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The Chivo ATMs can convert bitcoins to dollars. (Photo: El Salvador President's Office)
Thursday, January 20, 2022

Bitcoin: Boom or Bust for El Salvador Economy?

Bitcoin price volatility means the U.S. dollar remains the dominant currency.

Inter-American Dialogue

The International Monetary Fund has been openly critical of Salvadoran President Nayib Bukele’s decision to adopt Bitcoin as legal tender in the Central American country, and negotiations for a $1.3 billion aid package from the institution remain stalled. The negotiations were initially halted following Bukele’s dismissal of the Constitutional Chamber and attorney general, a move that human rights groups and rattled investors called a “technical coup.” Is Bukele gambling with El Salvador’s economic health by not complying with the IMF’s conditions? What is the outlook for the IMF’s talks with El Salvador? How likely is it that Bukele’s administration can pay down the national debt using Bitcoin, and is Bitcoin a viable tool to sustain and grow a country’s economy in the long term?

Douglas Farah, president of IBI Consultants and senior visiting fellow at the National Defense University’s Center for Strategic Research: The primary issue with Bitcoin in El Salvador is not the cryptocurrency per se, but rather the opaqueness surrounding the purchase of the currency, how it is spent and what the actual purpose is. The move to Bitcoin as a currency is deeply unpopular, and the dislike is compounded by the significant fraud and technical glitches in the state-run Bitcoin delivery system for most transactions, known as the Chivo Wallet. The privately owned wallet run by loyalists of El Salvador’s president, Nayib Bukele, effectively ties crypto transactions to government control—the antithesis of the Bitcoin ethos. In addition, four senior Bukele officials have also been labeled by the U.S. State Department as corrupt actors. One of them, Carolina Recinos, is part of Chivo Wallet’s corporate leadership. This means any U.S. platform supporting Chivo Wallet is at risk of being sanctioned, making corruption and transparency core issues for Bitcoin. Because of the overall lack of transparency in the Bukele administration’s public finances, concerns about corruption and the massive debt accrued with little public discussion or debate, it is unlikely the IMF will approve a loan. The Bukele administration is out of money, its Bitcoin investments have lost value and yet it has done nothing to meet the transparency and rule of law conditions that would make a loan tenable. In addition, Bukele has publicly and repeatedly attacked the United States, souring relations. Until Bukele takes steps to reverse these trends, there’s no foreign aid money on the horizon, and his Bitcoin investments are unlikely to provide any solutions.

Julia Yansura, program manager for Latin America at Global Financial Integrity: President Bukele was elected promising big changes, and he has delivered on this promise while garnering popular support in El Salvador. That said, international observers—and lenders—are right to be concerned about the country’s trajectory. Adopting Bitcoin as legal tender presents some benefits but also serious risks for the economy, and it’s not clear that these risks are being adequately managed—or even so much as discussed. Some issues, such as volatility, have to do with Bitcoin itself. Others, such as the lack of transparency surrounding the Chivo Wallet, have to do with the way it was implemented in El Salvador. Moreover, the hasty rollout raises questions regarding consumer financial protection, as well as sufficient AML/CFT controls to combat illicit financial flows. To be clear, the existing financial architecture in El Salvador has had problems with financial stability and integrity as well. These challenges are not unique to Bitcoin. However, the adoption of Bitcoin as legal tender raises these longstanding challenges for a new asset class, presenting risks that must be understood, assessed and mitigated with great care. This is especially true for AML/CFT policy. My greatest concern for El Salvador’s Bitcoin adoption is the lack of an open conversation regarding AML risks against a political backdrop where any criticism or concern is treated as heresy. In this context, the stalemate with the IMF is only the tip of the iceberg for underlying economic risks. The Bukele administration would do well to take action, not only for the IMF, but to ensure the financial integrity of the country’s economy.

