Bitcoin bonds and volcano infrastructure make headlines, but due diligence is always necessary.
When the news broke that the nation of El Salvador was set to issue a $1 billion sovereign bond, with approximately half of the proceeds to be reinvested in purchasing additional bitcoin, and the other half allocated toward infrastructure, the reaction was significant. This was – and still is – seen as another milestone in the inevitable adoption of bitcoin and cryptoassets by nations, organizations, and individuals the world over.
As the global economic outlook clouded in 2022, however, news broke that this bond issuance was going to be delayed, with forecasts moving this issuance from March 2022 to an estimated September date. As the cryptoasset market continues to develop, mature, and expand, the issuance of crypto-collateralized financial instruments, such as bonds, are an inevitable part of this evolution. That said, it is important for investors and policymakers alike to realize that along with these trends there is also a need for increased due diligence. Right alongside the growing acceptance of cryptoassets, there are discussions around how the non-fungible token (NFT) market might be cooling off, and increased scrutiny as to how crypto fits into a world of sanctions and geo-political uncertainty.
Investing is always a complicated endeavor, and crypto is no exception to this rule. Let’s take a look at a few of the factors that investors should consider with regards to crypto bonds, regardless of who the issuer is.
Who is issuing the bond? This might seem like an overly simplistic question to ask, but is one that can easily be overlooked. While due diligence procedures and best practices are well documented for traditional equity and debt investments, blockchain and cryptoassets can cloud the judgement of even the savviest investors. Examples of this abound, from the initial coin offering (ICO) bubble, the number of NFTs that have been proven to be frauds, and the general frothiness that cycles through certain sectors of the crypto market.
For example, during the due diligence of a crypto-collateralized bond offering, a few questions need to be asked. Firstly, which entity is actually issuing the bond, versus simply providing a guarantee of payments? Second, are the terms and conditions of the bond agreement (which is a contract) the same as the terms discussed during the roadshow? This is not to suggest any unethical activity, but full disclosure and snappy soundbites do not often go hand-in-hand. Lastly, is the form of payment clear? With uncertainty abound regarding sanctions and potential currency substitutions, this is not an idle concern.
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Are payment terms specified? Issues around the specifics of payments have moved from a technical or niche issue to one that makes front page news due to the financial sanctions that have been implemented against the Russian economy. Not directly connected to the topic of crypto instruments, it is worth noting that many crypto instruments are regulated by either 1) an array of regulators with conflicting rules, or 2) existing rules that do not apply very well to this fast growing asset class. This uncertainty can further complicate the terms of payment conversation.
One issue that must be absolutely crystal clear, in both the public discourse and legal specifics, is just how the payments from this bond will be denominated. For example, if an instrument is advertised as collateralized by a certain cryptoasset, what does that mean? Are payments also going to be made in that cryptoasset, or fiat currency? If investors contribute dollars to this campaign, how is the principal repaid – in that fiat currency, crypto purchased with these investment dollars, or some other option? Lastly, if the payments are denominated in the form of a percentage, what procedures are in place to guarantee (remembering that bond payments are contractual obligations) that said payments occur?
Insurance and policy protection? One last area that investors, especially institutional investors looking to add some diversification via crypto into portfolios, should look into, is the coverage and other protection instruments available over these investments? To put it simply, most insurance policies – even cyber policies – are not constructed to insure activities connected to blockchain or cryptoassets; investor protection is no exception to this fact.
With the valuation of this asset class exceeding trillions, institutions actively investing into this asset class, and retail investors increasingly exposed to crypto-instruments, establishing and proliferating appropriate protections is imperative. Especially with crypto bonds and financial instruments becoming viable methods for corporations and nations to raise capital, having clarity over how these investments will be safeguarded is a logical next step.
Crypto bonds and crypto financial instruments overall have rapidly moved from an idea and concept that might have seemed far-fetched, to a market reality that continues to redefine how markets function the world over. With that said, and fully acknowledging the opportunities that said instruments provide, it is also important to realize that there are certain items that investors need to assess during the investing process. In other words, even though crypto may be exciting and changing the way industries function, these are still financial instruments, and due diligence must always be conducted.
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Author: Sean Stein Smith, Contributor