Author: Otto (Analyst of OFR)

Advisor: Gui (Investment principal of Old Fashion Research)

In 2021, the president of El Salvador, Nayib Bukele, made the cryptocurrency bitcoin the legal tender of the country beside the US-Dollar, which was the first move of this kind in the world. This event put El Salvador on the headlines of every economic newspaper and raised both concerns by the IMF and cheers around the world from crypto advocates. Now, after one year and a sharp decrease in the price of bitcoin, consequences of the bold move are starting to show.

The country first started to buy bitcoins one year ago at a price of around $52k. Since then, it has purchased bitcoins worth $104 million, including 80 coins recently at a price of $19k . Considering the recent developments, the tables are now starting to turn, as their holdings experienced over 50% loss and are now worth around 45 million dollars. This only signifies the debt-problems and solvency issues the country has, which made the S&P Global ratings decrease their rating to a CCC+, one of the worst in the world (Bloomberg, 2022). This directly impacts the country's financing capabilities in the global market, but we will also see below that the country has been working on crypto-backed instruments to improve its borrowing capabilities in international markets. 

But how could this happen and where did this all start? 

The relationship between Bitcoin and El Salvador began long before the adoption as legal tender. In 2019, an anonymous donor talked to Micheal Peterson, a Calfornian Surfer who participated in charity work in the local town of El Zonte. He offered him over 100 thousand US-Dollar under the condition that he would start a pilot-project: Everywhere Bitcoin should be the local currency and fiat-money like the US-Dollar should mostly be avoided (Scheider, 2021; Linthicum, 2021).

After three years, El Zonte or infamous known as “Bitcoin Beach”, is a total success. Almost everywhere, from beers to hotels, tourists and locals alike can pay in bitcoin. Furthermore, the town developed their own wallet, Bitcoin beach wallet, and created a separate environment, where people not just scan a QR-Code to pay but do this via the Bitcoin beach website. Tourists from around the world travelled long before the adoption to El Salvador to witness the Bitcoin-paradise.

The majority of the country is young, compared to Europe and North America (Worlddata, 2022). The expected age lies far below the two mentioned continents, with 69 and 78 years for men and women. Lastly, El Salvador has a yearly income of 3 to 4 thousand US-Dollar per year, which lies far below countries like the US with around 63 thousand US-Dollar as well as a low banked population of only 30% (Statista, 2022).

The president aims to reach more people and solve the problem of low banked rate by introducing the cryptocurrency as legal tender. Registering a wallet comes far easier than setting up a bank-account. Moreover, the general population mistrusts the government and their policies, which makes the decentralised nature of a blockchain so appealing. But how are people going to pay transaction-costs that could often rise up to 70 Dollars and take more than 10 minutes? How can a local farmer assure that the transaction goes through and he actually receives his funds?

El Salvador has two approaches to this: Firstly, the lighting network:

It is a layer-two solution which is able to scale bitcoin transactions and minimises both time and costs. Users create a separate payment channel, where the transaction happens off-chain but still benefits from the security and decentralisation of the bitcoin-network (Bitpay, 2022). But this option is mostly used by tourists and foreigners. For locals, the government introduced the Chivo Wallet, which only residents can download. It was introduced with a 30 Dollar signing-bonus, which presents a huge incentive for a majority of the population to download the app. So far, over 4 million out of the 6 million people in El Salvador have downloaded the app to claim the reward. Bitso, a Latin American cryptocurrency exchange, is the "core service provider" for the digital wallet called Chivo ("cool") that will be used for the program, according to Reuters. BitGo, a Palo Alto-based crypto custody and security company, is reportedly providing security technology for the wallet.

Founded in 2014 Bitso was valued at $2.2 billion in May 2021 and is backed by Coinbase, Ripple, Valor and others. Bitso’s crypto remittance business is also a strategic area that suits El Salvador crypto plans, whose economy is heavily dependent on money sent home by citizens abroad. Bitso is said to be working closely with Silvergate Bank in transactions that involve US dollars. 

Chivo is actually not a real wallet, but more of a platform which can be compared to a centralised exchange. Nobody owns their private keys or seed phrases and transactions happen off-chain. Conclusively, transactions happen instantly without much complication and transaction costs, but the apparent decentralisation and security of the bitcoin-network disappears.

