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Shorting the Dollar: Nayib Bukele and Volcano Bonds in El Salvador

December 30, 2022 - 8 min read

El Salvador’s charismatic president is facing difficulties as his treasury’s bet on Bitcoin sees its value fall against the dollar. If political pressure mounts against him, can he wait things out until Bitcoin’s next bull run?

Bukele and Volcano Bonds in El Salvador

Introduction

When countries need to raise money for funding social programs, building infrastructure, or fulfilling debt obligations, they often issue central bank treasury bonds. These are often sold to other central banks, the IMF, or institutional investors. Bond purchase agreements by central banks are not only done based on economic decisions, but also political ones. 

Think about it, bonds are a type of investment where you lend money to governments as a kind of slush fund. While many governments are beholden to their voter base, the fact remains that investors may loan money based on their aversion to risk, the duration or liquidity of the bonds, or political favoritism/allegiance.

To pay investors back, governments repay investors based on agreed upon interest rates in the future once the bond matures- with higher rates usually being offered to compensate investors for longer durations or greater counterparty risk. That is, will the counterparty pay you back in full and will the returns outpace the rate of their or your own fiat currency’s inflation? Currency and counterparty risks are distinct issues to keep in mind regarding El Salvador’s new bitcoin strategy.

What are Volcano Bonds?

El Savador joins Tunisia, Afghanistan, and Uzbekistan to have reported their intentions to the International Monetary Fund (IMF) to issue bitcoin-backed bonds. In addition to paying off its debt obligations, El Salvador also plans to use their bitcoin-backed bonds to create a Bitcoin City next to a volcano, hence the name “volcano bonds.”

Holders will receive a 6.5% coupon on the 10-year Bitcoin Bonds. They will also enjoy periodic returns on their investments by way of what Blockstream and JAN3 CEO Samson Mow calls “special dividends.” Investors receive payments every three months as El Salvador realizes profits and liquidates its bitcoin holdings every three months.

Of course, the price of Bitcoin is volatile, but the special dividends only begin after an initial five-year HODL-period. The special dividend is special in that it is paid in addition to the 6.5% coupon. The thinking behind this strategy is likely to give the bonds at least a full halving cycle before liquidating any of the BTC.

Halving events, which occur every four years, increase the scarcity of the total bitcoin supply by cutting the rewards in half that miners get for hashing each new block’s header. Since many bitcoiners are long term HODLers, a lot of the circulating supply available on the markets at any given moment consists primarily of younger bitcoins.

Therefore, when that supply is cut in half, there is a smaller circulating supply of bitcoins to trade hands with, thus forcing the price higher as it is denominated against more inflationary assets. That is, those with ‘diamond hands’ might never put their coins back onto the market; but perhaps their grandchildren will cash some of it in some day at far higher prices.

Of course, higher spot prices should allow El Salvador to realize profits as they liquidate their bitcoin holdings to pay bondholders their special dividends. This hinges on the gamble that bitcoin’s next halving will have the desired effect on market prices. 

However, it isn’t clear if there are provisions to suspend the special dividend if they would result in catastrophic losses. It is hard to imagine the country’s treasury bankrupting itself during a bearish squeeze simply because they promised to pay this premium dividend.

Bitcoin-backed volcano bonds would allow large institutions to store their acquired wealth in the digital currency, banking on its scheduled halvings driving down the supply and consequently driving up the price. That is, investors who feel disdain for the debt-driven economic model of fiat currency debasement hope to trade their liquid cash into bitcoins while helping the country of El Salvador pay off its USD-denominated debts, and they’ll get paid extra for it.  

Once free of its IMF loans and other debts, President Bukele stands poised to move towards a model undergirded by the capped supply of bitcoins coupled with the periodic diminishing of its network’s mining rewards. It’s a massive gamble on Bitcoin being the hardest currency and without unknown risks; and the stakes could not be higher for President Bukele and the people of El Salvador. After all, how long can the young president ride out the bearish FUD which is permeating this crypto winter?

Volcano Bonds and Dreams of Bitcoin City

Normally, government bonds are mainly bought by financial institutions like banks, hedge or pension funds, insurance companies, and accredited investors. Sometimes individual investors can access treasury bonds via accredited brokers. El Salvador’s volcano bonds are structured in a way that allows access by both institutional investors and ordinary people.

Its designers said it will be sold in $100 tranches to democratize access to the fund. Accredited investors in the U.S. will be the only ones able to access them, however, due to restrictions placed on crypto-related investments by regulators in the country.

El Salvador intends to sell its own debt backed by Bitcoin in hopes it can avoid a “rescue” by the International Monetary Fund, meaning another flood of debt piled onto their existing debt. This is more a form of captivity than philanthropy, if considered properly. 

In that sense, Bukele could be understood as standing up for his people against perpetual, fiat debt-bondage. This is perhaps the most favorable narrative we can offer if we give him the benefit of the doubt regarding his motivations.

