There have been a lot of enthusiastic responses in the crypto community for the so-called volcano bond that El Salvador is going to start offering soon. The process of tokenizing a billion USD sovereign bond through the use of blockchain is going to be the first such measure in the world. It would also completely sidestep all financial institutions that otherwise facilitate such deals to issue debt. Instead, the process would see the country use a range of crypto exchange services to take all of the proceedings and buy BTC tokens.
The rest would be used to fund mining infrastructure and mining rigs for bitcoin that would appear in El Salvador. These would use the power of a volcano to harness geothermal energy and with it generate abundant amounts of electrical power. The same power would be completely clean and environmentally friendly. However, while the setup is a dream come true for many bitcoin aficionados and those who do not trust international financial institutions, it still has a range of possible problems and setbacks. All of these should give potential investors a strong reason to question the wisdom of buying El Salvador bitcoin volcano bonds in the first place.
One of the key facts about the El Salvador bitcoin bond is that the government of the country postponed the same scale recently. Last week, it said that the war in Ukraine is impacting the price of bitcoin, as well as the state of the global economy. So, the country’s finance minister explained that even though the bond is ready to go, the sale is still going to happen later on. The famous President Nayib Bukele also underlined the same message on March 23, but he also connected it with local pension reform laws that are currently being hammered out.
Both messages show that there is a postponement, but both worryingly give different reasons for it. While both alternatives are reason enough to put the bond issuance process on a hold and set out a later date, having a president and a finance minister unclear about which actually initiated the postponement is a problem. At the same time, like it often happens in crypto esports and other digital currency-backed projects, problems rarely appear as singular, uncontacted entities. That is why the same El Salvador bond has other potential faults as well.
Question of Issuer
Alejandro Zelaya, the Finance Minister of El Salvador said that LaGeo, a small energy company in the country, which is also state-owned, will issue the same bond. So, the issuer will not be the Republic of El Salvador. While the distinction might sound trivial, it holds a lot of open questions. The annual interest of the bond should be 6.5 percent. So, a billion USD bond will create 65 million USD each year. However, LaGeo booked some 136 million USD in revenue.
Out of that, only 36 million was in direct profit. Besides that, the company already has a debt of its own which is neither small nor trivial. It currently stands at 205 million. The choice of LaGeo thus makes little economic and financial sense as the go-to entity for the issuer of the bond, especially when the state of El Salvador could have done the same and established a lot more credibility from the get-go. While Zelaya said that the country would back LaGeo fully, it is still not a clear-cut explanation why the state did not back the same bond directly.
Lacking Legal Protection
The government of El Salvador has so far not provided any written information on the bitcoin bond. These usually come in the form of a document, which is over 100 pages and showcases financial information, presents risk factors, and offers terms and conditions. The government has not even published a website or whitepaper on how the bitcoin from the interest will be divided or how it will safeguard the BTC value of over 500 million USD that it plans to purchase.
So far, the potential buyers only have photos of a PowerPoint slide presentation that showcased the idea behind the bond and it dates back to last November. Legally, the bond will be governed by the local laws in El Salvador. That way, any future potential disputes will have to be resolved in a court in the country. It goes without saying that the rule of law in El Salvador is nowhere near western standards. At the same time, the law that will define the bond’s legal framework still did not reach the country’s Congress either. All of this points to the fact that the amount of legal unknowns at this moment for the same bond is staggering.
Long-term bonds in El Salvador are currently trading for around 50 cents on one USD. That is happening because experts believe that the same country will stop completely with its debt repayment process, potentially even as soon as the start of 2023. Usually, countries in this type of problem would try to stop an economic crisis through fiscal sustainability, using methods like tax increases, spending cuts, and other drastic reforms that should lower costs and increase fiscal income.
However, the same is clearly not in the mind of El Salvador’s government. This increases the possibility of insolvency and a prolonged debt crisis. In that type of financial environment, issuing bonds does not seem like something that is on the path to financial stability. Quite the opposite, the same beacons a range of new issues that will potentially coincide with a debt crisis.
So far, from what can be publicly seen, the El Salvador bond offers a series of red flags. The bond will be issued by a small energy company and not the government. The bond will be protected and regulated by local laws, many of which are still in Congress and not in an enacted phase. The financial structure behind the whole deal is shaky at best and downright fraudulent at worst. Here, the second alternative would see El Salvador’s ruling elite trying to give their way into some liquidity through the bond that is attached to the ever-popular buzzword of bitcoin. In any of these cases, the smart move would be to steer clear of the same bitcoin bond.