A closer look at the European Investment Bank’s first Ethereum-based bond

Last week, the European Investment Bank (EIB) issued a €100 million ($121 million) bond on the Ethereum public blockchain. 

The transaction marks the first time the bank — the lending arm of the European Union — has used blockchain technology for a bond issue.

It is significant because the EIB finances the bulk of its lending activities through bonds sold to capital markets investors. According to its website, the bank has authorization to borrow up to €70 billion in 2021 alone.

And while a €100 million bond is small relative to the bank’s borrowing capacity, it is, according to two EIB executives, a sign of things to come.

“We have a genuine interest in the debt capital markets and in the development of the markets,” said Richard Teichmeister, head of funding at the EIB.

Teichmeister and Xavier Leroy, capital markets officer at the European Investment Bank, spoke with The Block about how they tried to make traditional investors comfortable with using a blockchain; their choice of Ethereum over other, perhaps more efficient protocols; and the use of central bank digital currency (CBDC) to settle the bond.  

Keeping it simple

Despite being listed on Ethereum and incorporating the use of CBDC, the new bond was otherwise structured so as to be as familiar to capital markets investors as possible.

Take, for instance, the fact that investment banks Goldman Sachs, Banco Santander, and Société Générale were appointed to oversee the sale of the bond. Some might argue the appointments defeat the purpose of using a blockchain, which is supposed to eliminate the need for such intermediaries.

Part of the appeal of blockchain technology for debt issuers is the idea that bonds can be sold directly to investors, cutting costs and increasing efficiency. But Leroy told The Block that while the bank could have issued the Ethereum bond “without a dealer,”  it chose not to — so as not to intimidate would-be investors.

“For the main audience blockchain is still very new,” said Leroy. “And many, even very large and developed institutions, they don’t necessarily have the capacity, the expertise, the platforms in place to be able to do that.”

The EIB wanted to “outsource” all aspects of the issue that required blockchain expertise to the dealer, added Leroy. 

The desire to minimize complexity for participants in the deal appears to have been a big reason for drafting in the help of Société Générale’s Forge, a wholly-owned subsidiary of the French bank focused on helping financial institutions buy and sell bonds issued on blockchains.

Forge played a key role in the €100 million bond issue, providing the systems that allowed participants to easily issue, trade and settle bond tokens on Ethereum — in a way that complies with financial regulations. All the technical requirements basically were fulfilled by Forge,” said Leroy. “When we appointed Société Générale it was for channelling those details.” 

At an early stage of the bond’s development, the bank had considered building its own platform for blockchain issuance, but Leroy said the risk of such technology “becoming obsolete very fast” — for a public institution — would be too great to bear.

So many third parties had a hand in the transaction that it’s fair to wonder why the EIB used a blockchain at all. The answer seems to be that the bank wanted to create an armchair ride experience for investors that would showcase potential efficiency gains but without presenting overwhelmingly complex technological challenges. 

“We want to demonstrate to the markets what the benefits are, and for the benefits certainly faster settlement is one of them. It’s a key aspect,” said Leroy. 

Choosing Ethereum

Leroy said Ethereum was the obvious choice for the EIB’s first blockchain bond because of its ability to run smart contracts and because it is, among blockchains, well established. “Otherwise we would have needed to go to some more, let’s say, less developed blockchains or protocols,” he added. 

There are, however, well-known constraints to using Ethereum. Namely, that so-called “gas fees” (transaction costs) can be extremely high in times of heavy traffic on the network. Speed can also be an issue.

Leroy said these pitfalls were not so relevant for the EIB’s debut transaction, however, “because the digital bond market is very much nascent.”

The point seems to be that, although significant in size, the €100 million bond remains very much a taster for capital markets players.

“We don’t expect a lot of trading for instance to take place in that bond. It’s possible that trading will happen and it’s certainly a feature that’s possible with the bond, but it will not trade like a hundred times a day or something like that. So we don’t expect investors to turn around the bond, buying and selling very often that would cause issues,” said Leroy.

He compared the Ethereum bond to a test car. “We built the car, we put the car in front of your door, you can touch it, you can try it, you can see for yourself whether you like it or not — and that was very much the spirit of the transaction.” 

It should be noted, however, that although the EIB went with Ethereum for its maiden blockchain voyage, it has not ruled out using alternative blockchains in the future.

“The fact that we used Ethereum here doesn’t mean that in the future we would not look at other alternatives. We are well aware that there are other ways, well not other ways, but other blockchains which are potentially cheaper, yes,” said Teichmeister.

Digital euro mayflies

Perhaps more important than the choice of blockchain was the way the bond relied on digital currency issued by the Banque de France. 

The French central bank has been actively testing capital markets use cases for CBDC (specifically digital euros) in recent months. In March, Société Générale SFH issued €40 million in bonds on a public blockchain and settled the transaction instantly using digital euros issued by the Banque de France.  

The central bank played a similar role in the EIB transaction. 

According to Teichmeister, the CBDC that was used in the transaction only existed for a period of roughly 90 minutes. On the day the bond was issued, its underwriters exchanged euros for the digital currency. “Then we issued and settled the bond on the blockchain, so the underwriters transferred the CBDC from their wallet to the EIB wallet. We then in exchange transferred the bonds,” explained Teichmeister. 

Finally, the EIB sent the CBDC back to the Banque de France, which “burned” the tokens and transferred euros back to the EIB.

It is not clear exactly what comes next in the EIB’s work on digital bonds. What is clear is that the €100 million Ethereum bond should be viewed as a foundation stone in what could become a blockchain bond issuance program of some significance.

And the initial feedback has been encouraging.

“We were absolutely amazed by the answer that we got on that transaction. From investors, from issuers, from the media. It’s astonishing really,” said Leroy.