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El Salvador opted for bitcoin as its national currency. Now it’s about to go bankrupt

The sharp fall of Bitcoin in recent months (more than 50% from its all-time highs) can be painful for investors, especially those who cannot afford to hold out without selling waiting for a possible future rise. But it can’t be as bad news for anyone as it is for El Salvador, the first country in the world to accept it as legal tender since September 2021.

Nayib Bukele, president of the country, decided to make a all in to this cryptocurrency by developing its own electronic wallet, Chivo Wallet, and collecting bitcoins to give bonuses to citizens, the equivalent of 30 dollars per person at the time of delivery. The idea behind this movement, according to the Salvadoran government, was to open up business opportunities by reducing costs and attracting tourists. Nevertheless, the bet is not going well in this first year. And things could get worse in 2023.

sinking bonds

According to a study conducted by the National Bureau of Economic Research, only a fifth of Salvadorans who downloaded the Chivo Wallet app continued to use it after spending the $30 bonus provided by the government.

However, the government continued to announce plans along these lines, such as blockchain-based “volcano bonds” with which to finance itself to buy more cryptocurrencies —paralyzed by the little interest shown in them— or the ‘Bitcoin City’, a coastal city without taxes on income or contracts with its own geothermal power plant to mine bitcoins with hardly any energy cost. Mining using volcanic energy has already been launched, taking advantage of existing facilities, although it was not very profitable.

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These initial setbacks, together with the drop in the value of the cryptocurrency (40% since it was launched as legal tender, which has also led the government to buy 500 more) have led to another drop, that of prices. of its sovereign debt.

The sinking of its bonds is close to 30%, 40% in the case of those that mature in 2032, a sign that the markets perceive this debt as high risk and with a possible default scenario. Only Ukraine, a country at war due to the Russian invasion, has suffered a greater drop in its debt bonds.

Institutional and credit back

Fitch Ratings has already drastically reduced El Salvador’s debt rating from level B- to CCC, the lowest prior to the rating of pure speculation. A scenario of defaulting on your debts, known as “going into default”would imply losing access to financing in the marketsas happened with Greece in 2012 (138,000 million dollars) or Lehman Brothers in 2008 in the private sector (600,000 million dollars that made the world economy fall as if it were the first domino).

Moody’s gave it a minimum margin of confidence to be able to face the payment of 2023 bonds, 800 million dollars within seven months, although maintaining a high level of risk, since it is awaiting details on the reform of the system of pensions announced in recent months, something that could oxygenate the economy to deal with debts at the cost of the loss of purchasing power of its pensioners.

Already in the weeks prior to the entry into force of the cryptocurrency as a national currency accompanying the US dollar, there were protests in the streets, both due to the inherent volatility of Bitcoin since its birth and due to the possible money laundering that they feared it could generate. Neither of the two national currencies are issued by the country itself.

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The first factor, which triggers uncertainty about the real value of salvadorans’ savingshas been noted since then, although it could reverse its situation in the event of a hypothetical rise in its value that multiplies its price in dollars, as occurred at the end of 2017 or 2020.

The IMF did not take long to recommend reversing the decision to nationalize bitcoin, something that also fits in with its interests as a central currency stabilizing body, and warned that it could incur a breach of the conditions it sets for countries that request loans, that include overcoming the problems that led to that situation and that serve to guarantee the repayment of what was borrowed. Something that the IMF understands does not happen with an economy based on a cryptocurrency, and that therefore can lead to the inability to access more financingeven if you did not enter default.

The World Bank, for its part, also refused to assist the country in the deployment of Bitcoin. An institutional veto that does not help its future, especially with Bitcoin bonds that have not attracted a single investor. The financial instability that these global institutions warned of had risks that are intensifying.

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