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El Salvador’s Bitcoin City: An Overdue Eruption?

In the wake of a booming global crypto-currency market, Nayib Bukele, the El Salvadoran President, has recently announced that the Central American country is intending to create the world’s first ever “bitcoin city”. This wild proposition will involve funding through the issuance of $1bn in sovereign bonds backed by the crypto-currency, whilst the city will sit at the base of the Conchagua stratovolcano. This location has been chosen for its abundance of geothermal energy, which will be tapped into in order to power the giant bitcoin mining facilities that will sustain the city. In isolation, this project sounds almost impossibly ambitious, but when the economic and political history of El Salvador are factored in, the rationale for a “Bitcoin city” becomes even more questionable. Equally, with the market cap for global cryptocurrencies having now exceeded $2tn, one must consider the global impact that a “bitcoin city” will have, especially seeing as Bitcoin values have declined considerably since the news came out of El Salvador.

The Crypto-Country

To say that the “bitcoin city” has come as a surprising revelation would be highly fictitious, as El Salvador has long been a country attempting to integrate crypto-currency into their public system. For instance, in September 2021, El Salvador became the first country to adopt Bitcoin as a legal tender, accompanying the US dollar as the only other legal tender in the country. This move was accompanied by the launch of the government funded e-wallet service, Chivo, which offered every Salvadoran citizen a $30 sign up bonus. In some ways, the e-wallet service has been a success, with it having facilitated remittances from Salvadorians abroad to the tune of around $32mn, roughly 2.5% of all foreign remittances. Put simply, the e-wallet service has made it easier for Salvadorians abroad to financially support their families and businesses at home. Moreover, in the month following Chivo’s launch, it was announced that El Salvador had mined its first amount of bitcoin using clean energy from volcanic geothermal sources. This news stunned the crypto-markets, leading to a 10% rise in Bitcoin value for the day, despite the mined Bitcoin only being worth around $230 or 0.0048 bitcoin.

Inherently, it’s clear that uptake in crypto-currency has been a key policy aim for El Salvador. Philosophically, the key political justification for this has always been that blockchain technology facilitates decentralisation, which prevents corrupt or poorly structured governments from destabilising monetary policy. For Latin America, this has been incredibly prevalent in the experiences of Venezuela, with the country having experienced rampant hyperinflation in the face of poor governmental management. When turning back to El Salvador, it is clear that some of the justification for the Bitcoin boom has been attributed to the fear of centralised mishandling of policy. However, in reality, El Salvador could be on the brink of undoing much of its hard work to stave off monetary instability, especially when adopting a currency famed for its volatility.

A worrying reality

To understand the most worrying element of El Salvador’s Bitcoin policy, one has to consider the rationale underpinning El Salvador’s pre-existing monetary system. In 2001, the country adopted the US dollar as its only legal tender in order to ensure the monetary stability that the Salvadoran Colón had historically not delivered. This transition proved to be highly effective with inflation having decreased from an annual 10% from 1977-1995, to only 2% in the years following 2001. Naturally, giving up monetary independence has meant that the country has been unable to adjust its policies to local economic conditions, but in the light of the monetary chaos in other Latin American countries, this compromise has been a decent one at worst.

Inherently, ‘bitcoinizing’ the economy will derail the stability provided by the US dollar due to the crypto-currency’s high degree of price volatility. Regional stakeholders have reacted to this risk by boycotting the Chivo e-wallet programme, with this eventually resulting in the programme crashing a month after launch. International stakeholders have also reacted unenthusiastically to the risks, with Moody’s having already downgraded El Salvador’s debt rating in July. Moreover, interest rate spreads between the Salvadoran government and its US treasury debt have increased sharply. Ultimately, although it is still early days in the Bitcoin revolution, large cracks are already beginning to show.

The bigger picture

Due to the unprecedented size of the proposed “bitcoin city” project, the crypto-markets have experienced a sizeable price adjustment, with the reduction in Bitcoin’s price by 3% reflecting institutional hesitancy towards the project. In fact, the adjustment may be more a reflection of the hesitancy towards allowing central banks to integrate cryptocurrencies into a centralised system. This is especially noteworthy when considering that a key function of cryptocurrencies is facilitating illegal transactions. Therefore it is unsurprising that there is scepticism surrounding the intentions of the El Salvadoran regime.

However, despite the project being highly risky, outlandish and questionable, there are some beneficial implications. Most notably, crypto-mining uses an extortionate amount of energy, with any renewably-powered mines providing evidence that crypto-currencies have a place in a sustainable world economy. Ultimately, although the “bitcoin city” may not be a completely feasible reality as of yet, the intuition and environmental consideration given to the project makes it an exciting macroeconomic prospect, and one that may one day be exported from El Salvador in the future.

Sources

https://news.sky.com/story/el-salvadors-president-pledges-to-build-bitcoin-city-at-base-of-a-volcano-12475574

https://www.ft.com/content/67515f23-ccdc-4dbc-a184-70848e183ac3

https://www.theguardian.com/business/2021/sep/24/el-salvador-adoption-of-bitcoin-as-legal-tender-is-pure-folly

https://www.cnbc.com/2021/04/06/cryptocurrency-market-cap-tops-2-trillion-for-the-first-time.html

https://markets.businessinsider.com/news/currencies/el-salvador-bitcoin-mining-volcano-nayib-bukele-first-crypto-energy-2021-10

https://www.forbes.com/sites/garthfriesen/2018/08/07/the-path-to-hyperinflation-what-happened-to-venezuela/

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