Ricardo Valencia, assistant professor of communications at California State University, Fullerton: El Salvador’s president has a penchant for short-term popularity gains over the ability to tackle mid-term and long-term economic challenges. The Salvadoran economy is precarious, with no alternative to aid from the IMF. The adoption of Bitcoin has not brought in substantial revenues. The government-run Chivo Wallet has become a financial black hole—funded by public money but without public oversight. Salvadorans in the country and abroad have reported losses of tens of thousands of dollars in fraudulent or suspicious transactions. The Chivo Wallet has become the epicenter of dozens of scams in which fraudsters have used the National Registry database to defraud legit users. On top of that, the government has stopped honoring its commitments on things like a public transportation subsidy, bonus pay for health care workers and state university funding. Bukele has sought new resources through the issue of government securities to fund public infrastructure. These new sources of fresh money are jeopardized due to the fact that El Salvador is one of the three riskiest countries in Latin America in terms of international debt repayment. The adoption of Bitcoin looks like a Hail Mary to alleviate Bukele’s diplomatic isolation, and it might not be enough to be a viable tool to sustain the Salvadoran economy. The most likely scenario is that first, Bukele’s government will stop paying local debt, and if the situation continues to deteriorate, he might find it impossible to pay down international loans. Bukele is on a downward spiral that will lead to increased repression of the press, opposition politicians and dissidents, and may very well end in economic calamity.

Álvaro Trigueros, director of the Economic Studies department at the Salvadoran Foundation for Economic and Social Development (FUSADES): El Salvador’s main macroeconomic challenge is the tension between a high level of debt and limited access to financing in international markets. Public debt in 2021 reached 86.4 percent of GDP, while the JPMorgan Emerging Market Bond was 14.89 at the end of 2021—the third worst year for Latin America on that bond index. Even if El Salvador’s government does a full rollover of $2.6 million of short-term domestic debt, it faces a 2022 financing gap of $1.4 billion, plus a bond for $800 million that expires this month. Finding funding in the traditional market without an IMF agreement is almost impossible. Nayib Bukele’s administration is unlikely to reach a financing deal with the IMF, since the strengthening of democratic institutions, civil liberties and the fight against corruption are not a priority for his government. To avoid these conditions, the government seeks to open a non-traditional source of financing, issuing a $1 billion Bitcoin bond in early 2022 on an unregulated digital asset exchange platform. The result is highly unpredictable, and its destiny is not to close the tax gap, but to buy Bitcoin and finance Bukele’s Bitcoin city project, which is not in the 2022 budget. Thus, the government of El Salvador does not yet have a credible route to stop, and course correct, on the public debt.

Tim Jacklich, senior cryptocurrency analyst at Americas Market Intelligence:  By the end of September 2021, 2.2 million Salvadorans had reportedly downloaded the country’s Bitcoin-enabled Chivo Wallet. If accurate, this rate of uptake is quite impressive, potentially rivaling the penetration of mainstream bank accounts—only 30 percent of Salvadoran adults had one in 2017. However, Chivo’s long-term importance to Salvadoran commercial development remains very much in question. Rather than enthusiasm for Bitcoin, most Salvadorans likely downloaded the Chivo Wallet to access the government’s offer of $30 in Bitcoin as an incentive for opening an account. Some immediately withdrew their $30 from the Chivo ATMs around the country. For Salvadorans who remain in the Chivo ecosystem, the wallet can indeed provide some powerful benefits, namely access to a digital wallet account (with a balance in U.S. dollars) and the ability to make mobile app-based, real-time transfers. However, it is difficult to distinguish these benefits from those of a non-crypto digital wallet. Though Chivo is capable of transferring on the Bitcoin network, transfers between Chivo users are ‘between-us’ crypto transactions, meaning that they are settled to Chivo’s internal ledger (and not a Blockchain), much like a transfer between PayPal users. Further, though Salvadoran merchants are legally required to accept Bitcoin payments, the price volatility of Bitcoin makes it infeasible to list prices in Bitcoin, meaning that the U.S. dollar remains the dominant unit of account. Any long-term benefits from Bukele’s Chivo experiment may ultimately derive not from Bitcoin but rather from the launch of a widely accessible digital U.S. dollar wallet in an underbanked country.


Republished with permission from the Inter-American Dialogue's daily Latin America Advisor



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