El Salvador’s Bitcoin adoption - a genius marketing coup, but what of the consequences.
Part of these thoughts were initially featured on Cointelegraph on July 2nd 2021. Link below.
https://cointelegraph.com/explained/what-is-really-behind-el-salvadors-bitcoin-law-experts-answer
I am still of the opinion that bitcoin is a great alternative asset that has its place in an alternative portfolio allocation. However Bitcoin lacks the characteristics of a currency in terms of providing stability to a financial system. Its high volatility and lack of recourse makes it currently a less viable alternative to central bank currencies — particularly in developed economies. Additionally, if you expect bitcoin prices to go up in the future it makes little sense to use your bitcoin to pay for daily goods and services. 45% of total bitcoin circulating supply is HODLed and has not moved in the past two years. Therefore the velocity of bitcoin vs fiat money is much lower making it akin to an investment medium rather than a payment medium.
However, El Salvador is a developing country with a dollarized economy, meaning the government does not print its own currency, has little control over inflation, and money supply and is already relying on a third party issued currency with what it entails in loss of control. El Salvador dollarized its economy in 2001 and adopted the USD as its legal tender in an effort to curb — a non existinginflation — and facilitate trade with its main trading partner — the US.
El Salvador has gone through many hardships with a civil war ending in 1992, weakened institutions, rampant violence, wealth concentration and endemic corruption. Bukele, rose to power in 2019 in a unanimous vote while belonging to neither major party.
Adopting Bitcoin as a legal tender is a great marketing coup by Bukele — an ex marketing executive.
Adopting Bitcoin as a legal tender is a great marketing coup by Bukele — an ex marketing executive. It can be assumed that this coup will help categorize El Salvador as a bitcoin haven for miners and crypto enthusiasts alike — especially after the recent backlash by US and Chinese authorities. Indeed Bukele did tweet that they are putting together a plan to provide bitcoin mining facilities with “very cheap, 100% clean, 100% renewable, 0 emissions energy” using geothermal energy. This in itself could serve to turn El Salvador into a Bitcoin hub, allow foreign capital to flow into the country and at the same time allow the Government to enrich itself by operating its own bitcoin mining facilities. But the social and economic woes of El Salvador cannot solely be fixed by waving the magic bitcoin wand.
Since the announcement, El Salvador 3 to 5 year bonds widened by circa 150bps vs US Treasuries (a measure of increased risk and increased cost of borrowing) making it more expensive to El Salvador to borrow in traditional capital markets
In terms of risks, it seems that this move, and its ramifications, have not been thought through fully. Since the announcement, El Salvador 3 to 5 year bonds widened by circa 150bps vs US Treasuries (a measure of increased risk and increased cost of borrowing). This will make it more expensive for El Salvador to borrow in traditional capital markets. If El Salvador is able to mine bitcoin, one solution would be to issue bonds denominated in bitcoin and pay interest in bitcoin to somewhat hedge the exchange risk. Q12021 has seen a rising demand for bitcoin proxy investments from institutional players, mainly in equities through shares of Microstrategy and Coinbase, but more rarely in the form of bonds. One can incorrectly think of the oversubscribed $500M senior secured note issued by Microstrategy to specifically buy bitcoin. However, the note is denominated in USD, the coupons are paid in USD and the investors — most of whom are junk bond investors — were more in search of high yield — with the bond issuing circa 200bps cheap versus other junk bonds — than bitcoin proxy investments. In the current market, I do not believe there is neither enough demand nor the correct infrastructure in place to fulfil El Salvador financing needs with bitcoin denominated bonds.
Some other serious points that needs further investigation would be the effect of bitcoin as a legal tender on financial institutions and how to regulate them in terms of accounting and risk management frameworks, specifically in terms of increased capital requirements for commercial banks holding bitcoin as per the BIS recent proposal, increased cross-currency and liquidity risks, increased money laundering and tax evasion risks and also how the volatility of bitcoin would affect the central bank reserves, balance sheet and accounts.
There is no doubt that this is a bold move by El Salvador that could pave the way for smaller developing market economies to find new revenue streams through bitcoin mining. Alternatively it could lead to an increase in financial instability and have dire consequences in terms of inflation and access to capital. The world should definitely keep an eye on El Salvador. I know I am.
