Understanding El Salvador's "Bitcoin City" Plan

Author: Jasmine, Beehive Tech

Recently, the Central American country of El Salvador announced plans to build a "Bitcoin City" powered by volcanoes, with part of the funding coming from the country's issuance of $1 billion in cryptocurrency-backed sovereign bonds.

El Salvador's President Nayib Bukele stated that the city will not impose property taxes, income taxes, or capital gains taxes, and its infrastructure and other costs will be supported by funds raised from value-added tax and bond issuance.

In September of this year, El Salvador legislated to incorporate Bitcoin into the country's legal currency system and offered a reward of $30 to citizens who downloaded the government electronic wallet Chivo.

In just four months, this small Central American country, long affected by dollar inflation, has made significant strides on the Bitcoin path. The country has provided Bitcoin ATMs for public use, and local Starbucks and McDonald's have begun to adapt to Bitcoin payments. Salvadorans abroad have started using Bitcoin for remittances, and the local unique energy source—volcanic geothermal resources—is being explored for its potential in Bitcoin mining…

Now, a "Bitcoin City" may emerge in this country as a "tax haven." Some are concerned that El Salvador's Bitcoin monetary system may affect its standing with the International Monetary Fund (IMF). The country's central bank has stated that it has explained the role of Bitcoin as a payment method to the IMF and hopes it will not impact the $1 billion loan program the country has been seeking from the IMF.

Funding for the city comes from $1 billion in sovereign bonds

On November 20, as the week-long "Bitcoin Festival" was about to conclude in El Salvador, President Nayib Bukele announced the launch of a national project—to build a circular "Bitcoin City" near the volcano in the southeastern border province of La Unión, which will utilize the geothermal energy from the Conchagua volcano to power Bitcoin mining.

The 80s-born president wore his baseball cap backward and compared his plans to those of ancient Macedonian ruler Alexander the Great, who has been used by many countries around the world to name cities. "If you want Bitcoin to spread globally, we should build some Alexandrias, right?" He added, "Let everyone be part of it."

El Salvador's plan to build "Bitcoin City" near the volcano also promotes the country's geothermal energy advantages for Bitcoin mining. President Bukele had shared a video in a tweet in late September, featuring aerial shots of Bitcoin mining equipment and forests next to the volcano. For years, a quarter of the country's electricity has come from geothermal energy.

In early October, Bukele confirmed that he had mined 0.00599179 Bitcoin using energy released from the volcano. While this amount is relatively small, he hopes to demonstrate the viability of geothermal energy as a clean energy source for Bitcoin mining. Local Bitcoin miners stated, "Because of Bitcoin, a completely renewable and untapped energy source has been fully utilized… Bitcoin is the biggest catalyst for renewable energy development."

El Salvador's president launches the "Bitcoin City" project

Bukele summarized the future functions of Bitcoin City as "including everything." "Residential areas, commercial areas, services, museums, entertainment, bars, restaurants, airports, ports, railways—everything is dedicated to Bitcoin," he also stated that the city will not impose housing taxes, income taxes, capital taxes, carbon emission taxes, or municipal taxes, only value-added tax (VAT), with half of the revenue used for public infrastructure construction in the city and the other half for bond payments.

These bonds are the source of funding for El Salvador's plan to build "Bitcoin City." Just days before the project launch, El Salvador announced plans to issue $1 billion in tokenized bonds on the Liquid Network, with half of the proceeds used to purchase BTC and distribute dividends, while the other $500 million will be invested in energy infrastructure and Bitcoin mining. "Bitcoin City" is derived from the planning of this latter $500 million fund, and this new city can be understood as El Salvador's long-term layout for the Bitcoin mining industry.

Although Bukele has not yet provided a specific timeline for the city's construction, the Salvadoran government has stated that these bonds will be issued in 2022, meaning that the construction of "Bitcoin City" will begin next year.