Locals respond to the bitcoin adoption with mixed feelings. Most of the people using the app are from the younger generation, as older people tend to neglect the new developments and say that El Salvador is not ready for the new technology and bitcoin. (BBC World Service, 2022). Some are not seeing the value, as most of daily life is still happening in cash and US-Dollar (BBC World Service, 2022). This is confirmed through a recent study by the National Bureau of Economic Research in the US, where only 20% of the locals use bitcoin and the accompanied Chivo-wallet (BBC News, 2021). It shows that the government wants to paint a misleading picture by mentioning the downloads, which happened for the majority because of the financial incentive. 

Furthermore, a German journalist who just travelled to El Salvador mentions that approximately only 30% of the shops and restaurants accept bitcoin outside of El Zonte, even though it is obligatory. This is due to a lack of resources and technological knowledge by the local shops to implement such changes (Finanzfluss, 2021). But on the other side is the younger generation who welcomes the new direction of the government, as they frequently gamble on higher or lower bitcoin-prices and utilise the abstinence of transaction fees (Finanzfluss, 2021).

Given the difficulty on the usage side of Bitcoin as legal tender we also start to see initiatives such as that of Athena Bitcoin which plans to install around 1,500 ATMs in El Salvador, either to buy bitcoin or withdraw cash, according to the company's website. There are currently 200 such ATMs, according to government officials. Withdrawals, deposits and other transactions would reportedly be free of charge. 

Despite reactions from the people and recent price drops, Nayib Bukele has high aspirations for the project and is doubling down on his investments. He wants El Salvador to be a technology-hub for innovation, that companies from around the world are attracted by a unique infrastructure and knowledge cluster around cryptocurrencies. This should be implemented through a “bitcoin city”, which would be located near the Conchagua Volcano in the eastern region (BBC News, 2021). The volcano would serve as a source for geothermal energy that power the city and bitcoin mines. The Financials are provided through a one billion dollar bitcoin bond, which is the first of its kind in the world. People invest in this bond and earn 6% per year. The government invests the raised capital in bitcoin and locks it for five years, after which the bond will be paid through potential earnings.

The project has received huge criticism from the population and experts around the world. Massive protests have been organised after Bukele announced his vision via a tweet in May. Questions rose regarding the feasibility of a project with such a magnitude and the actual use case for the region. According to José Miguel Cruz, a director of research at the Florida International University, the money should rather be used to enhance education and health in the population rather than chasing an utopia (Linares, 2021).

When we further look into the initiatives being implemented by the government we see that El Salvador plans to use Koibanx to develop its blockchain infrastructure. The country plans to use the Algorand which is designed to use proof of stake and have low transaction fees. Algorand was founded in 2017 by Silvio Micali, an MIT professor. Using Algorand will reportedly allow for the storage of official documents on the blockchain thereby adding transparency into important legislative procedures and data keeping. 

Bitcoin entrepreneur Samson Mow incorporated a startup called JAN3, which signed an MOU with the country to help foster the growth of much needed digital infrastructure. At the Bitcoin 2022 Conference, Mow disclosed two new jurisdictions are set to follow in El Salvador’s footsteps. The Caribbean island of Roatan and Portugal’s Madeira will also be adopting Bitcoin as legal tender soon. All in all, it seems that the decision to make bitcoin legal tender has been more well received by private investors and the younger population who can more notably appreciate the value add that the technology brings, while the international authorities like the IMF show their concern and the older portion of the population remains sceptical about the decision. 

If the high aspirations of president Nayib Bukele actually work out in the end or if it is just a media-stunt remains to be seen. But one thing is for certain: El Salvador has massive financial and structural problems, which need to be addressed outside of the bitcoin-euphoria and whether the benefits of institutionalising bitcoin outweighs the costs it implicates, only time will tell.  

