El Salvador is betting its economic salvation on Bitcoin. But the adventurous experiment has not yet borne fruit as President Najib Bukele had hoped.
The value of government-owned cryptocurrencies has halved. National adoption of Bitcoin has not been successful so far, and more importantly, the country needs a lot of cash quickly to make its debt payments of more than $1 billion next year.
This comes as the price of Bitcoin has fallen more than 70% from its peak in November 2021, and more than 55% of the time Bukele announced his plan.
Meanwhile, El Salvador’s economic growth has declined, its deficit remains high, and the country’s debt-to-GDP ratio is set to reach nearly 87% this year, fueling concerns that El Salvador is not eligible to settle its loan obligations.
It is not Bitcoin’s fault that the government is heading towards financial ruin, and has an unrealized paper loss on the cryptocurrency of about $50 million, less than 0.5% of the national budget.
In total, the entire experiment and all associated costs cost the government about $374 million. But that number is not large, especially considering the fact that El Salvador has $7.7 billion in outstanding bonds.
Negotiations with international lenders have stalled in part because they are unwilling to give money to a country spending millions of tax dollars on a cryptocurrency whose price is subject to extreme volatility.
Rating agencies downgraded El Salvador’s credit score due to uncertainty about the country’s financial future, given the adoption of Bitcoin as legal tender. This means that it is now more expensive for President Bukele to borrow the money he desperately needs.
In terms of financial position, El Salvador has a lot of bonds that are trading at a significant discount. The country is heading towards debt default.
Bitcoin experience in El Salvador
The president linked his political fate to this crypto experience. As a result there is very little incentive to make it work in the long term, and pay off the country’s debts in the meantime. Bukele faces re-election for another five-year presidential term in 2024.
All of this comes as El Salvador faces looming deadlines to repay billions of dollars in debt, including an $800 million Eurobond due in January.
Since early 2021, El Salvador has been trying to obtain a loan worth $1.3 billion from the International Monetary Fund. But this loan seems out of reach due to the president’s refusal to heed the organization’s advice to abandon Bitcoin as legal tender.
The president’s efforts to consolidate his power also increased the risk premium. In addition, El Salvador cannot print money to support its finances.
El Salvador switched to the dollar in 2001, meaning it abandoned its local currency in favor of the US dollar.
Only the Federal Reserve can print more dollars. Meanwhile, its other national currency, Bitcoin, is revered for the fact that it is also impossible to mint in thin air.
In September 2021, El Salvador became the first country to adopt Bitcoin as a legal currency. The initiative included purchasing cryptocurrency with public funds, in addition to launching a national virtual wallet called Chivo, which offers transactions without fees and allows fast cross-border payments.
For a country with a largely cash economy, where 70% of citizens do not have bank accounts, credit cards or other traditional financial services, the aim of Chivo was to offer a convenient way to those who had not previously been part of the banking system.
The experiment also included building a national infrastructure for Bitcoin ATMs across the country. Besides requiring all companies to accept cryptocurrency.
The president upped the ante in November when he announced plans to build a Bitcoin city next to the Conchagua volcano in southeastern El Salvador.
The Bitcoin-funded city provides significant tax breaks, and geothermal energy flowing from a nearby volcano provides electricity to cryptocurrency miners.
Cryptocurrency will not solve security and economic productivity problems
The government has spent about $375 million on Bitcoin, including a $150 million trust fund designed to instantly convert Bitcoin into dollars.
$120 million in a $30 bounty for every citizen who proves a Chivo wallet, and about $104 million that the government has publicly admitted to spending on Bitcoin.
These expenses, plus $50 million in unrealized losses in the Bitcoin wallet, mean the state spent about $425 million on the experiment as a whole.
But after nine months of this nationwide bet on Bitcoin, it doesn’t appear to be delivering on many of its big promises.
President Bukele tweeted in January that the app had 4 million users (out of a total population of 6.5 million). But a report from the US National Bureau of Economic Research showed that 20% of those who installed the wallet continued to use it after spending the $30 bonus.
The amount of cryptocurrency transactions seems to be very low. There were also issues with state-issued wallets. Some people encountered technical problems with the application.
Other Salvadorans have reported cases of identity theft. The hackers used their national ID number to open Chivo’s e-wallet in order to receive $30 in free Bitcoin offered by the government as an incentive to join.
Another hope for Chivo Wallet was to help save hundreds of millions of dollars in transfer fees. Remittances represent more than 20% of El Salvador’s GDP.
Existing services can charge 10% or more for these international transfers, which can sometimes take days to arrive.
But recent data in 2022 shows that 1.6% of transfers were sent via digital wallets. Regarding merchant adoption, a survey found that 86% of businesses have never sold products for Bitcoin.
The Bitcoin city remains on hold, as is the sale of $1 billion worth of Bitcoin bonds, which were frozen in March due to unfavorable market conditions.
Tourism industry in El Salvador has boomed because of Bitcoin
The Bitcoin experience in El Salvador may be struggling at the moment. But it was undoubtedly a win in terms of attracting Bitcoin tourists. While El Salvador may have incurred unrealized losses on its Bitcoin investments, it has gained a lot in terms of tourism.
It attracted a lot of people who believed in cryptocurrency and a lot of capital from these people. If you think of unrealized losses as a marketing campaign, El Salvador has achieved what it wanted. There are countries like Costa Rica that spend billions of dollars on marketing campaigns.
The tourism industry has risen by 30% since the Bitcoin law came into effect in September. The country’s tourism minister also points out that 60% of tourists now come from the United States.
