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BETTING THE HOUSE

After the Bitcoin crash, El Salvador is betting its economy on buying the dip

El Salvador president Nayib Bukele smiling and wearing a black shirt and jacket
REUTERS/Jose Cabezas
Bukele’s bitcoin strategy: buy, buy, buy.
Published

The price of Bitcoin has fallen 43% from its high in November 2021. El Salvador’s president Nayib Bukele is buying the dip.

As one of the cryptocurrencies’ biggest promoters, Bukele has made the poor Central American country, with a median per capita GDP of less than $4,000, one of the biggest boosters of cryptocurrencies. In June 2021, Bukele championed a legislative vote adopting Bitcoin as legal tender in El Salvador. At the time, Bukele and many legislators claimed accepting Bitcoin could bring unbanked citizens into the economy and enable easier cross-border payments, while critics called the move irresponsible.

Now, that thesis is being put to the test. Bukele’s commitment to Bitcoin has sown distrust among citizens and in global financial markets. Lenders and international bond markets have begun to view Bukele and, by extension, El Salvador as a risky debtor. The country’s economy could suffer, along with Bitcoin’s prospects as a viable currency for other countries.

Bullish on Bitcoin

Bukele’s decision to use government funds to invest in Bitcoin as part of its financial reserves is unnerving creditors. The country holds at least 1,801 bitcoins, according to Bloomberg, worth about $66 million as of Jan. 25, or 2% of the country’s listed 2020 reserves. (At Bitcoin’s all-time high in November, those coins would have been worth $124 million.)

Bukele, whose pronouncements often sound more like those of a Wall Street day-trader than a head of state, announced a recent Bitcoin purchase on Twitter. “We just bought the dip,” he tweeted in September. “150 new coins!” Since Bukele bought the “dip,” the price of Bitcoin surged to an all-time high in November 2021, but has since lost nearly half its total value, a crash generally attributed to losses in the traditional financial markets amid record inflation and looming US interest rate hikes. Despite the volatility, Bukele announced on Jan. 21 the country had bought 410 additional bitcoin for $15 million, doubling down on his risky crypto gamble.

While Bitcoin is designed to be an alternative payment system, it’s mostly an unregulated and highly volatile asset used for speculation rather than spending. That makes El Salvador’s game a perilous one, according to the International Monetary Fund (IMF) and other critics. Since El Salvador adopted bitcoin as legal tender in September, its five-year credit default swap—a price measure of how likely a country is to default on its debt payments—has increased four-fold, a sign of waning faith in El Salvador’s ability to repay its sovereign bonds. And its devaluing bitcoin holdings are now a major impediment as El Salvador negotiates a $1.3 billion loan from the IMF.

What is Bitcoin doing to El Salvador’s economy?

When El Salvador’s legislature approved bitcoin as legal tender last June, it paved the way for the cryptocurrency to be integrated into its economy. Bitcoin can now be held in the country’s banks and businesses are required to accept it in exchange for goods and services. The government rolled out a digital wallet called Chivo that individuals can download for holding Bitcoin and converting it into US dollars, which has been the country’s official currency since 2001.

But by setting up its financial institutions to operate with Bitcoin, and purchasing large sums of it, the government tied the nation’s financial fate to a notoriously volatile cryptocurrency, while asking its citizens to do the same. If Bitcoin continues to lose value, the government risks the treasury reserves it has invested in the currency. Individuals have also already felt the personal risks of using the government’s Bitcoin platform; in the early days of Chivo’s rollout across El Salvador, users reported losing money through the digital wallets.

Even sending remittances through Bitcoin instead of US dollars is more expensive and potentially risky if the value of the cryptocurrency falls relative to the US dollar. El Salvador’s economy depends heavily on remittances—nearly a quarter of its GDP in 2020, according to CNBC.

But El Salvador’s financial authorities have insisted that Bitcoin would be an asset to its economy, not a liability. “We don’t see any risks,” said Douglas Rodriguez, El Salvador’s central bank president, in a recent interview with Fortune. “Perhaps, upside risks.” This was part of the pitch to IMF lenders as part of its ongoing loan negotiations.

But many Salvadoran citizens have protested against the move to Bitcoin. In October 2021, shortly after the law was passed, thousands of people took to the streets of the capital city of San Salvador denouncing Bukele’s Bitcoin plan as fraudulent and a power-grab. Bukele said in September that 2.1 million people were actively using the Chivo wallet, but a survey (link in Spanish) conducted by the Salvadoran Foundation for Social and Economic Development the next month found that 77% of consumers made no purchases with Bitcoin, and 90% of businesses reported no transactions with it.

Trouble with investors

To service its debt, El Salvador needs money. The country’s finances depend heavily on international investors willing to buy more of its national debt, now about 84% of its GDP (dangerous territory for a small, slow-growing economy). That’s prompted global financial institutions like the World Bank and the IMF to express grave concerns about El Salvador yoking its finances to Bitcoin.

In June, the World Bank rejected a request to help El Salvador implement Bitcoin as legal tender, citing the “environmental and transparency shortcomings” of Bitcoin. The same month, the IMF said that adopting Bitcoin “raises a number of macroeconomic, financial and legal issues” for the country. But in recent days, the institution’s warnings have become more pointed. In a Jan. 25 report on El Salvador’s public debt, IMF directors urged the country to better regulate its use of Bitcoin, citing risks to “financial stability, financial integrity, and consumer protection.” They also requested El Salvador drop Bitcoin as legal tender.

Bukele and his government are now attempting to negotiate a loan from the IMF. In May 2021, Bukele requested $1.3 billion in financing to relieve their public debt. Loan negotiations are still underway, but the country’s reliance on an unregulated, high-risk cryptocurrency has complicated the talks with the IMF. Meanwhile, the price of El Salvador’s debt continues to drop on international bond markets. It was last reported as trading at 36 cents on the dollar, down from 75 last year.

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