Bitcoin City was first marketed as turning El Salvador into the Singapore of Latin America. Now, there are many expecting it could collapse as its supply of dollars dry up, turning it into a failed state. After making Bitcoin legal tender in 2021, El Salvador has since accumulated nearly 3,000 bitcoins, though their holdings are reportedly down over 60% since beginning their Bitcoin endeavors. 

While not always explicitly stated, President Bukele’s monetary policy pivot towards a Bitcoin standard as legal tender and treasury holdings was to effectively take a long-BTC, short-USD position. As it stands, El Salvador still holds a large amount of USD-denominated debt obligations on its balance sheet.

Unfortunately, El Salvador is still saddled with its debt, but is left with fewer assets with which to service it, lest the country’s treasury mark its Bitcoin losses to market by realizing them. This opens President Bukele up to criticism since this type of thinking always predominates bear market conditions and major drawdowns in the orange coin.

Time Crisis: Volcano Bonds Repeatedly Delayed

Bitcoin Bonds, also known as Volcano Bonds, were set to be issued in Q1 of 2022, but were later postponed resulting from unfavorable market conditions and ongoing geopolitical crises. El Salvador isn’t really in a position to wait out crypto winter either. 

Ongoing economic woes could spell trouble for Bukele’s popularity, and fate of Bitcoin in El Salvador; and it’s unlikely that volcano bonds could help the optics of the unrealized losses incurred by the nation’s treasury to date. Political pressure must be mounting as the price of Bitcoin continues to fall.

Given the downside volatility Bitcoin has experienced lately, and its relatively slow adoption among Salvadorans, the IMF has urged Bukele to abandon his Bitcoin-centric monetary policies. There must also be whispers in the region of whether or not he should allocate resources towards social programs, hospitals, schools, and other infrastructure spending rather than buying cryptocurrency. In the short term, this could create serious headaches if Bitcoin FUD starts to win the hearts and minds of enough Salvadorans.  

To make matters worse, the IMF has been banging the table about the risk of El Salvador defaulting on its $800 million loan payment due in January of 2023, and his political opponents will use any opportunities available to kneecap his efforts to de-dollarize. President Bukele has said previously that there was “zero risk” of the country defaulting on its debts.

However, credit rating agencies and mainstream media outlets continue to sound the alarm that the country’s balance sheet, heavily weighted towards its Bitcoin allocation, will soon be heading towards utter destruction. Thus, bitcoiners remain hopeful, while banksters remain skeptical.

Final Discussion

Unfortunately, officials haven’t even broken ground yet on President Bukele’s Bitcoin City. The bonds, which are said to require a minimum investment of $100, were originally slated to launch in March of 2022, then delayed until May 2022, and have now been put on hold indefinitely. As for why volcano bonds aren’t already for sale, officials first cited the war in Ukraine and then the crashing price of bitcoin; now they’re being held up by the delays of legislation.

Once El Salvador’s most recent digital securities bill makes it through the legislative process, plans for the Bukele’s volcano bonds can finally proceed. Anyone with access to Bitfinex should be able to buy Volcano Tokens in order to participate.

Nevertheless, Bukele’s critics are wary of his decision to de-dollarize and opt for a bitcoin standard. Perhaps it is due to bitcoin’s volatility, political opportunism, or some combination of both. Notably, Bukele’s political opposition will be looking for opportunities to criticize the policies at every opportunity, and the IMF and World Bank are keen to keep the country indebted in dollars. 

Having said that, great achievements often involve taking measured risks. So long as the President doesn’t YOLO away all of his country’s operating liquidity by piling into Bitcoin too quickly, he may be able to weather this crypto winter now that he has effectively secured himself another term in office. Leaving the controversy surrounding his reelection off the table for now, it no doubt buys his strategy some much needed time if it’s to succeed.

Whether or not this will all pay off for bitcoiners and the newly minted bitcoiner-nation, El Salvador. If successful, it will create a precedent for others to follow, ultimately taking Bitcoin adoption to the next level as nation states FOMO into the race for stacking satoshis.

References

  1. Muci, F. (2022, 25 Mar.). 4 reasons why bitcoiners should pass on El Salvador’s bitcoin bond. CoinDesk. 
  2. Namcios. (2022, 22 Nov.). El Salvador takes first step to issue bitcoin volcano bonds. Bitcoin Magazine. 
  3. Partz, H. (2022, 23 Mar.). El Salvador postpones Bitcoin bonds to September: Report. Cointelegraph.
  4. Rincón, E. (2021 15 Dec.). The ideological mystery of El Salvador’s Bukele: Conservative, socialist, or political chameleon? El American.
  5. Wagner, C. (2022, 7 Sep.) One year in, El Salvador’s bitcoin bonds could be right around the corner. Blockworks.

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