IMF: BitcoinBitcoin is commonly said to be a cryptocurrency, a digital means of exchange developed by a set of anonymous authors under the pseudonym of Satoshi Nakamoto, which began operating in 2009 as a community project (Wikipedia type), without the relationship or dependency of any government, state, company or body, and whose value (formed by a complicated system of mathematical algorithms and cryptography) is not supported by any central bank or authority. Bitcoins are essentially accounting entries i... More as Legal TenderMoney that is legally valid for the payment of debts and must be accepted for that purpose when offered. Each jurisdiction determines what is legal tender, but essentially it is anything which when offered (“tendered”) in payment of a debt extinguishes the debt. There is no obligation on the creditor to accept the tendered payment, but the act of tendering the payment in legal tender discharges the debt. More is (Very) Risky Business

“Bitcoin is going to changeThis is the action by which certain banknotes and/or coins are exchanged for the same amount in banknotes/coins of a different face value, or unit value. See Exchange. More the world. It’s the evolution of humankind, and we’re going there.” – Nayib Bukele, President of El Salvador.

El Salvador has had a dollarized economy since 2001. In June 2021, millennial president Nayib Bukele announced that El Salvador would become the first country worldwide to make bitcoin legal tender. Bitcoin acquired legal tender status in the country on September 7, 2021.

El Salvador’s financial situation (already weakened during the Covid-19 pandemic) has worsened since then. Moody’s, Fitch, and other credit rating agencies have downgraded El Salvador’s sovereign debt, and the country is getting closer to a default.

According to the Financial Times, Salvadoran sovereign debt amounts to more than USD13 billion (equivalent to 85% of the country’s GDP). The government has less than USD3.4 billion in foreign exchangeThe Eurosystem comprises the European Central Bank and the national central banks of those countries that have adopted the euro. More reserves (equal to three months of imports).

Bukele’s decision surprised the International Monetary Fund (IMF), as the country sought USD1.3 billion in emergency funding. In January 2022, the IMF urged El Salvador to remove bitcoin’s legal tender status. “Using cryptocurrency as legal tender entails large risks for financial and market integrity, financial stability, and consumer protection,” said the IMF Executive Board. Although digital payments might promote financial inclusionA process by which individuals and businesses can access appropriate, affordable, and timely financial products and services. These include banking, loan, equity, and insurance products. While it is recognised that not all individuals need or want financial services, the goal of financial inclusion is to remove all barriers, both supply side and demand side. Supply side barriers stem from financial institutions themselves. They often indicate poor financial infrastructure, and include lack of ne... More in the country, bitcoin and the Chivo e-wallet require “strict regulation and oversight.”

Bitcoin’s Price Tag

“The government is betting more than [USD]200 million in a virtual casino, and that’s taxpayer moneyFrom the Latin word moneta, nickname that was given by Romans to the goddess Juno because there was a minting workshop next to her temple. Money is any item that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular region, country or socio-economic context. Its onset dates back to the origins of humanity and its physical representation has taken on very varied forms until the appearance of metal coins. The banknote, a typical representati... More.” – Ricardo Castañeda, senior economist at the Central American Institute for Fiscal Studies.

According to the Financial Times, El Salvador would have spent USD101.5 million to purchase 2,280 bitcoins as of May 10, 2022. The government has also spent USD180 million to develop the Chivo digital wallet and install 200 bitcoin ATMs in El Salvador and 51 in the United States.

President Bukele is the country’s day trader and crypto evangelist, buying bitcoin from his phone during the crypto assets’ periodic selloffs. “Most people go in when the price is up, but the safest and most profitable moment to buy is when the price is down. It’s no rocket science. So invest a pieceIn plural, it is commonly used as synonym for units of banknotes and coins. More of your McDonald’s paycheck in #Bitcoin. Now go back to flip more burgers you lazy fvçk,” tweeted Bukele.

