El Salvador is once again making headlines for its bold bitcoin moves.
President Nayib Bukele announced last week that the Central American country plans to issue the world's first "Bitcoin bond" early next year.
What is a Bitcoin bond? Cheddar asked Samson Mow, chief strategy officer for Blockstream, which worked with El Salvador in adopting Bitcoin as legal tender earlier this year and is the main architect of the new bond.
According to Mow, it essentially works like any other bond: A company or a country issues debt and investors buy it up in exchange for an annual coupon, which is a set percentage of what they invest.
The difference is what El Salvador plans to do with the proceeds.
Half of the $1 billion dollar bond will go toward buying Bitcoin on the open market, while the other half will support the country's efforts to build a "Bitcoin City" at the base of Conchagua, an oceanside volcano.
We'll get to Bitcoin City later, but the first half is crucial. Rather than simply spending the proceeds of the bond, the country will immediately reinvest the money into an asset that it expects to appreciate significantly.
In theory, this means the country will be able to recoup the principle — after a five-year lockup period — and make money on any gains in Bitcoin's price.
"The essence of a Bitcoin bond is that half of it is backed by a Bitcoin war chest," Mow said.
Investors also stand to benefit from any price gain. In addition to the regular 6.5 percent coupon, they'll also get 50 percent of whatever El Salvador makes on the Bitcoin investment after it recoups the first $500 million.
"You could model it in a number of ways," Mow said. "You could say that Bitcoin will gain 5 percent YOY [year-over-year] or 10 percent YOY, whatever you want, but as long as it gains something, this bond is probably better than any other bond on the market just from a traditional finance perspective."
All of this assumes, of course, that Bitcoin's price will continue to rise over the next five years — an article of faith for many in the crypto industry.
"It's highly unlikely that in 10 years Bitcoin is going to stay flat, but even if it does, they've still got $500 million in Bitcoin," Mow said .
For those who are more skeptical about Bitcoin's long-term growth potential, Mow said this is probably not the right investment for them.
"If they're worried about Bitcoin crashing, they should not invest," he said.
No More Debt
If the bond is a success, however, the upside potential is huge for El Salvador.
The country is currently struggling to secure a $1.3 billion loan from the IMF, in part because the country has been so aggressive in adopting Bitcoin.
The international lending agency has been publicly critical of the country's decision to adopt Bitcoin as legal tender, which became official as of September.
“Given Bitcoin’s high price volatility, its use as a legal tender entails significant risks to consumer protection, financial integrity, and financial stability,” IMF staff wrote in a memo.
Losing this funding could be a major drag on El Salvador's economy. According to ratings agency Fitch, the country could face a $1 billion budget gap in the coming year.
Notably, the Bitcoin bond will not help close this gap, but Mow said that it could serve as a framework for subsequent bonds that could help the country ease its reliance on foriegn debt.
"If you're relying on organizations like the IMF or World Bank for support, you kind of have to rely on them in perpetuity," Mow said. "You have to borrow more money to service old debt. There's no way out. I see Bitcoin as the way out for many developing nations. It's a way for them to reclaim sovereignty."
No other countries have yet announced plans to issue their own Bitcoin bonds, but the private sector is already following suit.
"We are in discussions with private companies interested in similar approaches," said a spokesperson for Bitfinex Securities, the crypto trading platform where the bond will be listed. "We believe Bitfinex Securities will open the way for a new industry of digitized/tokenized assets that includes tokenized shares of companies, bonds and funds."
Arguably the more sensational aspect of El Salvador's Bitcoin bond is the plan to build a so-called "Bitcoin City."
The bond will help pay for a build-out that could include geothermal power plants and crypto mining equipment, which itself could eventually help generate revenue for the nation.
The city would be built from scratch in the eastern region of the country at the base of a volcano.
Bukele has compared its design to cities founded by Alexander the Great, in that it will be circular. He also said it will include a central plaza designed to look like a Bitcoin symbol from the air.
"Invest here and make all the money you want," he said last week at a promotional event for the bond. "This is a fully ecological city that works and is energized by a volcano."
But first, El Salvador needs to pass a new law that will allow the country to grant a licence to Bitfinex to list the bond issuance. Once that happens, the goal is to issue the bond in the first quarter of 2022. Bukele hinted at a shorter timeline of the next 60 days.