El Salvadooooooooor Update
New crypto regulation, volcano bonds and sovereign non-default
Last November, when bitcoin was near the all-time-high of 69,000 dollars, President Bukele spoke to a roaring crowd of crypto fans with a backwards baseball cap. He announced that El Salvador would tokenize and sell a billion dollar sovereign bond on the blockchain. There was a lightshow. There were fireworks.
A few months later, his Finance Minister set a date for the issuance, March 15-20th, and even claimed the bond was oversubscribed to the tune of $500M. But then the weeks and months went by and excuses piled up and nothing ever happened. Here are some possible reasons why:
It wasn’t attractive to crypto investors. The volcano bond tokens were going to be issued on the Liquid side-chain of the Bitcoin blockchain, which nobody really uses (it isn’t integrated with many wallet apps or exchanges). It was also going to be issued through Bitfinex, an exchange that is banned in the US (where a large share of crypto ‘users’ are domiciled). There just weren’t many natural crypto buyers.
It didn’t attract traditional investors. The volcano bond bundled a 10-year local El Salvador law sovereign bond and a call option on bitcoin from the ‘bitcoin dividend’. For traditional hedge funds and fixed income funds, it was trivially easy to make a better version of that same investment by buying already-issued (New York law) El Salvador bonds and a Bitcoin ETF through a brokerage. The TradFi option had less legal risk and none of the hassle and risk from using crypto. There was no reason for regular investors to be interested in the token.
It didn’t make economic sense. El Salvador needed (and still needs) to cut spending and raise tax collections to avoid risking sovereign debt default and a potential run on domestic banks. Despite that, none of the billion dollars from the volcano bond were set to fund the general budget. Instead, half the funds were earmarked for yet more government spending on new non-essential geothermal energy and a half-baked ‘Bitcoin city’ and the other half was earmarked to buy bitcoin. It was deeply irresponsible.
It had no legal documents. No prospectus or whitepaper with terms and conditions for were ever published for the volcano bond. Nobody knows what protections investors would have in a default or what rights they would have in a restructuring. There was no documentation or even a legal framework to govern digital assets in El Salvador. It was deeply unserious.
Yet according to bitcoin magazine …
I will argue that this is vapid boosterism and that volcano bond is dead in a moment, but first let’s look at the bill.
🌴🌴Crypto Regulation 🌴🌴
El Salvador is planning to create a new regulator for digital assets and digital asset offerings and it’s also creating a new bitcoin agency to manage and custody the government’s digital assets1. The draft law and the initiatives it proposes sound vaguely reasonable in the abstract; the text is refreshingly readable for a law. But everything completely falls apart once you remember we’re talking about El Salvador. Why?
The intent to properly regulate crypto is farcical considering how opaque the government’s bitcoin rollout has been thus far. Take the bitcoin purchases that President Bukele has (allegedly) made, for instance. No official government website has any information about the supposed bitcoin portfolio or source of funds or how the coins are being custodied. That’s why the false rumors like the claim that El Salvador held its BTC on the now-bankrupt FTX exchange can spread like wildfire.
Instead of official information, one has to rely on nayibtracker.com, which logs all the times President Bukele has tweeted announcing a BTC buy, cross-references the time-stamp to the corresponding bitcoin price and re-constructs the portfolio. If we believe the tweets, the government is down $68M or 64% on an initial investment of $107M. Or maybe it never spent a dime. Again, we don’t know. There’s just the tweets.
This is part of a pattern. Take at the state-sponsored (or state-owned?) Chivo crypto wallet, which was used to make bitcoin legal tender alongside the dollar. It’s the same story. To date, there’s no clarity about the funding, ownership or management of the app. And more importantly, there are no audited financial statements to show that they have actual dollars and actual bitcoin to back customer balances (deposits). Maybe Chivo misplaced the money like FTX, or maybe they didn’t. How can we know without audited financials?
If El Salvador was serious about ‘doing crypto’ properly, it would first (a) produce documents about past bitcoin purchases, (b) provide information about the new supposed daily 1 BTC purchases, (c) state and justify the source of taxpayer funds for all this, (d) clarify how the coins are being custodied (whether on-chain with a government wallet, with a professional custodian or something else) and (e) disclose audited financials for the government wallet. Absent that, this effort to regulate crypto in El Salvador will lack all credibility.
Does the new regulatory framework and the new agencies mean the volcano bond is alive? No. The local-law volcano bond token obviously needs a domestic regulatory framework to make legal sense, but the issuance also needs to make economic and financial sense. And it doesn’t, not remotely.
Look, the party is over. Interest rates are going up, pointless tokens have been mauled or zeroed, retail investors are tapped out and crypto giants are blowing up and blowing each other up. There’s no more appetite for half-baked BS.
That said, happy thanksgiving!
🛑🛑In The Real World🛑🛑
After the success of the first debt buyback this fall where El Salvador retired $566M in traditional foreign bonds with $360M, President Bukele announced a second debt buyback (with no lightshow or fireworks, just a tweet). But again, they have not followed through. There’s a pattern there...
At any rate, markets are still pricing a small chance of default in the new year. The $800M sovereign bond2 that matures in two months on January 24th is trading at a discount for just 91 cents on the dollar, reflecting market jitters about non-payment. If you assume that buying the bond has an expected value of zero, the implied default probability is about 14%3. Still high!
You could buy $910,000 of the 2023 bond today, wait two months and get the full $1M for a neat 11% return in sixty days. If the bet goes wrong though, the bonds fall to about 30 cents and you lose 67%. The payoffs are asymmetric, which may explain why the 2023 notes refuse to ‘pull to par’ and sell for 100 cents on the dollar. I think markets are once again mispricing short-run default risk and that this trade is free money, but we’ll find out in sixty days.4
In the medium-to-long run, El Salvador is in trouble. It may have wiped out $433M of the $800M of the Eurobond that was due in 2025 with the debt buyback, but the macroeconomy remains very fragile. Remittances are 20%+ of GDP and the lifeblood of the economy. Well, they’re falling for the first time since the pandemic. Meanwhile, the government has not signaled any commitment to get the unsustainable budget deficit under control.
Regardless of whether they default on the sovereign debt in 2025 or before or never, El Salvador will have to start defaulting on someone or something soon. Will it be pensioners, doctors, teachers, civil servants, public investment or something else? I don’t know. But the government will start running short of cash after the big debt maturity this January. Bitcoin paradise will face tough choices…
The law contains more than that. It also create registries for digital service providers, issuers and certifiers to more or less license and control who is offering what digital services / assets. It also says crypto assets are not securities and outlines a few types of crimes like market manipulation. Etc.
Technically there are only $667M outstanding after the buyback.
This is a risk-neutral probability. The implied physical probability is likely lower due to investor risk aversion.
This is not investment or financial advice. It never is.