The financial innovation keeps coming. Since the idea of a Bitcoin Strategy Reserve was floated, it was only a matter of time before bonding was proposed.

We are now seeing calls for the next phase of the US government involvement with Bitcoin to occur. Some are proposing the idea of BitBonds. This could be a way to fund the Strategic Reserve without any cost to the taxpayers.

Before we dig into what might take place there, it is crucial for Web 3.0 to learn this lesson. Financial innovation is crucial, with the next leg of development coming from traditional assets amended to the digital realm. Since digital assets are a new technology, the forward progress potential is enormous.

Ironically, at the core of this would be collateralization. This is not something that is spoken about at this point yet that is exactly what the financial sector will utilize these for.

Let us take a look at BitBonds.

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Next Up For US Government: BitBonds

A bond is a debt instrument that is based upon the credit rating of the entity offering it. Basically, a company (or government) is looking for a loan, so it offers interest payments for use of the money. This is no different than what a bank does.

Here we see investors offering to buy the bonds (debt), and they receive interest payments along with their principal upon the expiration of the bond.

A 10 year bond, issued at 4%, would pay that interest each year plus return the entire principal at the end of the decade.

The risk, of course, is the entity cannot make the payment. This is why some companies are listed as "junk". The financial situation makes repayment less likely than a more sound corporation.

Here is where "faith" in the institution is required. Default means potential loss, although bond holders are first in line during bankruptcy proceedings.

The process is the same for governments. This is often called sovereign debt.

BitBonds are a twist on the traditional US Treasury.

BitBonds

US Treasuries as simply government debt. It is auctioned off by the Fed to its primary dealers (investment banks), with the debt working as described above.

BitBonds basically does the same thing except that it offer exposure to Bitcoin.

According to an article in Forbes, this is how it would work:

BitBonds are like regular bonds in the sense that Treasury would allocate 90% of the bond to fund the government. But it would then use the remaining 10% of funds to purchase bitcoin.

Upon maturity, investors would receive 100% of the bitcoin upside up to 4.5% of the total compounded return. After this benchmark is reached, investors would receive 50% of all remaining bitcoin upside. Meanwhile, the government would keep the other 50% of remaining bitcoin upside to supply the strategic bitcoin reserve.

The fact it is structured like a traditional bond means the principal is returned from future monies. That is how debt works.

What is different is the US government is taking a risk on the 10% of the total bond that is going to Bitcoin. It is betting on the long term upside.

Downward Pressure On Interest Rates?

Unlike the nonsensical Fed monetary policy regarding interest rates, which is nothing more than propaganda, here we could see a market driven rate established by the purchase of government debt.

If BitBonds are popular, the rate the government would have to offer to sell the debt is likely lower than typical Treasuries. Instead of 4% on a 10 year, perhaps buyers only require 1% on the same BitBond.

This could impact a few areas.

To start, the financial costs of the government could be reduced. If a significant portion of the annual debt are BitBonds, then a cost savings over the traditional bonds is realized.

Another benefit is the fact the adding to the Strategic Reserve without actually having to budget for it. Instead of funding it out of operates (i.e. taxes), it would be through the selling of the financial instrument. In an ironic twist, this might actually lead to the situation where the government will benefit, long term, by issuing more debt.

It is the strategy Michael Saylor is taking.

Finally, this could have an impact across the board on interest rates if BitBonds become widespread enough. Over time, a new standard for mortgages, as an example, could be established.

Collateralization

The next step in the process would be the collateralization of BitBonds. This is where Wall Street would run with it.

Under this scenario, the risk of volatility and price decline of Bitcoin is taken on by the government. It is taking a volatile assets and rolling it into a stream of payments. Of course, for those who believe the US Government is going under, this is a problem.

Hence, we are back to third party risk. The bond is still backed by the US Government, i.e. the economy that produces the revenues. In this case, it is really no different than a traditional Treasury (or any other form of debt).

The difference is that BitBonds can be collateralized due to the stream of payments. Bond holders know what they get, at a minimum. If the bond pays 1%, that is a standard which it operates. As described, there could be upside but from a collateral perspective, that means nothing.

If an institution has to take the collateral in the event of a default, it wants to know what will be collected if forced to keep the debt on its books. This is why Bitcoin lending and direct bonds will not be widespread. A bank is not going to want to have the Bitcoin price as the basis of the value for the collateral.

The 10 year Treasury is considered the standard for debt. A case could be made that BitBonds would replace this since part of the security would be backed by BTC. Since the government is taking the volatility (and risk) out of the equation, it could be a preferred for of collateral.

Of course, the counterparty risk still exists as does KYC, AML, and be the right person that we operate upon. For this reason, we are still not dealing with what I would call "pristine collateral".

Web 3.0 should learn from this.