El Salvador trembles for state finances

Bitcoin, of which there will never be more than 21 million pieces, represents the opposite of FTX. There, investors could place bets on thousands of cryptocurrencies, the money supply of which was practically unlimited. “Some get it, some don’t,” Bukele says.

El Salvador: experts warn of national bankruptcy

Experts who see something like Russian tax roulette in bitcoin’s rise to become the country’s official currency feel uneasy about the latest developments approved. Ricardo Castaneda of the Central American Institute for Fiscal Studies (ICEFI) warns of national bankruptcy. He assumes that bitcoin in El Salvador has lost around 67% of its value since its introduction.

Castaneda estimates the loss to public finances at around $70 million so far. “It’s the entire budget of the Ministry of Agriculture.” And this is in a country where half the population is food insecure.

El Salvador is the smallest country in Central America and is roughly the size of Hesse. According to the World Bank, a quarter of the population lives in poverty. The lack of internet access and the lack of smartphones prevent a large part of the population from paying with Bitcoin from the outset.

Possible savings of millions thanks to Bitcoin

Bukele, who considers himself the “CEO” of a country, sold Bitcoin as the ideal way to become independent from the international financial system and reduce many costs for the population. With the new means of payment, people would have to pay at petrol stations and in supermarkets. Taxes must also be paid in this way.

Above all, the transfers of millions of Salvadorans abroad should be done in virtual currency in order to save transaction costs. El Salvador has introduced its own bitcoin wallet, Chivo, for this purpose.

El Salvador has not had its own currency for about 20 years. The official currency, the Salvadoran colón, was abolished in 2001 and replaced by the US dollar.

>> Read here: President Bitcoin Bukele aims for total power in El Salvador

From the perspective of Gregor von Bergen, an expert in payment transactions at consultancy Capco in Zurich, the idea behind the introduction of Bitcoin still makes sense. “Many people in El Salvador do not have access to the traditional banking system. In addition, remittances from Salvadorans working abroad represent around 25% of gross domestic product.

Von Bergen estimates that, based on 2020 payment flows, a total of $400 million in fee savings could be realized if all home transfers were processed through the Bitcoin Lightning Network. “The success of the project depends on how many people actually take advantage of the opportunity,” says von Bergen.

So far, however, success has been limited: according to the central bank, only 2% of migrants use the virtual platform to transfer money to families back home. The balance sheet after 14 months of Bitcoin in El Salvador is sobering.

With the bankruptcy of FTX, the Bitcoin project threatens to become a complete flop, as economist Castaneda explains. “The recent losses almost sound the death knell for the government’s hope that Bitcoin will prevail in El Salvador in the long term and be accepted by the population,” he underlines. “To date, at the latest, people have directly experienced currency volatility.”

>> Read here: Supermodels, sports stars, professional investors – who are among the biggest losers after the bankruptcy of FTX

The authoritarian head of state Bukele still wants to get the country’s 6.5 million people to use cryptocurrency. “A paradoxical situation could arise,” says Castaneda. “El Salvador was the first country in the world to adopt bitcoin as legal tender, but it is quite possible that it is also the country where the vast majority of the population ignores payment.”

Example warning for other countries

The case of El Salvador could also serve as a cautionary tale for other states considering introducing Bitcoin as legal tender and currency reserve. These include Panama or the Central African Republic. Edoardo Beretta, an economist at the University of Lugano, sees the introduction of bitcoin in the tradition of dollar-based exchange rate systems, which were particularly prevalent in Latin America. “South America has always sought monetary stability and is therefore more open to alternative monetary solutions.”

However, it is debatable whether Bitcoin can perform this function. There is no doubt that Bitcoin was a profitable investment for those who got there early, says economist Beretta. “But from a macro perspective, cryptocurrencies do not increase the wealth of an economy because they have no real value. However, the same is true for the excessive creation of money by the banking system.

>> Read here: Bitcoin continues to fall below $20,000

The fact that El Salvador entered the crypto rally near its peak is now costing the country dearly. In January, the government must repay international debts of 667 million dollars, according to analysts, the Central American country could become insolvent.

Earlier this year, Bukele applied for funding from the International Monetary Fund (IMF). The multilateral organization refused, urging Bukele to reconsider introducing Bitcoin as legal tender.

According to Salvadoran Vice-President Felix Ulloa, China now wants to buy the country’s foreign debt. A corresponding proposal is being considered by the government, he said in early November. Shortly after, Bukele announced that El Salvador had signed a free trade agreement with the Beijing government.

After: Collapse of FTX exchange shows the crypto industry is built on sand

First published: 11/19/22, 5:00 p.m.