One Year of El Salvador's Bitcoin Experiment: Is the BTC Erupting from the Volcano Wealth or Disaster?

Author: Linqi, Chain Catcher

Editor: Demian, Chain Catcher

El Salvador has always been a stage for currency experiments. In 2001, the U.S. dollar became the only legal tender in the country. On June 9, 2021, the El Salvador Congress officially voted to pass the Bitcoin Law, making it the first country in the world to declare Bitcoin as legal tender, causing a sensation in both the crypto industry and the traditional financial sector.

Now, it has been a year since the El Salvador Congress passed the Bitcoin Law. During this time, the country has proposed a series of plans, including the construction of Bitcoin City, using geothermal energy from volcanoes to mine Bitcoin, and issuing $1 billion in Bitcoin bonds. What has been the actual situation regarding these plans for Bitcoin in El Salvador over the past year? What impact has Bitcoin had on this country?

Top-Down Policies

This national-level cryptocurrency experiment began in June 2021. At that time, the El Salvador Congress passed the bill to "make Bitcoin legal tender" with 62 votes in favor and 22 against. The 39-year-old president of El Salvador pointed out to Congress: "The purpose of this law is to establish Bitcoin as unrestricted legal tender, granting Bitcoin the freedom and unrestricted control in any transaction, and allowing ownership to belong to public or private entities, individuals or corporations." On September 7 of the same year, the president signed the bill, and Bitcoin officially became legal tender in the country, alongside the U.S. dollar. This marked the first time Bitcoin was recognized as legal tender by a country.

President Nayib Bukele, who announced the implementation of this policy, is part of the young force in the world, just like Bitcoin itself. Nayib Bukele was sworn in on June 1, 2019, for a five-year term. He is currently the youngest head of state in Latin America, having previously served as mayor of Nuevo Cuscatlán (2012) and San Salvador (2015). His party, the Grand Alliance for National Unity, is also primarily composed of young people.

El Salvador becoming the first country to legalize Bitcoin is also related to its unique national conditions. The country is located in Central America, where citizens have long relied on remittances, leading to a phenomenon of "dollarization" in the economic system. Since January 1, 2001, the Central Bank of El Salvador has ceased issuing colón (the former national currency). This effectively means that the official stance of El Salvador has defaulted to the U.S. dollar as legal tender. Since then, El Salvador has no longer had its own independent monetary system. From that time on, U.S. government fiscal decisions and Federal Reserve monetary policies began to have a profound impact on the domestic economy of El Salvador. Since the dollarization in 2001, El Salvador has faced rising debt and soaring living costs.

Zhou Ziheng, an associate researcher at the Financial Research Institute of the Chinese Academy of Social Sciences, pointed out in an article that since the COVID-19 crisis, under the loose monetary policies of the Federal Reserve and the U.S. Treasury, countries like El Salvador have suffered severe "currency erosion," and legalizing Bitcoin is a pragmatic strategy aimed at "de-dollarization."

Legalizing Bitcoin, at least in concept, can bring two benefits to the country. On one hand, Salvadoran expatriates send more than $4 billion in remittances to their hometowns each year, accounting for 20% of the country's GDP. International transfer fees are relatively high and time-consuming. If Bitcoin is used, it can effectively reduce remittance costs, saving $400 million in transaction fees annually. On the other hand, about 70% of the population in El Salvador does not have bank accounts, meaning they lack regular banking services. Using Bitcoin wallets would allow many Salvadorans to experience having banking services akin to savings accounts for the first time.

El Salvador has long had an interest in Bitcoin. Before the bill was passed, the country's Congress approved a $150 million Bitcoin trust fund to support the exchange of Bitcoin for U.S. dollars, with funds to be disbursed by the Treasury and managed by the Development Bank of El Salvador. Additionally, the government has deployed 200 Bitcoin ATMs nationwide to facilitate the exchange of dollars and Bitcoin for the public.

Furthermore, to assist in the application of Bitcoin, El Salvador partnered with AlphaPoint to launch a mobile crypto wallet—Chivo. AlphaPoint provides the front-end and back-end infrastructure services for this application and integrates the Lightning Network, as well as the entire country's Bitcoin application ecosystem, aiming to provide users with timely, nearly fee-free Bitcoin wallet functionality.

