Casey Wagner

<div id="highlights-block_61f05d508f12d" class="highlights">
 <ul>
 <li>IMF executive directors are uncertain about El Salvador’s future </li>
 <li>Bitcoin presents risks to financial stability and security, the IMF said </li>
 </ul>
 
</div>



The International Monetary Fund (IMF) is urging El Salvador to remove bitcoin’s status as legal tender, just four months after the Central American country <a href="https://cms.blockworks.co/el-salvador-buys-550-bitcoins-officially-adopts-the-crypto-as-legal-tender/" target="_blank" rel="noreferrer noopener">adopted</a> the cryptocurrency.&nbsp;



Bitcoin poses significant risks to financial stability and consumer protection, IMF executive directors said in their <a href="https://www.imf.org/en/News/Articles/2022/01/25/pr2213-el-salvador-imf-executive-board-concludes-2021-article-iv-consultation" target="_blank" rel="noreferrer noopener">concluding statement</a> on El Salvador’s Article IV consultation.&nbsp;



“[Directors] stressed that there are large risks associated with the use of bitcoin,” the statement read. “They urged the authorities to narrow the scope of the bitcoin law by removing bitcoin’s legal tender status.”&nbsp;



There also needs to be greater regulatory oversight of Chivo, El Salvador’s bitcoin wallet designed to be used for transactions in the digital currency, the IMF said.&nbsp;



<blockquote class="wp-block-quote is-layout-flow wp-block-quote-is-layout-flow">“The statement on bitcoin and Chivo shows this is too close to de-dollarization for comfort,” said Nathalie Marshik, head of emerging markets sovereign research at Stifel Financial Corp. “The tone of the statement is quite negative.”&nbsp;</blockquote>



Reviews of El Salvador’s bitcoin experiment are mixed, <a href="https://cms.blockworks.co/fraud-funding-woes-and-a-president-who-wont-quit-el-salvadors-bitcoin-experiment/" target="_blank" rel="noreferrer noopener">Blockworks previously reported</a>, with some observers viewing the move as a progressive step toward financial inclusion and others claiming it’s an irresponsible gamble.



The IMF projects that El Salvador’s fiscal deficit will reach 5.75% of gross domestic product (GDP) in 2021 and about 5% of GDP in 2022, according to the statement. Public debt is also anticipated to rise to about 96% of GDP in 2026. Given the circumstances, El Salvador is on an “unsustainable path,” the IMF said. 



“The IMF forecasts a primary balance for 2022 yet says the debt is unsustainable under current policies,” said Marshik. “El Salvador needs a 3% of GDP adjustment to get the debt to a sustainable level.”



Primary balance, the fiscal balance adjusted for net interest payment on public debt, is a key indicator for determining a government’s ability to meet obligations without taking on additional loans. The IMF predicts a 0.0 primary balance for 2022, up from its 2021 balance of -1.1.&nbsp;&nbsp;



El Salvador has an $800 million Eurobond, a debt instrument issued in an external currency, maturing in January 2023. Marshik predicts that the country will be fine, financially, through the first half of 2022, but after that it will be up in the air.&nbsp;



Based on statements from El Salvador President Nayib Bukele, who regularly <a href="https://twitter.com/nayibbukele/status/1484651539587289091?s=20" target="_blank" rel="noreferrer noopener">Tweets</a> when he makes bitcoin purchases on behalf of the country, El Salvador holds at least 1,801 bitcoins. Given the recent market sell-off, it is likely the country has lost money on its bitcoin investment, assuming that none of its holdings have been sold.&nbsp;



Article IV consultations are annual assessments conducted by the IMF on all members. During the evaluation, IMF officials visit the country to assess economic developments and discuss policy with the country’s central bank.

