Why Is El Salvador Buying The Crypto Dip?

by Sourav Datta - Jan 26, 2022 01:44 PM +05:30 IST
Why Is El Salvador Buying The Crypto Dip?El Salvador is now looking at legalising bitcoin.
Snapshot
  • The shift to cryptocurrency was justified by dictator-President Nayib Bukele by citing the need for financial inclusion for Salvadorians, who did not have any way to access the financial system.

El Salvador’s President Nayib Bukele bought the dip, and added 410 bitcoins to the country’s treasury at a cost of $ 15 million recently.

It is reported that El Salvador owns Bitcoin worth $ 66 million in total, amounting to 1,800 bitcoins. The President, who describes himself as the “CEO of El Salvador” and the “world’s coolest dictator” on Twitter, had announced the conversion of Bitcoin into legal tender for the country.

The country ,however, remains highly indebted, with the total debt amounting to almost 50 per cent of Gross Domestic Product.

The investor jitteriness is visible from a high yield on the country’s bonds that have been on the rise since the conversion of Bitcoin to legal tender.

Bitcoin Declared Legal Tender

El Salvador initially legalised Bitcoin and incentivised citizens to buy the coin by doling out $30 for downloading the payment application. Previously, the country had been “dollarized”, and used the US dollar as official currency.

However, the shift to cryptocurrency was justified by Bukele by citing the need for financial inclusion for Salvadorians, who did not have any way to access the financial system.

Around 24 per cent of El Salvador’s GDP was dependent on remittances for 2020, and the figure has continually increased since 1976 when it was near zero.

Bukele’s argument has been that Bitcoin would have lower transaction charges when compared to traditional players. Nearly 18 per cent of El Salvador’s households receive remittances.

However, critics have argued that El Salvador has one of the lowest remittance costs in the world. In addition, a significant number of citizens are unfamiliar with the Bitcoin and ultimately convert it back to dollars — resulting in a higher-than-expected cost of remittance.

The volatility of the currency remains an added risk as well, given that prices of goods are still determined in dollars — a constraint in its ability to act as a store of value.

Can Bitcoin Adoption Boost The Remittances?

With lower remittance costs, the government expects remittances to rise, and a resultant boost to the country’s GDP growth rate. EL Salvador has been in discussion with the International Monetary Fund (IMPF) to raise $1 billion to support its economy.

However, now, the President has come up with another way of raising funds. He has announced plans of opening a Bitcoin City that would be financed by a $1 billion bond offering with a tenure of 10 years with a coupon of 6.5 per cent.

The coupon is quite low in comparison to the yields on the country’s dollar-denominated bonds.

In order to make it accessible to crypto bulls, the minimum investment has been brought down to $100. Anyone buying more than $100,000 would receive a fast-track citizenship of the country as well.

Of the $1 billion, $500 million would then be used to buy bitcoin, which would be locked in for five years. Then, the Bitcoin holdings would be liquidated over the next five years, and half of the profits earned would be distributed among the investors.

The other $500 million would be used to fund construction of the city’s infrastructure and mining operations for bitcoin. The mining operations would be powered by geothermal energy from an inactive area.

Hence, these bonds have been dubbed as “volcano bonds”.

The entire plan bets on Bitcoin’s price rise to fund the faltering economy. El Salvador has bonds maturing in 2023, and investors are already sceptical of full repayment — evidenced clearly from the bonds selling at 36 cents on the dollar.

Moody’s had already declared the country’s debt as junk, even before the Bitcoin plan was announced. The IMF has already warned the country on several occasions about the problems associated with using Bitcoin.

These steps probably stem from the leadership’s desperation to pay back the money owed to creditors in 2023.

Distraction From Pressing Issues

Critics of the move believe that, in reality, El Salvador has little reason to move away from the dollar, having enjoyed low inflation for years. The economy hasn’t faced the typical issues of high inflation that usually support the case for crypto adoption.

In that light, these gimmicks are seen by some observers as a means to distract the public from various political manipulations that Bukele has been accused of.

So far, the country has made several purchases of Bitcoin, which was bought using public funds through Bukele’s own phone.

Salvadorans have held protests against the adoption of Bitcoin, and the government’s insistence behind the adoption. However, with the current fall in crypto, the President-turned-trader is probably looking at losses in his crypto portfolio.

Mathematically, one is better off buying existing bonds which trade at a deep discount and bet solely on El Salvador’s solvency, rather than betting on volcano bonds that bet on both Bitcoin’s price, and El Salvador’s solvency.

Nevertheless, the Bitcoin buys are still quite small in relation to the country’s balance sheet.

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