Staving Off Default? The Bitcoin-Backed Volcano Bonds

During a bitcoin festival in November 2021, Bukele announced that La Geo, a state-backed thermal energy company, would issue USD1 billion in 10-year, 6.5% bitcoin-backed bonds. The government planned to use USD500 million to buy bitcoin. The other USD500 million would finance the construction of “Bitcoin City,” a tax-free zone for bitcoin mining companies supplied with thermal power from the extinct Conchagua volcano.

Blockstream, a Canadian blockchainAn unchangeable digital record where transactions are processed and verified by a network of independent computers rather than by a single referee. This decentralised structure has been described as an open distributed ledger. It supposedly enhances security as there is no single entity to be hacked. It also protects personal identity and guarantees that governments can’t block transactions or otherwise manipulate the payments space. The blockchain is the underlying technology supporting most ... More technology company, would sell the “volcano” bonds as crypto tokens on the Bitfinex platform. U.S. citizens and entities are barred from using this crypto exchange.

“If this [bitcoin-backed bond issue] is a failure, a lot of doors close. This issuance is going to define a lot.” – Carlos Acevedo, former president of the country’s central bank.

With the volcanic bonds’ issuance, the Bukele administration could bypass the IMF and prevent El Salvador from defaulting on its debt, securing the president’s reelection. According to the IMF, bitcoin-backed sovereign bonds would “require a very careful analysis of implications for, and potential risks to, financial stability.”

“Bizarre Things” and “Big, Attractive Bets”

“The bitcoin community does some bizarre things. If they end up providing an avenue of financing without the IMF, that could totally change El Salvador’s fortunes for the next few years.” – Bradley Wickens, founder of Broad Reach, an emerging markets hedge fund holding conventional El Salvador bonds (emphasis added).

At first, the volcano bonds captured the attention of retail and “meme” investors. Josué País, the owner of a cab company accepting bitcoin payments from foreign tourists, planned to buy USD200 in volcano bonds. “The curiosity is what gets me. Number one, I’m going to do it to support the country. Number two, because it’s a big, attractive bet,” said País, 36 (emphasis added).

Large institutional investors with massive holdings of crypto assets (the so-called bitcoin “whales”) remained sceptical. “Some of our users have proactively reached out to us to express their interest, […] but they are waiting for the details to be published,” said Paolo Ardoin, chief technology officer of Bitfinex. By late March, Bukele backtracked, postponing the volcano bonds’ issue to focus on pensions reform.

“Cryptoisation” and Capital Flight

“The impact of bitcoin in El Salvador so far has been to increase macroeconomic potential risks rather than introduce any material change in how economic transactions are conducted.” – Barclays analysts, March 2022.

“Cryptoisation,” or replacing national currencies with crypto assets, poses significant risks to small economies. There has been little to no discussion in El Salvador about bitcoin’s role as a vehicle for capital flight and financial instability.

Bitcoin’s price went from USD35,809.66 on June 6, 2021 (the day of Bukele’s announcement) to USD29,072.73 on May 23, 2022, a fall of 23.2% in value (see Graph 1).

Graph 1. Price of Bitcoin in USD, June 2021-May 2022

Source: Coindesk.

By their very nature, crypto networks lack centralized authorities. The volatility in crypto markets has magnified El Salvador’s structural weaknesses, bringing the country closer to financial collapse and economic crisis.

“Crypto is being used to take money out of countries that are regarded as unstable. It is a big challenge for policymakers in some countries. […] Capital flow management measures will need to be fine-tuned in the face of cryptoisation. Applying established regulatory tools to manage capital flows may be more challenging when value is transmitted through new instruments, new channels, and new service providers that are not regulated entities.” – Tobias Adrian, head of the IMF’s monetary and capital markets department.

CAR adopts Bitcoin as Legal Tender

In April 2022, the Central African Republic (CAR), one of the world’s poorest countries, became the second country to grant bitcoin legal tender status. According to Reuters, less than half of the CAR’s population have a mobile phone, only 14% of people have electricity, and just 11% have internet access.

The CAR is a member state of the Central African franc zone (CFA), a monetary union governed by the Bank of Central African States (BEAC). On May 13, 2022, the Banking Commission of Central Africa (COBAC), the union’s financial regulator, reminded member states that using cryptocurrencies is banned in the CFA zone.

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