IMF Asks El Salvador to Remove Bitcoin’s Legal-Tender Status

<div id="highlights-block_61e844a9aeff6" class="highlights">
 <ul>
 <li>Four months after bitcoin became legal tender, El Salvador citizens and businesses are taking longer to adjust than the president would like</li>
 <li>From a rocky economic situation to a troublesome crypto wallet, the country has faced challenges in getting the bitcoin program up and running</li>
 </ul>
 
</div>



At a packed convention center in Miami in early June 2021, El Salvador’s President Nayib Bukele announced in a prerecorded video that the Central American country would soon be making history. Bitcoin was going to become legal currency in El Salvador, and it was going to be great, Bukele insisted.&nbsp;



Today, four months into El Salvador’s bitcoin experiment, the reviews are mixed: some praise the move as the most progressive step in history toward granting financial access while others claim it’s an irresponsible gamble and a credit-rating nightmare.&nbsp;



Just days after Bukele <a href="https://cms.blockworks.co/el-salvador-to-become-first-nation-with-bitcoin-as-legal-tender/" target="_blank" rel="noreferrer noopener">announced</a> his bitcoin plans, El Salvador’s Bitcoin Law was passed. Roughly three months later, on Sept. 7, 2021, bitcoin joined the US dollar as an official currency of El Salvador.&nbsp;



In that time, El Salvador devoted $200 million to implementing the digital currency, a <a href="https://www.laprensagrafica.com/elsalvador/Uso-de-bitcoin-cumple-2-meses-en-El-Salvador-entre-polemicas-y-ganancias-20211105-0038.html" target="_blank" rel="noreferrer noopener">controversial allocation</a> of funds, according to local media outlets.&nbsp;



If that timeline seems quick, it’s because it was. In true “move fast and break things” fashion, the hasty rollout was intentional, those who worked on the project said.&nbsp;



<blockquote class="wp-block-quote is-layout-flow wp-block-quote-is-layout-flow">During a <a href="https://www.whatbitcoindid.com/wbd362-jack-mallers" target="_blank" rel="noreferrer noopener">podcast interview</a>, Strike CEO Jack Mallers, who worked with El Salvador’s government, shared that authorities said,“We can do this slowly, or we can just put it on the people and people will learn. If they’re forced to do it, they’ll learn and they’ll learn quickly.”&nbsp;</blockquote>



The people have been forced to learn, but progress has been slower than anticipated. Bukele has been faced with a myriad of challenges, including a botched wallet launch, slow adoption and dwindling funds.&nbsp;



<h3 class="wp-block-heading">Chivo woes&nbsp;</h3>



A portion of the $200 million went toward developing and launching the Chivo Wallet app, which is intended to be used for bitcoin transactions and is compatible with other major digital wallets. Chivo came with an incentive to lure in skeptical Salvadorans: anyone that downloaded the app after it launched on Sept. 7 would be given $30 worth of bitcoin.&nbsp;



“We heard from the president a month later that around three million users had downloaded the wallet,” said Andres Pineda, treasurer at Banco Cuscatlan in El Salvador. “However, the government installed around 200 ATMs throughout the country, so what most of the people did was monetize the $30 that was deposited in the wallet and cash out.”&nbsp;



Many Chivo users downloaded the wallet only to retrieve the $30 and never use the service again, a local newspaper in El Salvador <a href="https://www.laprensagrafica.com/elsalvador/Uso-de-bitcoin-cumple-2-meses-en-El-Salvador-entre-polemicas-y-ganancias-20211105-0038.html" target="_blank" rel="noreferrer noopener">reported</a>.&nbsp;



The mass cash-out showed that Salvadorans had not come around to bitcoin’s use case as quickly as Bukele had anticipated. One local publication reported that more than <a href="https://www.elsalvador.com/noticias/negocios/el-salvador-bitcoin-dolar-bukele-ciudad/902708/2021/" target="_blank" rel="noreferrer noopener">91 percent of citizens</a> preferred dollars to bitcoins.&nbsp;



The Chivo Wallet came with glitches, too. The app did not require photo identification, only a citizen’s date of birth and national identity card number (similar to a social security number). This resulted in reports of fraud and the government subsequently halted its Chivo promotional campaign on social media and on the radio in October in response to protests, according to <a href="https://www.elsalvador.com/noticias/nacional/chivo-wallet-fraudes/889706/2021/" target="_blank" rel="noreferrer noopener">local reports</a>.&nbsp;