The government is also vigorously promoting the Chivo wallet. The president of El Salvador has extensively advertised it on social media and television, even providing hands-on tutorials for the public on how to use Chivo. In September of last year, the government planned to spend over $225 million to promote it, including distributing $30 worth of Bitcoin to each user's account to incentivize consumption. In the beautiful new world envisioned by this president, in El Salvador, Bitcoin could be used to purchase anything—from street vendor fried corn to fast food, from street trinkets to real estate transactions.

President Bukele's long-term vision is to create a "Bitcoin City." In addition to legalizing Bitcoin, the country also hopes to leverage its geographical advantages—volcanoes—to mine Bitcoin. Bukele has also posted a scale model of "Bitcoin City" on Twitter, stating that it will be built at the foot of a volcano, powered by geothermal energy for a massive Bitcoin mining operation.

Volcanoes of El Salvador

In October of last year, the government stated that it successfully mined 0.00599179 Bitcoin using volcanic resources. In reality, the so-called volcanic energy is geothermal energy; El Salvador is already known as the "Land of Volcanoes," with one-fourth of its electricity supply coming from geothermal sources. Its advantages include being cheap, clean, renewable, and zero-emission. However, Bitcoin mining in Iceland has relied on volcanic energy from the start, so this method is not entirely new.

To develop the "mountainous plan," the government announced plans to issue the world's first Bitcoin bonds—"Volcano Bonds"—on the Liquid Network, with a total of $1 billion and a 10-year term. Half of the proceeds will be used to purchase BTC and distribute dividends, while the other $500 million will be invested in energy infrastructure and Bitcoin mining. "Bitcoin City" is essentially 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.

In addition, Bukele has also planned to draft a bill that grants permanent residency to foreign immigrants who invest three Bitcoins in El Salvador. The government's legal advisors have stated that the government will exempt foreign investors from taxes on profits from Bitcoin. The government believes this is a measure that encourages entrepreneurs and investors to enter the country. Furthermore, the Bitcoin-related legislation mentions that "the state should promote necessary training and mechanisms to enable the public to enter the Bitcoin trading system," aiming to popularize crypto knowledge and provide various education to facilitate the "popularization" of Bitcoin.

Beyond the myriad of policies promoting Bitcoin, the government has also personally entered the fray as an investor in Bitcoin. According to Chain Catcher statistics, as of now, President Nayib Bukele has purchased a total of 2,301 Bitcoins in ten transactions using treasury funds, with an average purchase price of $44,880.

Note: Since the El Salvador side usually only announces the number of BTC purchased, the average price and amount are estimated based on the BTC price at the time of announcement.

Bottom-Up Challenges

This rapid and heated national-level Bitcoin experiment soon encountered cold reality. A few months after the proposal to legalize Bitcoin was passed, protests against Bitcoin erupted in El Salvador, with protesters burning a Bitcoin ATM located in the capital, which was painted with "Anti-BTC" symbols and slogans reading "Democracy is not for sale."

The usage rate of the Chivo wallet is also not high. Although over 1.6 million registrations were made within two weeks of its launch, and the app's download surged to the top of major app stores, the core reason for this surge was the $30 BTC registration reward. In a Central American country with a per capita GDP of $4,131, this is a considerable bonus.

Subsequently, issues with the use of the Chivo wallet continued to arise. Due to technical imperfections, some users experienced delays in receiving funds when transferring using Chivo, even though the blockchain records showed that the funds had been sent. The amounts lost by these users ranged from dozens to thousands of dollars. When users sought help from the Chivo customer service team, they sometimes received notices that their issues could not be processed or were not accepted for processing.

Ultimately, despite many Salvadorans having smartphones with internet access, less than 60% have downloaded the Chivo wallet. Among them, less than 40% of citizens continued to use the application after receiving the registration reward.

