El Salvador is betting its economic salvation on Bitcoin. But the adventurous experiment has so far not yielded results as President Najib Abu Kila had hoped.
The value of government-owned cryptocurrencies has halved. Also, nationwide adoption of Bitcoin has not worked so far, and most importantly, the country needs a lot of cash quickly to pay its debts 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 when Bukele announced his plan.
Meanwhile, El Salvador’s economic growth has fallen, 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.
And it’s not Bitcoin’s fault that the government is heading for financial ruin, and has an unrealized paper loss in the cryptocurrency of about $50 million, less than 0.5% of the national budget.
In all, the entire experiment and all associated costs cost the government about $374 million. But that number isn’t much, especially given the fact that El Salvador has $7.7 billion in bonds outstanding.
Negotiations with international lenders have stalled in part because they are unwilling to give money to a country that spends millions of tax dollars on a cryptocurrency whose price is highly volatile.
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 much-needed money.
In terms of financial position, El Salvador has a lot of bonds that are trading at a huge discount. The country is moving towards a debt default.
The president linked his political fate to this coded experiment. As a result, there is very little incentive to make it work in the long run, and pay off the country’s debts in the meantime. Abu Kila faces re-election for another five-year presidential term in 2024.
And all this comes as El Salvador faces impending deadlines to repay billions of dollars in debt, including an international bond worth 800 million dollars due in January.
El Salvador has been trying since early 2021 to obtain a $1.3 billion loan 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 ditch 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 financial resources.
El Salvador converted to the dollar in 2001, which means that 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 out of thin air.
In September 2021, El Salvador became the first country to adopt Bitcoin as a legal currency. The initiative included the purchase of cryptocurrency with public funds, as well as the launch of a national virtual wallet called Chevu that offers fee-free transactions and allows for rapid 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 Chivu was to offer a method suitable for those who had not previously been part of the banking system.
The experiment also included building a nationwide infrastructure for Bitcoin ATMs across the country. Besides requiring all businesses 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 offers significant tax breaks, and geothermal energy flowing from the nearby volcano provides electricity to crypto 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 reward for every citizen who installs a Chevu wallet, and about $104 million the government has publicly acknowledged spending on bitcoin.
These expenditures, plus $50 million in unrealized losses in the Bitcoin wallet, mean that 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 seem 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.
And it seems that the amount of cryptocurrency transactions is very low. There were also problems related to the portfolios issued by the state. Some experienced technical problems with the app.
Other Salvadorans have reported cases of identity theft. The hackers used their national identity number to open the Chifu e-wallet in order to get $30 in free bitcoins provided by the government as an incentive to join.
Another hope for Chivo’s 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 a fee of 10% or more for those 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. In terms of merchant adoption, a survey found that 86% of businesses have never sold products for bitcoin.
Bitcoin City remains on hold, as does the sale of its $1 billion Bitcoin bond, which was frozen in March due to unfavorable market conditions.
Tourism industry boomed because of Bitcoin
The Bitcoin experiment in El Salvador may be struggling at the moment. But it was undoubtedly a win in terms of attracting Bitcoin tourists. While El Salvador has 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. And if you think of unrealized losses as a marketing campaign, El Salvador has achieved what it wanted. Henk Dua like Costa Rica spend billions of dollars on marketing campaigns.
The tourism industry is up 30% since the Bitcoin law went into effect in September. The country’s tourism minister also notes that 60% of tourists now come from the United States.