El Salvador’s Volcano Bond, RIP

The craziest bond that never was

Sep 26, 2023

If you forgot about El Salvador’s plans to issue a billion dollar ‘bitcoin backed’ ‘volcano’ bond, I don’t blame you. The proposal was bizarre. It embodied the magical thinking, bitcoin maximalism and crackpot economics typical of the 2020-2021 bull market in crypto. I covered it at length because it captured the moment, the exuberance that had retail investors throwing billions of dollars at self-described ponzi coins, ape JPEGs and real estate in the metaverse (what was that?).

Well, the proposal to tokenize a sovereign bond on a blockchain is now officially dead. This summer, Forbes contributor and Tether/Bitfinex spokesperson Javier Bastardo wrote that El Salvador will “tweak the investment scheme from issuing public debt [the volcano bond] to private equity funding rounds by the Volcano Energy initiative [a joint venture with the government, private firms and crypto companies]”.

In other words, some joint venture will raise equity to fund wind and solar energy capacity, but there won’t be debt or a bond. There won’t be geothermal energy from the volcano as originally advertised either, oh well. This post is an obituary, a requiem for the volcano bond and the insanity that was crypto just two years ago. It’s important that we never forget.

Off the Rocker

In November 2021, bitcoin was near the all-time-high of 65,000 dollars. El Salvador had made it legal tender a few months earlier and President Nayib Bukele was basking in wall-to-wall media coverage that put his central american country on the map. Crypto seemed inevitable to millions of people who would tell the no-coiners and skeptics to ‘have fun staying poor.’

One night, President Bukele spoke to a roaring crowd of crypto enthusiasts and announced that El Salvador would tokenize and sell a billion dollar sovereign bond backed by bitcoin on a blockchain. The announcement made headlines in the global financial press even though it never made any sense.

For starters, the economics were wacky. Half of the issuance ($500 million) was supposed to fund ‘infrastructure build’ for a brand new ‘Bitcoin city’ for bitcoin miners powered by geothermal energy from a nearby volcano. This was crazy, not least because the sticker price of brand new cities is typically in the multiple billions of dollars. Plus, El Salvador desperately needed to cut government spending and raise taxes to avoid a messy default on its existing debts. It couldn't afford half-baked infrastructure projects worth hundreds of millions of dollars.

The other $500 million was supposed to buy bitcoin. The idea (as far as anyone can tell) was that volcano bondholders would get half the upside if bitcoin’s price rose, but none of the downside if it fell – good for investors and bad for El Salvador. Needless to say, borrowing on behalf of taxpayers in a poor country to gamble on cryptocurrency is deeply irresponsible (more later).

The product didn’t make sense either. The volcano bond bundled a traditional fixed income instrument (tokenized on a public blockchain) with a call option on bitcoin (a derivative), but your typical emerging market bond investor is a pension fund or bond fund run by someone with silver hair that won’t touch crypto with a ten foot pole. Your typical crypto options buyer is under 30, has 90% of his net worth in coins and doesn’t know or care what a bond is. These are non-overlapping groups. There was no natural buyer for the volcano bond.

Plus, the venue didn’t make sense. Instead of issuing through Binance or FTX, at the time the most popular unregulated exchanges, they went with Bitfinex, which is banned in the US, the largest market for crypto in the world. And instead of tokenizing the volcano bond on Ethereum, by far the most popular programmable blockchain, they went with the Liquid side-chain of the Bitcoin blockchain, which is so niche that even die-hard crypto ‘degens’ don’t use it. Most popular wallets and exchanges aren’t even compatible with it.

The legal details didn’t make sense either. As the March 15-20 (2022) issuance date crept closer, there was no prospectus or formal legal documentation. That could only mean one thing: that El Salvador planned on issuing the volcano bond as a token with no debt contract under local El Salvador law (and not New York law like all its other bonds). If the volcano bond ever missed a payment, investors would have to sue the government in El Salvador (although it's unclear how without a contract). In any case, not an enticing prospect after Bukele packed the country’s supreme court in May 2021.

Two days before the supposed issuance, things got really crazy. The FT reported that the volcano bond would “be issued by state thermal energy company La Geo.” And so the world learned that the volcano bond wouldn’t be a debt of the government (which has billions of dollars in tax revenue) and would instead be the liability of a state-owned enterprise that nobody had ever heard of.

It was nuts. La Geo has just $136 million in annual revenue and the volcano bond would saddle it with $65 million in interest expenses, bankrupting La Geo. Plus, the government could have just pulled the money out of La Geo and defaulted on the bond without triggering a cross-default on the rest of the sovereign debt, making the volcano bond much riskier for holders.

Lastly, the timing couldn’t have been worse. Coin prices peaked in November 2021 and by the supposed issuance in March 2022, bitcoin had fallen over 35% from the all-time-high. Terra/Luna would death-spiral just two months later and FTX would follow shortly after.

The proposal was dead at birth, and all the government could do was deflect and stall for time. After weeks of delays and excuses, Bukele pivoted to saying that El Salvador’s crypto laws needed an update before the volcano bond could be issued. After the laws passed this January, the government then pivoted again to this volcano-branded wind and solar project that won’t do geothermal energy or issue a bond. So the idea lives on, sort of, if you squint.

Why..?

At the height of the pandemic, as health and social spending ballooned and tax revenue collapsed, Bukele’s government found itself having to choose between building hospitals, paying pensioners and making debt payments. Instead of muddling through with borrowed money from the IMF, President Bukele opted for a radical alternative proposed by his crypto friends:

Issue a bond to borrow money
Buy bitcoin with the money
Wait for bitcoin to appreciate
Sell it for a profit
Pay down the original bond and other sovereign debts with the proceeds
Do this enough times and become entirely debt free (debt/GDP = 0)

Amazingly, the volcano bond was just the first in a series of imagined issuances designed to fund a massive, multi-year leveraged bet on bitcoin that would pay down the country’s other debts during the inevitable collapse of the fiat system and subequent ‘hyperbitcoinization’. Because satoshi and 21M coins and all that.

Of course, leveraged crypto gambling could also saddle the country with massive losses, debt, stagnation and insolvency. That’s gambling; more often than not, you lose. At any rate, if President Bukele’s tweets are true, El Salvador is already down 35% on separate bitcoin purchases totaling $122 million. Salvadoreans are lucky their government failed to raise billions of dollars to double down.