Average life expectancy by country. (2022). Worlddata.Info. https://www.worlddata.info/life-expectancy.php

Statista. (2022, June 30). El Salvador: gross national income per capita 2010–2020. https://www.statista.com/statistics/1070121/gross-national-income-per-capita-el-salvador/

Statista. (2022a, June 28). Personal income in the U.S. - income per capita 1990–2021. https://www.statista.com/statistics/205199/per-capita-personal-income-in-the-us/

Statista. (2022a, May 31). El Salvador: population with bank account 2011–2017, by type. https://www.statista.com/statistics/1011424/el-salvador-bank-account-ownership-rate-type/#:%7E:text=El%20Salvador%3A%20population%20with%20bank%20account%202011%2D2017%2C%20by%20type&text=In%202017%2C%20approximately%2029%20percent,from%2014%20percent%20in%202011.

Team, T. B. (2022, April 22). What is the Lightning Network? Bitcoin Lightning Network Explained | BitPay. The BitPay Blog. https://bitpay.com/blog/what-is-the-lightning-network/#:%7E:text=The%20Lightning%20Network%20is%20a,known%20as%20off%2Dchain%20transactions.

BBC World Service - Business Daily, El Salvador’s Bitcoin gamble. (2022, June 16). BBC. https://www.bbc.co.uk/programmes/w3ct311s

BBC News. (2021, November 21). El Salvador Bitcoin city planned at base of Conchagua volcano. https://www.bbc.com/news/world-latin-america-59368483

#241 Alltag mit Bitcoin: Thomas’ Reisebericht aus El Salvador. (2022, February 23). Finanzfluss. https://www.finanzfluss.de/podcast/folge-241/

El Salvador Buys More Bitcoin Despite 57% Loss and Debt Woes. (2022, July 1). Bloomberg. Retrieved July 9, 2022, from https://www.bloomberg.com/news/articles/2022-07-01/el-salvador-buys-more-bitcoin-despite-57-loss-and-a-debt-crisis

CABEZAS. (2021). Bitvoin in El Salvador [Photograph]. https://www.manager-magazin.de/finanzen/bitcoin-in-el-salvador-ist-die-kryptowaehrung-offizielle-waehrung-ein-grosses-experiment-a-e6943513-25aa-436e-acb7-83ef289e4ad3#bild-7a50f215-f9b2-4744-aa8f-aee45cb63dcd

Scheider, D. (2021, November 22). Bitcoin Beach: Surfen, Sonne und Satoshis. BTC-ECHO. Retrieved July 9, 2022, from https://www.btc-echo.de/news/bitcoin-beach-surfen-sonne-und-satoshis-129892/

Linthicum, K. (2021, July 14). How a California surfer helped bring bitcoin to El Salvador. Los Angeles Times. Retrieved July 9, 2022, from https://www.latimes.com/world-nation/story/2021-06-22/in-el-salvadors-bitcoin-beach

Linares, A. N. T. (2021, November 30). A ‘Bitcoin City’ in El Salvador inspired by ancient Greeks? Here’s a reality check. NBC News. https://www.nbcnews.com/news/latino/bitcoin-city-el-salvador-inspired-ancient-greeks-s-reality-check-rcna6944

Orešković, D. (2020, June 8). bitcoin-lightning-network-basic. Hrvatski Bitcoin Portal. Retrieved July 9, 2022, from https://crobitcoin.com/sto-je-lightning-network-i-kako-funkcionira/bitcoin-lightning-network-basic/

T. (2022, June 21). El Salvador: Im Bitcoin-Fieber in den Staatsbankrott? tagesschau.de. https://www.tagesschau.de/wirtschaft/finanzen/el-salvador-bitcoin-103.html

Bitcoin protests in El Salvador. (2021). [Photograph]. https://www.premiumtimesng.com/news/more-news/483786-protests-as-bitcoin-crashes-after-el-salvador-adopts-coin-as-legal-tender.html

Romero. (2021). Bitcoin city. Treehugger. Retrieved July 9, 2022, from https://www.treehugger.com/volcano-powered-bitcoin-city-proposed-for-el-salvador-5210927

Krammer, A (2021). The companies powering El Salvador’s new bitcoin economy. Retrieved July 11. 

https://www.protocol.com/fintech/el-salvador-crypto-economy

 El Salvador’s Bitcoin City ropes in new startup to set up digital infrastructure. Business Insider India, retrieved July 11. 

https://www.businessinsider.in/investment/news/el-salvadors-bitcoin-city-ropes-in-new-startup-to-set-up-digital-infrastructure/articleshow/90728932.cms