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The idea of leaning on the emerging technology to issue municipal bonds in small denominations has the potential to benefit governments and investors alike. But can the muni market adapt?
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Public Finance Update - Oct. 4, 2022
Welcome back to Route Fifty’s Public Finance Update! I’m Liz Farmer and this week I’m writing about the use of blockchain technology in the municipal bond market. Ever since the mid-2010s when blockchain and cryptocurrency really started catching on, people have been talking about the implications for government debt issuance. These include the possibility of local governments “crowdfunding” smaller and medium projects, like parks upgrades, by giving people a chance to buy municipal debt in amounts under $100, rather than the $5,000 floor that is the current standard.
The idea of “democratizing” the municipal market—i.e., making it more accessible to regular folks—has pretty wide appeal. In fact, in late 2021, the city of Berkeley announced it was set to become one of the first cities in the nation to incorporate blockchain technology in its bond offerings. Very exciting, except for one small thing: for years now, headlines have been saying the city is poised to issue “microbonds.” I even wrote a feature article in 2018, saying that later that year, Berkeley expected to pilot its microbonds idea by issuing them to buy a firetruck.
But, it turns out, fundamentally changing muni bond issuance takes a while. It begs the question, is drastically altering access to the municipal market—which has historically been pretty resistant to change—even possible?
The Berkeley microbonds project is the brainchild of Mayor Jesse Arreguín and Councilmember Ben Bartlett, who started working on the idea in 2017. Microbonds have the potential to make investing in municipal bonds more accessible than ever by lowering the barrier to entry with denominations as low as $25. It’s been compared to crowdfunding, except with a lot more money and it has the potential to open up a whole new way for the city to borrow to finance infrastructure and other projects that benefit the public.
“Our goal is to achieve a dual function,” said Bartlett when I caught up with him recently over the phone. “Offer yield-bearing instruments for cheap which democratizes money by letting ordinary folks have equity in something. And at the same time, start filling the infrastructure [funding] deficit.”
Here’s how: Using blockchain technology, all transactions would be digital, including the currency. But unlike, say Bitcoin, which can be volatile based on the whims of the market, this digital currency is government-backed which should stabilize its value. And the transactions would be recorded on a public digital ledger where traders could buy and sell them directly and avoid brokerage markups or delays. This would, theoretically, lower the cost of debt issuance for Berkeley, enabling it to borrow for smaller-dollar projects like parks without having to bundle it into larger issuances for multiple projects.
The Challenges of Revolutionizing the Muni Market
Berkeley’s microbond idea generated a lot of buzz in 2018, when the council unanimously voted to direct city staff to evaluate the benefits of a pilot program in which Berkeley would offer municipal debt using blockchain technology. Market watchers got excited again in 2019, when the city put out an RFP seeking a firm to manage services for establishing and executing its new financing program. But by then, the startup company that Bartlett and Arreguín initially had in mind for the project and which had helped Cambridge, Massachusetts issue its “minibonds,” had folded.
Then, the Covid-19 pandemic slowed everything down. Finally in late 2021, the city announced it had selected a vendor. That was followed by months of contract negotiations and ironing out other details.
Now, Bartlett said the project really is getting going and the city is working on scheduling a kick-off call with vendor Valdés & Moreno, a Kansas City-based firm that specializes in municipal bonds.
“In those early days, I was still a little green in government,” Bartlett said of the process. “I recognize now that anything of substance takes at least five years to realize.” He added that a prefabricated rent-to-own housing initiative he’d also gotten passed that same year was just now getting off the ground. “And that’s not even a radical money experiment, it’s just a new fiscal way of doing development.”
In the meantime, the idea of smaller denomination bonds to tap new investors continues to be appealing. In 2019, the Connecticut Green Bank issued $25 million in Green Liberty Bonds to meet climate change and green infrastructure challenges. The bonds were offered to moderate-income investors in denominations of $1,000. Not exactly cheap, but even so, the issuance sold out in a few days.
And China has cracked the blockchain conundrum—over the last few years the national government has sold a total of 70 billion yuan in small and micro-debt, which it has turned around and loaned to small and micro enterprises.
But in the U.S., issuing microbonds in a way that can be replicated by other governments (which is part of the goal for Berkeley) means figuring out how to do it in the municipal market. And that means adapting a relatively low-tech legacy system to new innovations.
The challenges are substantial, said Rudy Salo, an attorney who specializes in bonds. “I’m rooting for them,” he said, but issues like what entity will hold the digital currency and potential regulation of digital currency by the Securities and Exchange Commission will have to be addressed. What’s more, how will taxation work?
“The unique thing about muni bonds is that it’s a legal tax shelter,” Salo said. “So what do governments need to be aware of if they’re trying to issue a tax-exempt cryptocurrency versus a taxable one?”
But to Bartlett those are issues worth tackling. He sees endless options to further equity and promote the local economy precisely because of what blockchain technology makes possible. For example, he said, the technology allows for “smart contracts,” or programmable actions, which means that interest earned on a microbond could be programmed to only be spent at local stores or go to certain charities. He even sees the potential to use blockchain to issue “baby bonds,” which are government-seeded trust accounts for kids from lower-income households.
“The creativity this will unleash will be amazing,” he said. “The demand is real and everyone’s watching to see how we do.”
Launch date, TBD.