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True or False: Is Crypto Collapse a Real Risk for El Salvador’s Economy?

As cryptocurrencies are falling triggered by interest rates, Bloomberg Línea explains what is true and what is unclear about how it affects El Salvador

A person holds a Bitcoin token at the Bitcoin automated teller machine (ATM) in El Zonte, El Salvador.
May 12, 2022 | 07:11 am

Bloomberg Línea — The main cryptocurrencies are plummeting in a five-day rout in a reflection of the stock market. Nayib Bukele, El Salvador’s president, wrote on Twitter on Monday that the country was taking advantage of this drop and buying 500 Bitcoins at an average price of $30,744 each.

El Salvador was the first country to adopt Bitcoin (BTC) as legal tender. As crypto plummets, this is what is known and what is unclear about how it will affect the country:

  • El Salvador can default due to crypto collapse:

False.

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The risks of a default on El Salvador’s sovereign debt have increased in recent months, but they are not directly related to the fall of Bitcoin. If it happens, the default would be due to an unclear plan to finance the next bonds payments in January 2023.

“The problem of a potential El Salvador’s default has a lot to do with its own fiscal dynamics,” says Carlos Acevedo, economist, and former president of Banco Central de Reserva de El Salvador.

There is a perception in the international press that El Salvador depends on Bitcoin’s success to honor its payments. “If investors have that idea in their minds, about a connection between bitcoin and our country’s financial capabilities, it may be harmful to us”, according to Acevedo.

However, Salvadoran Bitcoin holdings are relatively few. Even counting the most recent acquisition of 500 bitcoins this week announced by Nayib Bukele, the country owns a portfolio of 2,301 Bitcoins.

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From September 2021 to date, the government has made an investment of $103.6 million, not counting unrealized losses. While the figure is significant for a small economy, it is far from the $800 million it needs to pay its sovereign bond maturity in January 2023.

Bitcoin interferes between El Salvador and the International Monetary Fund (IMF) to achieve an agreement for a $1.3 billion loan to meet that financial need. The IMF has pointed out multiple risks of the cryptocurrency adopted as a legal tender.

In its most recent report on Salvadoran debt, Moody’s stated that El Salvador lacks a credible financing plan to amortize the referred bonds. Even if it gets the money, the pressures will remain.

The government is facing a tight amortization schedule, an excess of short-term local debt and access to few sources of external financing. For these reasons, Moody’s downgraded it to Caa3 from Caa1.

  • El Salvador’s bonds are worth 40% of face value:

True. Salvadoran bonds have plummeted sharply. On May 11, 2021, the worst performer was the 2050 maturity, at 93% of its original value; the best was the 2029, with 114%, according to Bloomberg.

One year later, bonds price goes around 40% for most securities. The best valued is the one maturing in January 2023, around 78%.

“I think the sovereign debt market does not have much patience with El Salvador, let alone how the international markets are,” a financial market analyst with extensive experience in WallStreet, who asked to be unnamed, told Bloomberg Línea.

In his opinion, the price of the bonds reflects investors are not only doubting the capacity, but also the willingness to pay, in the context of the upcoming 2024 presidential elections, in which Nayib Bukele would run for a second period. Only a “seal of quality” of support from the IMF would restore their calm.

Meanwhile, Acevedo believes that El Salvador does have the resources to honor its commitments, although that could mean the erosion of its international reserves or implementing a reform that nationalizes the current private pension system.

“I am among those who think that El Salvador will pay because (Bukele) personally pledged his word to investors. It would look very bad if he don’t pay, and it would also close international financing valves to the country”, Acevedo told to Bloomberg Línea.

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  • Bukele tried to sell US$ 1 billion in Bitcoin-linked securities but sold none:

False. The Bitcoin bonds have experienced a significant delay, but technically the Salvadoran government has not carried out the issuance it promised to place $1 billion, with a 10-year term and a rate of 6.5%.

The perception that the bitcoin bond has failed can be traced to an announcement by Alejandro Zelaya, Minister of Finance, who said that the issue would come between March 15 and 20. It did not happen.

Zelaya defended that the war between Russia and Ukraine disrupted the government’s plans and suggested it could take place in the first semester of the year, although he did not rule out reaching the market in August.

Bukele said the only reason Bitcoin bonds have not reached the market yet is because his main short-term goal moved to the pension system.

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“The short delay in the issuance is only because we are prioritizing internal pension reform and we have to send that to congress before”, tweeted the President, more than a month ago.

The funds that the government chases with the also-known as ‘volcano bonds’ will not be used for debt payment, but to finance the construction of Bitcoin City and the purchase of more bitcoin.

