five-year period, El Salvador will take 1/20th of the bondholder’s bitcoin every quarter and sell it. Then in January of each year, El Salvador will distribute these shared profits to the bondholders along with the accompanying coupon payments.
The viability of this transaction all depends upon the future price of bitcoin.
If bitcoin goes to zero, the transaction would prove disastrous. But the bondholders would still own the geothermal electric plant that the $500 million was used to construct.
If bitcoin remains at current levels, it will still generate a yield 67% higher than U.S. Treasury bonds are offering at the present.
However, if bitcoin just gradually moves higher from its current levels of $17,000 the returns for investors on this volcano bond offering are exponentially higher than anything a sovereign state has ever offered before.
It is quite easy to find bitcoin enthusiasts who think that the leading cryptocurrency will be trading at several hundred thousand dollars in 10 years. This is not a recommendation to buy Bitcoin, we do not give financial advice. Instead, I’m simply trying to draw attention to how revolutionary this method of financing is and how much it challenges the status quo.
For example, suppose El Salvador buys 30,000 Bitcoin with the initial $500 million investment. Then five years later, bitcoins price has risen to $25,000 a bitcoin, which is a very conservative estimate. The 30,000 Bitcoin is worth $750,000,000 At that point, El Salvador would sell 20,400 Bitcoin to recoup the initial investment. El Salvador would share the remaining 9,600 Bitcoin equally with the bondholders, which means the bondholders have a claim to all the remaining value that the 9,600 remaining Bitcoin generate over the remaining 5 years.
This is clearly a very, very conservative example.
Based on bitcoins’ 13 years price history it is unlikely that any other bond offering could effectively compete with this type of bitcoin backed offering.
Keep in mind that the remainder of $500 million in proceeds from the bond issuance will build abundant geothermal electric energy from volcanoes to effectively mine bitcoin. President Bukele has stated that one project will provide approximately 95MW of 100% clean, zero emission geothermal energy. The bitcoin mining infrastructure turns El Salvador’s natural energy assets into a much-needed stream of bitcoin income. Ultimately, El Salvador is creating an asset that ties international investors together with local communities through bonds backed by nature – a win-win scenario!
The other amazing thing about this offering is that traditionally bond offerings require a minimum of $10,000 to participate. This Bitcoin Volcano Bond will permit investors to participate with as little as $100. Investors can fund their purchases by using bitcoin, U.S. dollars, Tether, or any recognized U.S. dollar stable coin.
Any investor who invests at least $100,000 will qualify for permanent residency and citizenship in El Salvador.
Since these bonds will trade on bitcoins Liquid Network, they are available for purchase or redemption 24 hours a day, 7 days a week, 365 days a year.
All these innovations stand in stark contrast to how financing has occurred in the past.
Many people think that the securities laws in the West are too complex, outdated, and difficult to deal with. These laws make it hard for businesses to grow and innovate. However, it is very difficult to change these laws because of how much inertia there is around them.
El Salvador has a great opportunity to create a modern framework for regulating digital assets. This will make it easy and business-friendly for companies to work with digital assets. The new law has already been submitted to Congress and is expected to pass before Christmas. After it has passed, El Salvador could issue the Volcano Bonds sometime in Q1 2023.
El Salvador is trying to become like Dubai by making it attractive for businesses and skilled expatriates. Bitcoin exchanges and other firms don’t need to be in a specific location, so many could move there. This is because El Salvador has said that it will have no income taxes, no corporate taxes, no property taxes, no payroll taxes, and no other taxes of any kind except for a 10% VAT tax to pay for municipal services like water and garbage collection.
El Salvador plans to finance the construction of Bitcoin City with further Volcano Bond issues, presuming the initial one is successful.
In short, if the first Volcano Bond issue is successful, it could lead to a huge increase in Bitcoin adoption as other sovereign nations and corporations potentially adopt this financing model.
As an investor and trader, you need to be aware of how technology is changing how money is defined, valued, and transacted.
The difference between risk and opportunity simply lies on whether you are on the right side, of the right market at the right time.
We live in interesting times.
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We live in unique times. The Printing Press is diluting the value of our money.
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