Stroke of genius or sheer madness?

Just over a year ago, El Salvador made a bold bet on Bitcoin. The Central American nation of 6.5 million people has become 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 the move.

Needless to say, the whole world raised eyebrows when Bukele announced the country’s switch to Bitcoin. Until then, El Salvador was famous for many reasons, but none of them were good. In addition to being one of the poorest countries in the Western Hemisphere, El Salvador is plagued with a pernicious violent crime problem due to the entrenched presence of MS-13, one of the street gangs the most famous in the world.

With this as a backdrop, Bukele felt the need to make a drastic decision to turn the country’s fortunes around. By announcing the adoption of Bitcoin as legal tender by the country, he did exactly that. As part of implementing the change, the central bank of El Salvador purchased nearly $425 million worth of Bitcoin. Bukele also proclaimed that he would build a Bitcoin City, which would serve as an international hub for Bitcoin investors.

This crypto haven was supposed to include all new infrastructure designed to facilitate cryptocurrency trading. In a groundbreaking ceremony in November 2021, Bukele promised that Bitcoin City would inaugurate its own airport, new commercial and residential developments, and its own Bitcoin mining facilities. More importantly, it would become a tax haven, where Bitcoin investors from all over the world could live and trade Bitcoin.

Bitcoin conversion did not go as expected

When El Salvador announced the switch to Bitcoin in September last year, economists around the world saw the move the same way. There would be no middle ground. Either it was going to be a stroke of genius that revolutionized the country and made it an investor’s paradise, or it was going to be an absolute disaster.

A little over a year later, it’s starting to look like a disaster. When El Salvador made its $425 million bet on Bitcoin, it was trading at a (then) all-time high of $47,000. Today, it is hovering around the $20,000 mark. This essentially means that much 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 city before it becomes a city. phantom.

By all accounts, none of the promised infrastructure projects have been inaugurated. There is no airport, no commercial development, and certainly no Bitcoin mining. Between this lack of infrastructure and the bitcoin crash, needless to say, there hasn’t been a large 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 ends. The country has about $1.6 billion in bond issues maturing in 2023 and 2025. And that’s only part of the country’s debt. In total, El Salvador has bond debt of $7.7 billion. But the total value of the country’s economy is estimated at just $29 billion.

Worse still, El Salvador currently has a debt-to-gross domestic product (GDP) ratio of almost 87%. This is largely the reason why FitchRatings downgraded El Salvador bonds from B- at a CCC rating. In plain English, this means that at the same time that El Salvador’s economy is in the tank, it will become even more difficult for the country to borrow funds and raise capital.

It’s basically the equivalent of someone with a FICO score of 500 trying to get a debt consolidation loan. Even if approved, the terms of the loan will be so severe that there will be little or no benefit in obtaining the money. At this point, any loan to El Salvador will carry annual interest rates between 25% and 29%.

This dire estimate was provided by Frank Muci, a policy researcher at the London School of Economics who has served as a financial adviser to many Latin American governments. The International Monetary Fund (IMF) has also taken note. He is basically telling Bukele that if he is to hope for continued financial aid, the country will have to end its bitcoin experiment in a hurry.

The IMF is still largely skeptical of cryptocurrency, and talks with Bukele over a $1.3 billion loan to cover the country’s bond issues have largely stalled. The move has as much to do with El Salvador’s grim economic situation as it does with Bukele’s unwavering faith in Bitcoin.

Another problem is that El Salvador cannot simply print money for debt relief like some other countries. In 2001, El Salvador abandoned its colon currency in favor of the US dollar. The move made sense at the time, especially in light of the millions of dollars a year flowing into the country via remittances from Salvadorans living in America. However, since only the Federal Reserve can print dollars, El Salvador cannot pull this lever.

Then there is the question of Bukele himself. The man who describes himself as “the coolest dictator in the world” on his Twitter account has worked to consolidate his power in a number of decidedly undemocratic ways. Last year he sacked the country’s attorney general and many of its top judges – especially judges who were politically a thorn in his side.

It is also upping the ante on Bitcoin and reportedly commanded the acquisition of nearly 2,400 more coins despite its precarious decline in value. Apart from the international issues that Bukele faces with Bitcoin, the Salvadoran population has also been slow to embrace his experience. When the plan was announced, each Salvadoran received the equivalent of $30 worth of Bitcoin through the country’s Chivo app.

The original plan was that Salvadorans would embrace the app because it would allow them to access funds without going to banks that charge hefty fees. The first signs were promising when almost 80% of Salvadoran households downloaded the app. Unfortunately for Bukele, less than 20% of Salvadorans who downloaded Chivo continued to use it after spending their initial $30 credit.

Apparently, there is still a very strong preference for cash among the general population and the business community in El Salvador. And although all Salvadoran businesses are supposed to accept Bitcoin, it is estimated that only 20% of them do. All of this contributed to making the first year of El Salvador’s Bitcoin Experiment a disaster.

Possible silver linings

Many economists are worried about whether El Salvador is headed for default or whether it will have to resort to austerity measures to avoid it. However, there are also very real silver linings in the clouds forming over this Central American nation. Salvadoran Tourism Minister Morena Valdez reports that tourism in the country has increased by 30% since it started accepting bitcoin as legal tender.

It remains to be seen how sustainable this trend is in the long term. However, Bukele’s support in El Salvador remains high. Along with its Bitcoin agenda, it also took a tough stance on MS-13 and locked up thousands of its members. This is bound to make you popular in a country known to be one of the most violent places on the planet. As things stand, Bukele’s approval rating is over 80% by some estimates.

So, is President Bukele a madman or a genius?

In reality, it is too early to know if Bukele’s Bitcoin bet will pay off. With hindsight being 20/20, it is unlikely that he would have adopted Bitcoin as legal tender had he known the crypto crash was coming. And while there’s no doubt that early returns have been lackluster and his Bitcoin City has yet to be built, it’s still impossible to predict what the future holds.

Right now, that looks like one of the most colossal mistakes imaginable. However, the same was true of the Las Vegas Flamingo Hotel in 1947. The official opening of the hotel was such a flop that the original owners (the New York mob) obliterated Benjamin “Bugsy” Siegel as punishment for losing all their money. However, 80 years later, Siegel’s belief in Las Vegas has been vindicated.

It could still happen that Bukele’s Bitcoin bet is the prescient vision of a man several decades ahead of his time. The question of timing determines the fate of almost all investments, Bitcoin included. It is entirely possible that Bukele’s dream of El Salvador as a crypto-state with Bitcoin City acting as an international crypto hub will come true. Only time will tell, even if things don’t look so good right now.

Could it work elsewhere if it fails in El Salvador?

Like all bold moves, El Salvador’s bet on Bitcoin is the product of both inspiration and desperation – probably in equal measure. For this reason, it may not be wise to completely remove Bitcoin as a currency if it does not work for El Salvador. Even if Bukele’s move worked perfectly, it wasn’t going to solve all of El Salvador’s problems.

The truth is that there are many structural problems such as crime, entrenched poverty, the legacies of a decades-long civil war, and corruption that make the Salvadoran economy a difficult puzzle for any policy maker to solve. monetary. Another country with a more developed infrastructure and a population with higher disposable income might be able to get Bitcoin accepted as legal tender.

Unfortunately for Bitcoin holders, as long as the currency shows such volatility, it is unlikely that a country not in such dire straits as El Salvador will soon adopt Bitcoin as legal tender. This 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 be decades ahead of its time.

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