Even without the aforementioned technical issues, using Bitcoin for everyday payments is not easy. Not all consumers and merchants accept this method, and since most people in the country do not understand Bitcoin and are filled with anxiety and concern about it, they choose to refuse it outright. Relevant data shows that only 20% of companies reported accepting Bitcoin as a payment method, most of which are large organizations. In all sales transactions, only 5% are conducted using Bitcoin, with most transactions being converted to U.S. dollars immediately after merchants receive payment.

A recent survey indicated that after the El Salvador government initially encouraged its citizens to start using this new financial system, public enthusiasm and adoption rates have remained low. The adoption rates for most key indicators have been shrinking, with almost no momentum. One company involved in developing Chivo stated, "The application only has between 6,000 to 15,000 transactions per day," which is a small number compared to El Salvador's 4.3 million adult population.

The deeper reasons for the difficulties in promoting Bitcoin in El Salvador may be related to the country's inherent social, economic, and cultural foundations. El Salvador is located in the "Northern Triangle of Central America," which refers to the three countries of Honduras, El Salvador, and Guatemala. These three countries are the poorest, most violent, and most gang-ridden in the entire Western Hemisphere, with severe refugee issues and political chaos. El Salvador, as an agricultural country with a weak industrial base, has 90% of small farmers unable to be self-sufficient, forcing them to accept extremely low wages while being dependent on large landowners. The wealthiest 14 oligarch families in El Salvador control the vast majority of land and financial resources in the country.

In this country of less than 7 million people, there is one gang member for every 70 people. Kidnapping and extortion have almost become a commonplace "profession" in this country: Salvadorans pay $756 million annually in protection fees to gangs, which alone accounts for 3% of the country's GDP. Each year, the number of people murdered in the country exceeds 1,000; in just half a year in 2015, 3,400 people were murdered, surpassing the number of deaths in war-torn Yemen and Afghanistan during the same period. The two largest gangs in the country, MS-13 and the 18th Street Gang, have a combined membership of over 70,000, nearly double the size of the national military. Homicides, which are considered extremely serious incidents elsewhere, seem to be a way of life for locals in El Salvador, faced with daily. There have even been bizarre scenes where Salvadorans celebrated because there had been no murders for an entire day.

The poverty and chaotic social environment directly lead to a concerning level of basic education among the populace. Children and youth who should be sitting in classrooms learning are instead drawn into violence and crime at an early age in El Salvador. In 2005, the median age of gang members in El Salvador was only 19 years, and now over 60% of gang members joined before the age of 15.

Within the crypto industry, many individuals, represented by Ethereum founder Vitalik Buterin, have also opposed the country's adoption of Bitcoin as legal tender. Vitalik stated, "Forcing businesses to accept a specific cryptocurrency is contrary to the ideals of freedom, which is so important in the crypto space. Moreover, the strategy of pushing Bitcoin onto millions of Salvadorans without prior education is reckless and could expose many innocent people to hacking or fraud. It is shameful to uncritically praise Nayib Bukele (specifically naming the main responsible parties: the extremists of Bitcoin are truly shameful)." Vitalik also stated that Nayib Bukele's actions violate the spirit of Bitcoin and will ultimately only make the president richer, representing speculative behavior.

Accelerating Debt Crisis

As of June 22, the value of Bitcoin assets held by El Salvador is approximately $46.59 million, while the country has invested $102 million in Bitcoin since it became legal tender last September. In other words, El Salvador's Bitcoin assets have now lost $57.41 million.

The president of El Salvador seems to have become "low-key." Previously, almost every time the crypto market crashed, Nayib Bukele would tweet about buying Bitcoin at a low price, but during the recent crash, the president has not made similar statements. The "Volcano Bonds," which were once enthusiastically planned for issuance, were supposed to be launched in mid-March of this year, but have now disappeared without a trace.

The above image shows the president of El Salvador announcing the purchase of Bitcoin for the second and final time this year.

El Salvador's Finance Minister Alejandro Zelaya stated that the losses from Bitcoin pose very little risk to the national financial situation, noting that this amount is less than 0.5% of the government budget.