The more time run, the more doubts surge about a successful operation. Respected Bitcoin believers, like Michael Saylor, founder of MicroStrategy, thinks financial markets are unprepared for bitcoin-backed bonds.

  • El Salvador has lost money with Bitcoin investments:

True. El Salvador has spent $103.6 million in acquiring 2,301 Bitcoins, currently valued at US$66.6 million, a loss of 35.7%.

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The question is whether the losses will continue to widen or if they will manage to recover.

To return to the starting point of the investment, El Salvador needs a price of $45,031 per Bitcoin, according to Bloomberg Línea estimations.

But if the market prolongs its slump, the consequences could be disastrous for the Salvadoran strategy.

A study by the Universidad Francisco Gavidia (UFG) suggests that if Bitcoin recovers in the best scenario, it could achieve a price between $54,000 and $65,000

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In the worst forecast, the cryptocurrency value would go down in a range of $5,000-$15,000, by the end of 2022.

  • Falling Bitcoin price will negatively impact commerce and the economy

False. In a country with Bitcoin as a legal currency there is a risk that the price collapse will impact the economic dynamics.

El Salvador is not the case. This happens because the cryptocurrency is rarely used in daily transactions.

According to the government, 4 million Salvadorans downloaded Chivo Wallet to receive the $30 welcome bonus.

Only 20% of Salvadorans who have used Chivo Wallet keeps using it, according to a National Bureau of Economic Research (NBER) study.

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A survey by the Chamber of Commerce and Industry of El Salvador in February found that 92% of companies have no impact of Bitcoin on their business. In addition, only 14% of companies had processed any type of transaction, most of them the big ones.

Why has Bitcoin failed to capture the enthusiasm of Salvadorans? According to the NBER, users still prefer the US dollar, which is also legal tender in the country.

Also, the implementation of Bitcoin suffered from technical failures from the beginning and generated distrust in the system.

Conveniently, the fragile adoption of bitcoin plays into El Salvador’s favor with the recent price collapse. “Since the use of Bitcoin has been a failure, we are protected against this risk drop. We are not so exposed,” Acevedo concluded.

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Brazilian cryptocurrency expert Keiji Sakai said that the main goal of adopting cryptocurrencies in El Salvador was to facilitate exchange since a large part of the country’s GDP (Gross Domestic Product) came from sending dollars from Salvadoran immigrants in the United States for their families in El Salvador.

“This process generated huge queues at banks, I remember a friend who worked at an international bank that had branches in Central America reporting this. If the process continues to be remittance and subsequent conversion to dollars in the country, volatility would not affect so much, it would be an exchange operation,” said Sakai.

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On the other hand, he claims that if cryptocurrencies were to be used as a bank reserve, this would significantly affect the country’s economy and savers.

How long until the tables turn?

André Franco, head of research at Mercado Bitcoin, Brazil’s crypto exchange unicorn, says in a report that the Bitcoin-guided crypto market mirrors the stock market and falls as risk assets worldwide lose value. “We can expect more drops, going below $30,000 and nearing $20,000″.

Franco writes that if the macro landscape wasn’t so negative, Bitcoin would go up soon, however, as investors are risk-off, Bitcoin can fall further and in the aftermath, the crypto market as a whole.

But he says there is a light at the end of the tunnel. Mercado Bitcoin analyst says if he was totally price agnostic, he would say Bitcoin metrics have never been so positive, as long-term investors continue to accumulate bitcoin. “We are at the highest and most positive point in history for this metric. Another metric that goes in the same direction is the balance of Bitcoins that haven’t moved in a year or more, which is already above the 65% mark and is also at its all-time high.”

Franco believes there are metrics to know where the crypto fall would end such as the unrealized net profit/loss, which measures the ratio of unmoved bitcoins that are at a profit to those that are at a loss, since their last move -- which is now shows extreme euphoria.

“Another important metric to understand the timing of capitulation is the Puell multiple, which measures how much the current Bitcoin price deviates from the moving average of the price at which it was mined in the last 365 days. So, like the NUPL, the Puell multiple is a great indicator of capitulation and euphoria,” he says.

“The percentage of Bitcoins in profit is also a great indicator of capitulation. Should Bitcoin repeat past cycles, we could still see lower prices before the reversal. These metrics presented can guide us in the current moment of the market and also make us understand the best time to turn the hand and get back to being optimistic about the market. However, they should not be followed as if they were rules in stone. That’s because the crypto market never tires of surprising us and being sensitive to the market’s moment also has its value.”

Updated to add a comment by Keiji Sakai