In American football, a “Hail Mary” is a desperate throw by the quarterback to attempt a last-minute score that saves the game.
El Salvador just threw its Hail Mary pass this week with its declared intent to raise $1 billion in bonds for its bitcoin plans.
President Nayib Bukele announced the government will seek to raise the money in dollars and use half the proceeds to buy bitcoin. After a five-year lockup, investors in the bonds would be rewarded with a staggered sale of those bitcoin proceeds.
Reserve rush
Since El Salvador’s populist ruler made bitcoin legal tender in June, he has set his country on a course to operate a parallel economy running on crypto.
To succeed, he will need to build a huge cache of bitcoin to keep the economy from falling into a depression, as basing the money supply on a scarce asset inhibits its ability to grow. El Salvador also needs bitcoin to circulate so that it isn’t hoarded, which would drain the retail economy of currency.
Both goals require El Salvador to acquire massive bitcoin reserves. The government can do so my either taxing financial flows (mainly remittances, in El Salvador’s case), by pricing exports in bitcoin, or by attracting inflows of bitcoin. Inflows can be in the form of investment, or the government can mine new bitcoins.
As taxes and pricing exports in bitcoin aren’t feasible, Bukele is opting for both investments (using half the bond’s proceeds to buy bitcoin on the open market) and mining (with the other $500 million in bond proceeds to go to infrastructure including bitcoin mining).
He is betting that bitcoin’s value will rise so much, so quickly, that it will reward investors and fill up his treasure chest.
Bitcoin to the moon?
As several media report, Bukele is basing his optimism on projections by Blockstream, a bitcoin-focused tech company. Blockstream predicts the currency’s unit value will reach $1 million within five years (and stay there). The strategy is meant to be self-fulfilling: by removing $500 million equivalent of bitcoin from circulation for five years, El Salvador reduces the supply of a scarce asset.
It might work. Betting against bitcoin has, so far, been a bad idea.
The bond sale is being arranged so that ordinary crypto enthusiasts from around the world can participate. The minimum subscription amount is only $100. The bonds can also be purchased with bitcoin and the controversial stablecoin Tether, via Tether’s controversial operator Bitfinex, the exchange mandated to handle bond purchases. BlockStream’s bitcoin protocol Liquid Network will be used to process transactions.
Many people will subscribe simply because they want to support bitcoin adoption and they think this is very cool.
Still, $1 billion is a lot of Ben Franklins. Bukele will need whales.
Bondholder risks
It is unlikely that traditional investors will put dollars into these bonds, which provide rather low interest: 6.5 percent for 10-year notes. The government’s outstanding bond issues average 13 percent, more than double what Bukele would pay holders of his bitcoin-backed bonds.
Bitcoin believers might find the bonds attractive anyway. If bitcoin’s price continues to appreciate at an exponential rate, holders of the bitcoin-backed bonds would do very well from the crypto payouts that begin after five years. And they’d get bonus points for having made those uppity institutional asset managers look like chumps.
Bondholders would face big risks, however. The obvious one is that bitcoin doesn’t hit $1 million. It trades at $56,590 as of today’s writing. Two weeks ago, it was at $67,582.
Sure, a 16 percent loss in two weeks may not mean much considering the currency was valued at $1,000 in 2017. But Blockstream and Bukele are assuming the unit will maintain this rate of appreciation, rendering short-term volatility irrelevant.
That’s a mighty assumption for a bond investor, who deals in “fixed income” for a reason.
Nor is Bukele assuming that risk. The bond’s bitcoin investment distribution only begins once the initial $500 million bitcoin investment is recovered, according to his term sheet.
Therefore, if the bitcoins that El Salvador purchases with the bond proceeds lose value, the government doesn’t have to make the crypto payout.
Why buy?
Buying the bond then is not really about bonds. It’s a bet on bitcoin, one that comes with administrative hassle and the risk of not getting paid the bitcoin tranche.
It would make more sense to simply buy bitcoin directly, which people already do with ease. If bitcoin goes on a massive winning streak, holders could opt to trade it, put it into DeFi accumulators, or whatever else – but bondholders’ capital will be tied up.
Whales are reputedly smart people. They might back Bukele to show some support for “the future of finance”, but are they going to put meaningful amounts at stake? For the retail base, it’s more a test of faith, a pledge of allegiance, than a rational investment strategy.
There’s one other incentive: investors who put in more than $100,000 will qualify for El Salvador citizenship after five years, with no income or real-estate tax. It’s a good passport, too, enjoying visa-free access to 134 countries.
There may well be some wealthy crypto enthusiasts who’d buy the bonds just for the passport and a new tax jurisdiction.
El Salvador’s risks
Bukele needs this to work to secure a bitcoin hoard. Without a big reserve, it will be difficult, if not impossible, for El Salvador to maintain bitcoin as legal tender. He’s de-risked his side of the deal by offering a low rate of interest and a valuation hurdle before the government must repay bondholders in bitcoin.
But the president is still taking a big risk.
These safeguards make his proposed bonds even less appealing to buyers. There’s no rational reason to buy these instruments.
And it’s making his conventional debt even more expensive.
The value of El Salvador’s outstanding debt has been impacted by Bukele’s embrace of bitcoin: since June, Moody’s Investor Services downgraded the country to junk status, making further conventional borrowing even more expensive and shutting it out of many investor mandates.
El Salvador cannot simply abandon dollar-based financing. Its total external debt was $18.4 billion in 2020, around 90 percent of GDP, a high level for a small economy. This year Fitch estimates the country must borrow about $2 billion to cover pensions, COVID-related relief measures, and other expenditures.
The president’s bitcoin ambitions have annoyed the International Monetary Fund, whose help he needs to obtain financing, as well as prompted downgrades and jeers from his traditional bondholders. It’s their money that pays El Salvador’s pensioners and police.
Alienating financial institutions in favor of a different kind of investor – if the term “investor” truly applies – whose motivations are founded on faith rather than fundamentals, or desire for a passport, seems like a “Hail Mary” kind of move.
