A stroke of genius or pure madness?
A little over a year ago, El Salvador made a bold bet on Bitcoin. The Central American nation of 6.5 million inhabitants became the first country in the world to accept Bitcoin as legal tender. Led by its young president, Nayib Bukele, El Salvador sought to change its economic fortunes overnight with this decision.
Needless to say, eyebrows were raised around the world when Bukele announced the country’s transition to Bitcoin. Up until that point, El Salvador had been known for many reasons, but none of them good. In addition to being one of the poorest countries in the Western Hemisphere, El Salvador is plagued by a crippling violent crime problem due to the established presence of MS-13, one of the world’s most notorious street gangs.
With this as a backdrop, Bukele felt the need to make a radical move to turn the country’s fortunes around. When he announced the country’s adoption of Bitcoin as legal tender, he did just that. As part of the change, El Salvador’s central bank bought nearly $425 million worth of Bitcoin. Bukele also proclaimed that he would build a Bitcoin City, which would act as an international hub for Bitcoin investors.
This crypto paradise was supposed to include all new infrastructure designed to facilitate cryptocurrency trading. At a groundbreaking ceremony in November 2021, Bukele promised that Bitcoin City would break ground on its own airport, new commercial and residential developments, and its own Bitcoin mining facilities. More importantly, it was to become a tax haven, where Bitcoin investors from all over the world could live and trade Bitcoin.
The Bitcoin conversion has not gone according to plan
When El Salvador announced the transition to Bitcoin last September, economists around the world saw the move in much the same way. There would be no middle ground. It was either going to be a stroke of genius that revolutionized the country and turned it into an investor’s paradise, or it was going to be an unsolved disaster.
After a little over a year, it’s starting to look like a disaster. When El Salvador bet $425 million on Bitcoin, it was trading at an all-time high (at the time) of $47,000. Today it hovers around $20,000. It essentially means that a large part of the “currency” in El Salvador has lost more than half of its value. As for the Bitcoin City that was supposed to spark El Salvador’s emergence as a cryptocurrency economic superpower, it’s not even a ghost town—you have to have a town before it can be a ghost town.
By all accounts, there have been no breaches of any of the promised infrastructure projects. There is no airport, no commercial development and absolutely no Bitcoin mining. Between that lack of infrastructure and the Bitcoin crash, it goes without saying that there hasn’t been a huge influx of Bitcoin investors arriving in private jets to help revolutionize El Salvador’s economy.
Unfortunately for El Salvador and Bukele, that’s not where the bad news stops. The country has an estimated $1.6 billion in bond issues maturing in 2023 and 2025. And that’s only part of the country’s debt. All told, El Salvador has $7.7 billion in bond debt. But the total value of the country’s economy is estimated at only 29 billion dollars.
To make matters worse, El Salvador currently has a debt ratio of nearly 87% of gross domestic product (GDP). That is a large part of the reason why FitchRatings has downgraded El Salvador’s bonds from B- to a CCC rating. In plain English, this means that at the same time El Salvador’s economy is on the mind, it is going to be even more difficult for the country to borrow funds and raise capital.
It’s basically the equivalent of a person with a 500 FICO score trying to get a debt consolidation loan. Even if it is approved, the loan terms will be so strict that there will be little or no benefit in getting the money. At this point, any loan to El Salvador will have an annual interest rate of between 25% and 29%.
This dire estimate was provided by Frank Muci, a fellow at the London School of Economics who has served as a financial adviser to a number of Latin American governments. The International Monetary Fund (IMF) has also noticed this. It’s basically telling Bukele that if he wants any hope of continued financial aid, the country needs to end its Bitcoin experiment post-haste.
The IMF remains largely skeptical of cryptocurrency and negotiations with Bukele on a $1.3 billion loan to cover the country’s bond issues have largely stalled. This decision has as much to do with El Salvador’s bleak economic picture as it does with Bukele’s unwavering faith in Bitcoin.
Another problem is that El Salvador cannot simply print money to ease its debt like some other countries. In 2001, El Salvador dropped its colon currency in favor of the US dollar. The move made sense at the time, especially in light of the millions of dollars per year that flow into the country via remittances from El Salvadorans living in America. But because only the Federal Reserve can print dollars, El Salvador cannot pull that lever.
