In less than two weeks, El Salvador will become the first country to adopt bitcoin as a national currency. No one knows what comes next.
The government of the impoverished Central American nation aims to spend up to $75m as part of a plan to hand out $30 to people who sign up to an e-wallet called Chivo, or ‘Cool’. That software-based system would allow an estimated 2.5 million Salvadorans to buy goods or pay for services in US dollars or bitcoin, El Salvador’s two official currencies as of 7 September.
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The foray into bitcoin risks wrecking El Salvador’s $26bn economy. The indebted nation’s central bank could be forced to spend hard-currency reserves to buy bitcoin if the value of the crypto asset craters and consumers rush to the safety of the dollar. The government can’t print its own money — El Salvador ditched the colón in favour of the greenback two decades ago — and is struggling to earn dollars.
“Adopting bitcoin as legal tender puts us on a roller coaster,” says Carlos Acevedo, an economist who served as governor of El Salvador’s central bank from 2009 to 2013.
President Nayib Bukele has said that adopting bitcoin will help attract foreign investment, foster more and cheaper financial services and lower the cost of sending and receiving remittances, which reached a high of almost $6 billion last year. The 40-year-old president also wants to lure foreign investors to develop geothermal power from volcanoes to supply the large amounts of electricity needed for mining the cryptocurrency.
“With its very small economy, El Salvador was usually behind when it came to innovation,” Alejandro Zelaya, the country’s finance minister, said in an interview. “We are now becoming an investment destination.”
But the plan also carries significant risks because the government has limited access to debt markets, and faces rising borrowing costs and a wide budget gap. El Salvador is currently negotiating a $1.3 billion financial aid program with the International Monetary Fund, but didn’t consult the lender about the move, according to people familiar with the negotiations.
The IMF has warned against adopting highly speculative crypto assets as national currency, primarily because the privately issued tokens bypass authorities and central banks, which are tasked with preserving economic and currency stability.
For tiny El Salvador, bitcoin’s decentralised system opens doors to anonymous and illicit transactions, like money laundering or ransom payments, economists say.
“The country has no tools and no capacity to contain a speculative attack,” said Claudio Loser, a former Western Hemisphere director at the IMF.
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US-based ATM operator Athena Bitcoin Global plans to invest $1m to install a network of bitcoin ATMs in the country. Salvadorans with the Chivo mobile wallet app would then be able to scan a QR code at the ATM’s large screen to buy and sell bitcoin in exchange for dollar bills.
Bitcoin is volatile, and can be vulnerable to so-called flash crashes in which news or social-media rumours spark a selloff. The price has swung between $47,000 and $50,000 just this week, and reached a peak of about $65,000 in April.
As a means of exchange, it could fuel sharp fluctuations in the prices of goods and services. The nation’s tax revenues would also swing wildly in conjunction with the price of bitcoin.
The Bukele administration has set aside $150m for a convertibility exchange to allow automatic conversion of bitcoin to US dollars and vice versa through the Chivo e-wallet. Zelaya compared that to consumers traveling abroad and buying goods in a foreign currency, saying he thought consumers would only gradually adopt the cryptocurrency.
Zelaya said he doesn’t expect bitcoin’s volatility to pose a problem in its use, and that the government facility to allow the instant convertibility of bitcoin to dollars is likely to be sufficient.
In late July, Moody’s Investors Service lowered El Salvador’s already speculative debt further into junk territory, citing “a deterioration in the quality of policy-making” because of bitcoin’s adoption and other measures. It also cited El Salvador’s difficulties accessing credit markets ahead of a heavy debt-repayment schedule as of next year, and uncertainty surrounding negotiations for fresh financing from the IMF.
The nearly completed bailout deal with the IMF stalled after legislators of Bukele’s New Ideas party replaced the attorney general and magistrates of the Constitutional Court in May, according to people familiar with the negotiations.
Last week, El Salvador’s central bank released the financial regulations for adopting bitcoin, including provisions to prevent money laundering and other illicit activities. Financial institutions will also be required to alert consumers of bitcoin’s volatility risks. Financial service providers have until 6 September to submit comments on the regulations.
Write to Santiago Pérez at santiago.perez@wsj.com and Caitlin Ostroff at caitlin.ostroff@wsj.com
This article was published by Dow Jones Newswires.