The Road to Bitcoin in El Salvador

[TL; DR]

🔹 El Salvador intends to legalize cryptocurrencies and introduce Volcano bonds.
🔹 Part of the fund raised through Volcano bonds will be used to build Bitcoin City near the Conchagua volcano.
🔹 President Nayib Bukele believes that El Salvador has not made any loss from the Bitcoin project since BTC will rally in the future.
🔹 El Salvador may fail to honor its international financial obligations since negotiations with IMF to get a $1,3 billion financial package has stalled because of the country’s Bitcoin policy.


Introduction
El Salvador became the first country to use Bitcoin as a legal tender, having adopted it on 7 September 2021. As such, many countries and analysts want to find out how the country has, so far, fared in using BTC as a medium of exchange as well as an investment asset. This article evaluates El Salvador’s successes and constraints from the time it adopted BTC as a legal tender.

Why El Salvador did adopted Bitcoin as a legal tender

There are several reasons why El Salvador adopted Bitcoin as a legal currency in the country. The main reason is that El Salvador President’s Nayib Bukele believes that digital assets such as cryptocurrencies have the power to transform the country’s economy because many people can easily use them.

The country has chosen BTC because it is the number one cryptocurrency, based on market capitalization. Since, BTC is a decentralized currency Salvadorans around the world are able to remit it to their country at low cost and conveniently.

The other reason is that El Salvador is a cash economy since close to 70% of its residents do not have access to banking services. As such, the country’s leadership envisioned that these people would easily accept and use Bitcoin.

Thirdly, the leadership believes that using BTC would reduce the country’s dependence on the United States dollar. They also assumed that adopting Bitcoin would attract foreign investment, create employment in the country as well as improve the welfare of the citizens.

As soon as the country enacted the relevant regulations, it started purchasing Bitcoin.

El Salvador’s BTC holding

After purchasing more Bitcoin on 30 June 2022, El Salvador has a total of 2,381 BTC. In all, the country used over $103 million to buy bitcoin. Although it bought the BTC at an average price of $43, 357 its estimated net worth is less than $40 million. With the current price of BTC around $17,000 El Salvador has a book value loss of over $60 million.

However, the total cost of the Bitcoin project is far higher than $103 million. For example, there is also a $150 million trust used for converting Bitcoin into dollars. There is also $120 million the country used to reward the citizens who downloaded the Chivo wallet. In all, the country spent around $425 million on the Bitcoin project.

The effect of adopting BTC as a legal tender on the Salvadoran economy

There are mixed feelings on the effect of BTC as a legal tender in El Salvador. Generally, pessimists feel that the project is a failure while optimists say that BTC will rally in the future, therefore there is no loss.

The sad thing is that the price of Bitcoin has fallen by over 70% since November 2021. And its price dropped by 55% after El Salvador purchased Bitcoin in 2021. Although the country is facing several economic challenges they are not attributed to the Bitcoin project.

As an example, El Salvador’s debt-to-GDP ratio is 87%, meaning that the country is highly weighed down by international debts. However, the total cost of the Bitcoin project is only about 0.5% of its national budget. Considering that the country’s economy is valued at more than $29 billion, the $425 million it spent on the Bitcoin project, so far, is insignificant.

How the country was adversely affected by adopting BTC as a legal tender

The country has been adversely affected by adopting the BTC in two major ways. It is facing problems in meeting financial obligations to international lending institutions. Also, since the time that it adopted BTC as a legal tender its credit rating has worsened.

Credit rating
As a result of adopting Bitcoin as a legal tender the country has a low credit rating. The main reason why rating agencies such as Filch give El Salvador a poor credit rating are the risks associated with BTC. Mainly, Bitcoin is highly volatile which poses risks on the Salvadoran economy. As such, very few international lending institutions are willing to give it credit lines.
What has worsened the country’s credit rating is its use of many highly discounted bonds. Therefore, faced with a poor credit rating, the country can only access credit lines with expensive rates such as 20% to 25%.

Secondly, the use of Bitcoin as a national currency has stalled the country’s negotiation with the International Monetary Fund (IMF) for a $1.3 billion loan required to cover its financial gaps, including loan repayment to international lending institutions. The International Monetary Fund has said that it will only continue with the negotiations after the country stops using BTC as a national currency.

In terms of its international financial obligations, El Salvador is expected to pay back $667 million in January 2023 and another $1 billion in 2025. Therefore, without accessing credit lines the country may default on these financial obligations.

Bitcoin regulation and Volcano Bonds
The bear market and its current financial challenges have not stopped El Salvador from pursuing its Bitcoin vision. It has already lined up several ways to boost the Bitcoin project such as introducing Volcano bonds and a suitable regulatory framework to govern the use of cryptocurrency and other digital assets in the country.

Volcano Bonds
El Salvador is planning to introduce Bitcoin backed bonds worth $1billion, with a coupon of 6.5%. About half of the money raised through the bonds will go towards purchasing BTC while the remaining amount will be used to establish Bitcoin City.

Interestingly, El Salvador plans to sell some of the Volcano bonds after 5 years to raise funds. The country aims to create the bonds on the Bitcoin side chain network, Liquid Network.
In order to create the bonds and expand the use of cryptocurrencies in the country, El Salvador is in the process of enacting an enabling piece of legislation. The Economy Minister has already submitted the bill to the Congress for consideration.

Bitcoin City
As mentioned above, El Salvador plans to build Bitcoin City in the South Eastern part of the country, near the Conchagua volcano. This city will be funded by Bitcoin and requires approximately 300,000 BTC. Notably, it will get its power from the volcano’s geothermal energy.

Bitcoin investment is safe- Bukele

Both El Salvador President Bukele, and the Minister of Finance Alejandro Zelaya believe that the country has not made any losses from its Bitcoin project. Their assumption is that a loss is only incurred when the BTC is sold.

As you note in the tweet, President Bukele believes that the country has not made any loss by purchasing and holding BTC.

Conclusion

In short, El Salvador has not benefited much from the Bitcoin project it started in September 2021.Instead, the price of BTC has gradually decreased since then. In the meantime, the International Monetary Fund is pushing El Salvador to stop using Bitcoin as a legal tender in order to get financial assistance through the organization.

Further Reading

The President of El Salvador Seeks Re-election. How will This affect Bitcoin development in El Salvador?
El Salvador Purchases an Additional 80 BTC
IMF urges El Salvador to drop bitcoin as legal tender
El Salvador’s response in Crypto winter
Bitcoin as Fiat Money? Good Move By El Salvador?



Author: Mashell C., Gate.io Researcher
This article represents only the views of the researcher and does not constitute any investment suggestions.
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