Then there is the question of Bukele himself. The man who styles himself as “the world’s coolest dictator” on his Twitter account has been busy consolidating his power through a number of decidedly undemocratic means. Last year, he fired the country’s attorney general and many of its top judges – specifically judges who were a thorn in his political side.
He is also increasing the premium on Bitcoin and reportedly ordered the acquisition of nearly 2,400 more coins despite the precarious drop in value. Aside from the international problems Bukele is facing with Bitcoin, El Salvador’s population has been slow to embrace his experiment as well. When the plan was announced, each El Salvadoran received the equivalent of $30 in Bitcoin through the country’s Chivo app.
The original plan was that El Salvadorans would embrace the app because it allowed them to access funds without going to banks that charge large commissions. Early signs were promising as nearly 80% of households in El Salvador downloaded the app. Unfortunately for Bukele, less than 20% of El Salvadorans who downloaded Chivo continued to use it after using the initial $30 credit.
Apparently, there is still a very strong preference for cash among the population and business community in El Salvador. And although all El Salvadoran businesses are supposed to accept Bitcoin, it is estimated that only 20% of them do. All of this has helped make the first year of El Salvador’s Bitcoin experiment a disaster.
Possible silver linings
There is concern among many economists whether El Salvador is headed for default or may have to resort to austerity measures to avoid one. However, there are also some very real silver linings to the clouds forming over this Central American nation. El Salvador’s Tourism Minister Morena Valdez reports that tourism to the country has increased by 30% since it began accepting Bitcoin as legal tender.
It remains to be seen how sustainable that trend is in the long term. However, Bukele’s support in El Salvador remains high. Along with his Bitcoin program, he has also taken a hard line on MS-13, locking up thousands of its members. It’s sure to make you popular in a country known for being one of the most violent places on earth. As it stands, Bukele’s approval rating is above 80% by some estimates.
So, is President Bukele a madman or a genius?
In reality, it’s too early to know whether Bukele’s Bitcoin gambit will pay off. With 20/20 hindsight, it is unlikely that he would have adopted Bitcoin as legal tender if he had known that a crypto crash was coming. And while there can be no doubt that early returns have been poor, and his Bitcoin City is yet to be built, it’s still impossible to tell what the future holds.
Right now it looks like one of the most colossal blunders imaginable. However, so did the Las Vegas Flamingo Hotel in 1947. The hotel’s opening was such a flop that the original owners (the New York mob) famously rubbed out Benjamin “Bugsy” Siegel as punishment for losing all their money. However, 80 years later, Siegel’s faith in Las Vegas has been vindicated.
It may still be the case that Bukele’s Bitcoin gambit is the prescient vision of a man decades ahead of his time. The question of timing determines the fate of almost all investments, including Bitcoin. It is entirely possible that Bukele’s dream of El Salvador as a crypto-state with Bitcoin City as an international crypto-hub could come true. Only time will tell, although things aren’t looking too good right now.
Can it work elsewhere if it fails in El Salvador?
Like all bold moves, El Salvador’s venture into Bitcoin is a product of both inspiration and desperation — probably in equal measure. Because of that, it might not be a good idea to write off Bitcoin entirely as a currency if it doesn’t work for El Salvador. Even if Bukele’s move worked perfectly, it would not solve all of El Salvador’s problems.
The truth is that there are many structural problems such as crime, entrenched poverty, the aftermath of a decade-long civil war and corruption that make El Salvador’s economy a difficult puzzle for any monetary policy to solve. Another country with more well-developed infrastructure and a population with more disposable income might be able to make it work well to accept Bitcoin as legal tender.
Unfortunately for Bitcoin holders, as long as the currency shows such volatility, it is unlikely that any country not in as desperate a situation as El Salvador will adopt Bitcoin as legal tender anytime soon. That may not always be the case. If Bitcoin – and cryptocurrency in general – can solve its volatility and regulatory problem, it still has the potential to be a game changer. El Salvador may just be decades ahead of its time.
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