Introduction
Bonds have long been a cornerstone of traditional finance (TradFi), offering a reliable way for investors to earn income and issuers to raise funds. With the rise of blockchain technology, this financial instrument has evolved into blockchain and cryptocurrency bonds, bringing innovation to the world of fixed-income securities. Here we explain their unique features and the key differences between traditional, blockchain, and crypto bonds.
What Are Bonds and How Do They Work?
A bond is a financial instrument that represents a loan made by an investor to a borrower, with the borrower typically a government, corporation, or municipality. It is a fixed-income security, meaning it provides regular interest payments (called coupon payments) to the investor (the person who buys the bond) until it matures. At maturity, the borrower repays the bond’s face value, also called the principal, to the investor.
To recap, here are key components of a bond:
- Face Value (Principal): The amount of money the bondholder will receive when the bond matures. This is usually issued in increments of $1,000.
- Coupon Rate: The interest rate the bond issuer agrees to pay the bondholder, expressed as a percentage of the face value. Payments are typically made semi-annually or annually.
- Maturity Date: The date when the bond issuer repays the principal to the bondholder. Maturities can range from a few months to several decades.
- Issuer: The entity borrowing money by issuing the bond. Common issuers include governments (sovereign bonds), corporations (corporate bonds), and municipalities (municipal bonds).
- Market Price: Bonds can be bought and sold in the secondary market before they mature. The market price can fluctuate based on factors like interest rates, credit ratings, and economic conditions.
- Yield: The return an investor earns on the bond. It can differ from the coupon rate if the bond is bought or sold at a price other than its face value.
Bonds are often used by investors as a stable, predictable source of income and by issuers as a way to raise funds for projects and operations or to refinance debt. Their coupon rate is generally lower than returns that investors can expect in the stock market; but while stock returns fluctuate, bond coupon rates are fixed.
One of the largest bond issuers in the world is the government of Japan. Its bond market is valued at $9 trillion — with the majority of the bonds held by the Bank of Japan, and many more by Japanese citizens.
What Are Blockchain Bonds?
A blockchain bond, also called a digital bond, is a financial instrument that operates similarly to a traditional bond but is issued, traded, and managed on a blockchain or distributed ledger. It still comes with a principal, coupon rate, and maturity date like a traditional bond.
But blockchain bonds come with a few added components:
- Digital Tokenisation: Instead of paper certificates or traditional electronic records, the bond is represented as a digital token on a blockchain.
- Blockchain Platform: The underlying network where the bond is issued and traded is a blockchain. Examples include Ethereum, Polygon, or custom-built blockchains.
- Smart Contracts: Blockchain bonds are often managed via smart contracts (i.e., automated, programmable contracts that manage the bond’s terms, such as coupon payments and redemption of the principal), ensuring transparency and reducing the need for intermediaries.
While traditional bonds can usually be purchased only via TradFi brokers and market places, blockchain bonds can sometimes be traded on decentralised or centralised crypto platforms, as well. They provide several advantages, such as increased transparency, faster settlement times, reduced costs due to automation, and the elimination of intermediaries.
Blockchain bonds are an emerging and innovative way to combine TradFi with blockchain technology. Examples include Nomura Research Institute’s blockchain bond in Japan, the World Bank’s bond-i, and Siemens’ digital bond.
What Are Crypto Bonds?
Most crypto bonds leverage blockchain technology, making them blockchain bonds. But what differentiates a crypto from a traditional bond is how the principal and coupon rate are paid, as the coupon and principal are denominated in crypto.
Since cryptocurrencies are volatile, crypto bonds in turn often offer higher yields compared to traditional bonds. Additionally, as they are a financial instrument in the crypto industry, crypto bonds are usually smart contract-based and issued on crypto platforms.
For example, a crypto bond might be issued on a platform like Ethereum, with interest payments made in stablecoins or the platform’s native token. The entire bond lifecycle — from issuance to interest payments and principal return — can be managed through transparent, automated smart contracts.
Crypto bonds come with several advantages, including lower transaction costs (decentralised technology eliminates the need for intermediaries like banks), faster settlement times, enhanced transparency through blockchain technology, and wider accessibility for global investors. Since the terms are written into the code of these self-executing smart contracts, they automatically handle interest payments and repayment of the principal.
However, keep in mind that the cryptocurrency market is generally more volatile than traditional markets, and crypto bonds still have a less established track record than traditional bonds. Additionally, crypto bonds may face regulatory risks due to vague regulations, potential vulnerabilities in smart contract technologies, and lower liquidity compared to traditional bonds, particularly in a weak market.
The crypto bond market is still very nascent. The European Investment Bank issued a bond on Ethereum in 2021, and a German government bank plans to issue a bond on Polygon in 2025. However, as both bonds are still tied to euro fiat currency, they aren’t true crypto bonds; rather, they more so fall under the general umbrella of digital bonds.
Conclusion
Crypto bonds represent an intersection of traditional finance and blockchain, offering unique advantages like increased transparency, automation, and potentially higher yields due to their connection to the cryptocurrency market. They can open up new opportunities for investors seeking to diversify their portfolios and participate in the rapidly evolving blockchain ecosystem.
However, as with any investment, crypto bonds come with risks. The cryptocurrency market is highly volatile, and the relatively nascent nature of crypto bonds means they lack the established track record of traditional bonds.
Before investing in crypto bonds, it’s essential to thoroughly research and understand the underlying technology, market conditions, and issuer credibility.
Crypto bonds may not yet be mainstream, but they are paving the way for the next generation of financial instruments. For investors willing to embrace innovation and navigate the risks, they could represent a promising addition to a forward-looking investment strategy.
Due Diligence and Do Your Own Research
All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, cybersecurity, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any coins, tokens, or other crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction. Any descriptions of Crypto.com products or features are merely for illustrative purposes and do not constitute an endorsement, invitation, or solicitation.
Although the term ‘stablecoin’ is commonly used, there is no guarantee that the asset will maintain a stable value in relation to the value of the reference asset when traded on secondary markets or that the reserve of assets, if there is one, will be adequate to satisfy all redemptions.
Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.