Bukele and other officials have since shifted to advocating for a new project that would use surplus funds to build “bitcoin schools,” announced in November. There will be 20 schools devoted to bitcoin education, according to local <a href="https://diariolahuella.com/gobierno-informa-que-construiran-las-primeras-20-escuelas-bitcoin-gracias-al-fideicomiso/" target="_blank" rel="noreferrer noopener">reports</a>. The government has not yet provided details on construction or revealed details about the amount of surplus funds, if any.&nbsp;



The Bitcoin Law states that all businesses are required to accept bitcoin as payment, but this has not been the case so far. While there are some merchants that are accepting bitcoin, Pineda said, businesses have struggled with implementation.&nbsp;



“The education component has not been very strong by the government on how bitcoin works and how to use Chivo,” he said. “We, as a bank, are obligated to accept bitcoin… use of our services to convert bitcoin to USD have not been very active.”&nbsp;



Few businesses are currently accepting bitcoin, citizens say.&nbsp;



“The only businesses that are accepting bitcoin readily, aside from a few, are big corporations like Starbucks and McDonald&#8217;s that have tech teams to implement it,” Alexandra Dumitru, a cryptocurrency consultant and advocate living in El Salvador. “It’s a pretty small percentage of businesses in the country, especially considering how many small tiendas [convenience stores] and whatnot there are.”&nbsp;



<h3 class="wp-block-heading">Out of money&nbsp;&nbsp;</h3>



After months of Chivo troubleshooting, Bukele faces another issue: funding.&nbsp;



El Salvador has an $800 million bond maturing in January 2023. In July 2021, ratings agency Moody’s downgraded the country’s debt rating to CAA1, meaning it is considered at risk of defaulting on loans.&nbsp;



Public perception is deteriorating, too, thanks to a series of <a href="https://twitter.com/nayibbukele/status/1483194959989719059?s=20" target="_blank" rel="noreferrer noopener">tweets</a> from Bukele making light of the situation. Bukele trades bitcoin on behalf of El Salvador on his cellphone, he admitted in another <a href="https://twitter.com/nayibbukele/status/1467333081505976323?s=20" target="_blank" rel="noreferrer noopener">tweet</a>.



“That kind of behavior doesn&#8217;t help, it really shows that he either doesn&#8217;t understand or he doesn&#8217;t care,” said Nathalie Marshik, head of emerging markets sovereign research at Stifel Financial Corp.&nbsp;



<blockquote class="wp-block-quote is-layout-flow wp-block-quote-is-layout-flow">“You have massive financing needs and you use your taxpayer money to day-trade bitcoin? What is the strategy in that?”&nbsp;</blockquote>



In November, Bukele revealed plans for the first ‘Bitcoin City,’ a nearly tax-free utopia for Bitcoiners funded by a bitcoin-denominated bond—which could solve the country’s financing woes—and geothermal-powered bitcoin mining.&nbsp;



Two days after Bukele’s November announcement, the IMF criticized El Salvador’s bitcoin adoption, effectively ending discussions over a $1.3 billion loan Bukele was seeking, in a report on El Salvador.&nbsp;



&#8220;Given bitcoin&#8217;s high price volatility, its use as a legal tender entails significant risks to consumer protection, financial integrity, and financial stability,&#8221; the IMF said in a concluding statement in its 2021 Article IV mission to El Salvador. &#8220;Its use also gives rise to fiscal contingent liabilities.&#8221;



With slim loan prospects and mounting debt, getting the bitcoin bond, nicknamed “volcano bonds” because the mining operation would be powered by the Conchagua volcano, off the ground has become increasingly important, Marshik said.&nbsp;



El Salvador’s Minister of Finance Alejandro Zelaya said in a <a href="https://www.pymnts.com/blockchain/bitcoin/2022/el-salvador-regulatory-regime-for-bitcoin-volcano-bonds-as-soon-as-february/" target="_blank" rel="noreferrer noopener">recent interview</a> that a series of laws will be needed for the bitcoin bond. “We do not have a law for the issuance of securities in crypto assets, nor an authority that verifies operations in the securities market,” he said.