Samson Mow, Chief Strategy Officer of Blockstream, the technology provider for the Liquid Network, stated that the $1 billion bond is backed by Bitcoin, with a coupon rate of 6.5%. After a five-year lock-up period, El Salvador will begin selling some of the Bitcoin used to finance the bonds, providing investors with "additional coupons," assuming the value of the cryptocurrency continues to rise strongly over the next ten years, "El Salvador will become a global financial center." Mow also revealed that to facilitate the bond issuance process, the Salvadoran government is drafting a securities law, and the first exchange to obtain a license to support the bond trading will be Bitfinex.

El Salvador's radical actions may affect IMF support plans

In addition to mining, Bitcoin as a payment method has begun to be used in El Salvador's commercial landscape, with the state-backed Chivo wallet appearing on many merchant platforms nationwide. Local Starbucks and McDonald's have also quickly taken action to accommodate Bitcoin payments. Recently, the low-cost airline Volaris confirmed that it will accept Bitcoin payments in El Salvador. On October 19, Bukele stated at a Volaris event, "As the world's first airline to accept Bitcoin and the Chivo wallet, Volaris has increased its flight services for Salvadorans."

Data disclosed by the Central Bank of El Salvador shows that between September and October, Salvadorans abroad used the Chivo wallet to remit approximately $32 million back home, accounting for about 2.5% of all remittances sent during those months.

El Salvador is showcasing the use of Bitcoin as legal tender locally, but at the same time, the country has been negotiating with the International Monetary Fund (IMF) throughout the year, seeking a $1 billion loan. It hopes that its recent actions regarding Bitcoin will not hinder its access to funding.

Bitcoin may affect El Salvador's relationship with the IMF

In early November, the IMF met with a Salvadoran delegation in Washington, discussing policies to support potential fund organization plans, and this annual meeting may involve discussions about new loan plans. The IMF has stated that discussions about the plan have stalled since April, "The developments in El Salvador since (April) will require some adjustments to the policies needed to ensure inclusive growth, fiscal sustainability, and financial stability," said Alina Carare, head of the IMF's Salvadoran delegation.

Due to the spread between Salvadoran national bonds and U.S. Treasury bonds (.JPMEGDELSR) rising to over 1100 basis points at the end of September, reaching a historical high, this has nearly made it impossible for the country to access the financing market, making it particularly important for the country’s economy and financial system to reach a loan agreement with the IMF. Currently, there is no outcome on whether the loan plan will be approved. Analysts in the banking industry believe that this loan will not be realized quickly.

Some also question whether El Salvador's adoption of Bitcoin may weaken its negotiating position with the International Monetary Fund (IMF). After all, the IMF had warned in June that the country's use of cryptocurrency poses challenges in terms of finance and regulation. Moody's Investors Service had also warned that El Salvador's formal adoption of Bitcoin could threaten the stability of the country's position within the fund organization.

"We don't see any risks. Perhaps, some upside risks," El Salvador's Central Bank President Douglas Rodriguez recently responded to Bloomberg, stating that Bitcoin will "become a payment system, an inclusive financial system… We have explained to the IMF that for us, Chivo and Bitcoin are just a payment method." Rodriguez added that Bitcoin will lose its reputation as a speculative asset, as it has proven to be useful as a legitimate payment system supported by Chivo. Rodriguez also believes that the leading cryptocurrency should actually benefit El Salvador in terms of economic growth exceeding the central bank's expected 9%, despite its notorious price volatility.

Due to the passage of the "Bitcoin Law" in El Salvador being driven by the strong will and means of the president, the opposition in the country has characterized Bukele's style of governance as authoritarian and dictatorial. Regarding how El Salvador's cryptocurrency bonds will affect the country's financial system, analysts at Amherst Pierpont Securities recently mentioned conventional assessment theories in a report, stating, "When there is not much consistency in economic policy management, and when the economic agenda still submits to an authoritarian political agenda, it is difficult to assess the rules of a game (good or bad)."