However, this radical cryptocurrency experiment has implications for El Salvador's national finances that go far beyond a loss of over $50 million. According to relevant analyses, El Salvador's Bitcoin "initiative" has already affected its ability to repay external debts. Since El Salvador adopted Bitcoin as legal tender, the spread of El Salvador's credit default swaps (CDS) has risen by over 20 percentage points, indicating an 87% likelihood of default in the next five years. On June 15, El Salvador paid $38.25 million in coupon interest on a bond maturing in 2035. In other words, the losses from "going all in" on Bitcoin exceed the principal interest that the country needs to repay on its sovereign debt by over $20 million.

This year, the country's debt prices plummeted by 15.1% in April, a decline only surpassed by the bonds of war-torn Ukraine. Overall, they have fallen by about 18%, with El Salvador's benchmark bonds maturing in 2032 currently trading at 40% of face value, yielding 24%, a level indicating that investors are preparing for default.

This year, El Salvador needs to pay approximately $382 million in interest to bondholders, with $183 million due in July, making it the month with the largest repayment amount. The next bond requiring principal repayment for El Salvador matures in January next year, amounting to $800 million. This batch of bonds is currently trading at a 22% discount, indicating investor hesitation about whether this bond will be honored. This is also reported by most foreign media, suggesting that El Salvador is very likely unable to repay this debt.

According to previous disclosures from the Central Bank of El Salvador, the country had $3.4 billion in foreign exchange reserves in April this year, and the government plans to raise $1 billion through Bitcoin-supported bonds. Although this plan is at best unconventional, some investors still hope it can at least bring some cash into the government treasury. It remains unclear whether the transaction will go through. This "robbing Peter to pay Paul" approach has already drawn negative evaluations from various international sectors.

In February of this year, Fitch downgraded El Salvador's junk-rated sovereign debt from "B-" to "CCC," citing the significant risks brought by the country's adoption of Bitcoin as legal tender. Fitch also stated that before the $800 million global bond matures in January next year, El Salvador's "reliance on short-term debt has intensified, increasing financing risks." Additionally, the authoritative bond rating agency Moody's downgraded El Salvador's debt rating to CAA3, indicating "poor quality, very high credit risk, and a very high probability of severe credit events."

According to data from S&P Global, the cost of insurance against sovereign default for El Salvador has reached its highest level since 2020.

After El Salvador's credit rating decline, the difficulty of issuing external debt will increase. If it cannot repay old debts by issuing new ones in the future, it will face sovereign debt default, putting El Salvador in a very passive position, with the possibility of national bankruptcy not being ruled out.

Moreover, El Salvador's adoption of Bitcoin has led to disputes with multilateral lenders such as the International Monetary Fund (IMF). The IMF, acting as a lender of last resort, has been urging El Salvador to repeal Bitcoin's legal tender status since the country fully embraced it, warning of risks associated with Bitcoin usage in terms of financial stability. Last year, Finance Minister Alejandro Zelaya stated that the government was seeking $1.3 billion in financing from the IMF, but the IMF advised El Salvador to abandon its policy of using Bitcoin as legal tender. Some executive directors expressed concerns about the risks of issuing Bitcoin-supported bonds. They believe El Salvador needs to start fiscal consolidation this year to restore fiscal sustainability and steadily reduce public debt levels.

The reasons the IMF has been warning the El Salvador government are largely not because Bitcoin has led the country's economic situation further toward "destruction," but because, given the country's conditions, the unthinking full acceptance of Bitcoin could further push it off the cliff. The IMF projects that under the current policies, El Salvador's remittance-dependent economy will have a current account deficit of around $2 billion by 2025, and by 2026, public debt will account for 96% of its GDP. As of the beginning of this month, El Salvador's debt point against U.S. Treasuries has already broken through the record high of 2,500 basis points.

In Conclusion

Now, a year has passed since El Salvador's international Bitcoin experiment began. Observing this experiment over the course of a year reveals widespread public indifference and resistance, as well as the country's finances sinking deeper into turmoil. However, looking at a longer time frame, it is clear that no definitive conclusions can be drawn yet. After all, the history and current situation of this country are quite complex, and President Nayib Bukele and his "prescription" of Bitcoin for this troubled nation are still young; they have not yet admitted defeat.