If the laws are passed, the bonds may be issued as soon as February or March 2022.&nbsp;



<h3 class="wp-block-heading">What’s next&nbsp;</h3>



In terms of cash flow, El Salvador will be fine though the first half of 2022, but the payment due in 2023 is still up in the air, Marshik said.&nbsp;



“They have a few things they can do,” she said. “We know they have some deposits in the central bank, they&#8217;re gonna have a massive increase in revenues in April when people pay their taxes, and we know they&#8217;ve had a pretty decent program to fight evasion.”&nbsp;



<div class="wp-block-image"><figure class="alignleft size-medium"><img decoding="async" src="https://blockworks-co.imgix.net/wp-content/uploads/2022/01/AP21249435380210-300x196.jpg" alt="A youth stands next to a car as he waits in front of a small shop that accepts Bitcoin in San Salvador, El Salvador, Saturday, Sept. 4, 2021. Starting Tuesday, Sept. 7, all businesses will have to accept payments in Bitcoin, except those lacking the technology to do so. (AP Photo/Salvador Melendez)" class="wp-image-15584"/><figcaption>A small shop that accepts Bitcoin in San Salvador, El Salvador. Source: AP Photo/Salvador Melendez</figcaption></figure></div>



The success or failure of the volcano bond will foreshadow the future financial situation, Marshik said, but given the current looming debt payment, the success of bitcoin itself is less of a concern.&nbsp;



“I think bitcoin is a bit of a sideshow in a way. I know it&#8217;s Bukele’s big project, but it&#8217;s kind of going nowhere,” she said. “From our point of view, it kind of shades what really matters.”&nbsp;



Bukele has not publicly said that adopting bitcoin is a step toward de-dollarization (El Salvador has been a dollarized economy since 2001), but there is speculation that this is the goal.&nbsp;



“The most important thing, if de-dollarization is the end goal, is going to be whether or not Chivo works,” Marshik said. “If they de-dollarize, it does not make sense to de-dollarize and use bitcoin, but it does make sense to de-dollarize and use Chivo, because Chivo can be controlled.”&nbsp;



The dollar and bitcoin could coexist in El Salvador in theory, others say, because El Salvador’s central bank cannot print dollars like the Federal Reserve.&nbsp;



“There’s something that sometimes we don’t take into account, and that is the role of the central banks. There are certain markets in which the role of the central bank is not as critical as other markets because they don’t print currency. They just import money like in the case of El Salvador,” Anabel Perez, CEO and co-founder of NovoPayment, an API-based Banking-as-a-Service. “When the monetary authority doesn’t play a big role in the arbitrage, this type of model works when currencies can coexist, for example, the US dollar and crypto assets as a means for payments.” 



Given El Salvador’s economic situation, the lack of success of Chivo Wallet and citizens’ general lack of interest in bitcoin, some are calling the experiment a waste. Others insist that it is too soon to judge.&nbsp;



“Most people in El Salvador don&#8217;t have credit cards, don&#8217;t have bank accounts, they deal almost exclusively with cash, and that&#8217;s kind of a little bit advantageous, I think, when it comes to adopting bitcoin,” said Dumitru. “It’s nothing like the financial system in the US, and I definitely think bitcoin could work, it’s just very early.”



<hr class="wp-block-separator has-alpha-channel-opacity"/>



Start your day with top crypto insights from David Canellis and Katherine Ross. <a href="https://blockworks.co/newsletter/empire">Subscribe to the Empire newsletter</a>.



Explore the growing intersection between crypto, macroeconomics, policy and finance with Ben Strack, Casey Wagner and Felix Jauvin. <a href="https://blockworks.co/newsletter/onthemargin">Subscribe to the Forward Guidance newsletter</a>.



Get alpha directly in your inbox with the <a href="https://blockworks.co/newsletter/research">0xResearch newsletter</a> — market highlights, charts, degen trade ideas, governance updates, and more.



The Lightspeed newsletter is all things Solana, in your inbox, every day. <a href="https://blockworks.co/newsletter/lightspeed">Subscribe to daily Solana news</a> from Jack Kubinec and Jeff Albus.