World watches through its fingers as El Salvador bets on Bitcoin

El Salvador’s President Nayib Bukele has adopted Bitcoin as legal tender – JOSE CABEZAS/ REUTERS

A “Bitcoin city” powered by a volcano may sound like a villain’s lair from the latest Bond film, but for El Salvador’s president Nayib Bukele it’s a vision of the future.

The Central American minnow has become the first country to adopt the cryptocurrency as legal tender, alongside the US dollar, and is launching a $1bn “Bitcoin bond” that has raised eyebrows both in the crypto and traditional finance worlds.

Half of the proceeds will be invested in Bitcoin and the other $500m will be used to build the new city.

El Salvador’s 40-year-old millennial leader looks the part at least, launching the Bitcoin plans on Saturday as he donned his trademark backwards baseball cap and an open-collared white shirt.

“Invest here and make all the money you want,” Bukele said at the beach resort of Mizata, comparing his plans to cities built by Alexander the Great. “If you want Bitcoin to spread over the world, we should build some Alexandrias.”

El Salvador’s bold foray into the cryptocurrency world comes as top central banks, including the Bank of England, consider launching their own digital currencies. On Tuesday, Governor Andrew Bailey and Deputy Governor Sir Jon Cunliffe were grilled about Threadneedle Street’s plans for a state-back digital version of sterling, which has been dubbed ‘Britcoin’.

The central bankers were keen to emphasise how nascent their plans are – a far cry from Bukele’s full-blown embrace. El Salvador’s approach is much bolder: where the BoE is proposing a more stable form of coin that is pegged to the pound and supported by the full weight of the British state, Bitcoin is totally decentralised meaning Salvadorans would be vulnerable to wild price swings that occur on things as trivial as Elon Musk tweets.

But behind Bukele’s “tech bro” facade lies an authoritarian leader battling to shore up the country’s finances. Experts suspect the launch of the Bitcoin bond is linked to soured funding talks with the IMF and warn of the economic risk of embracing such a volatile asset.

President Nayib Bukele - YURI CORTEZ/AFP

President Nayib Bukele – YURI CORTEZ/AFP

Catherine Mulligan, an expert at the University of Lisbon, says the plans are akin to running an “experiment on other people”.

She warns against the crypto community using “unstable or lower income nations as testbeds for these technologies”, calling the impoverished country’s plans “basically an unregulated trial”.

“It really has a massive impact if someone suddenly says to you your wages are getting paid in this massively fluctuating currency,” Mulligan says.

Maturing in 2032, Bukele’s Bitcoin bond will pay an annual coupon of 6.5pc – roughly half the amount paid on standard 10-year El Salvador bonds. While that level of yield is high for government debt, it may be a turn-off for the crowd of retail investors that helped power Bitcoin to record highs earlier this year and who crave chunkier gains.

Siobham Morden, head of Latin America Fixed Income Strategy at Amherst Pierpont, says the new bond could support El Salvadoran government debt if it can extend “beyond the ‘novelty’ of the Bitcoin audience and into mainstream investors”.

But, she says, “innovative financing is not in itself a solution” to the country’s financial problems.

Bigger gains could come down the line. According to Bukele and bond sale partner Blockstream’s proposals, 50pc of the subsequent proceeds raised after the initial $500m Bitcoin investment is recovered will be returned to investors. Blockstream’s chief strategy officer Samson Mow says this could mean a top-flight yield of 146pc in the 10th year – but this is based on modelling by the Canadian company that the price of Bitcoin will have risen twenty-four-fold to $1m within the next five years.

The rest will go to the city. Bukele says this as-yet-unnamed metropolis will “include everything”: commercial and residential areas, an airport, ports, rail links and geothermal power from the Conchagua volcano. No taxes will be levied except value added tax on spending. He estimates public infrastructure for the city will cost 300,000 Bitcoins – which, when he said it, equaled about $135bn. For comparison, Saudi Arabia’s planned super-city Neom is expected to cost $500bn.

The president is hoping that being an early mover on cryptocurrencies will open the door to foreign investment, shifting El Salvador’s reputation from murder capital of the world to crypto trailblazer.

However, plans have garnered a lukewarm reception. Despite Bukele being wildly popular in the country, thousands of Salvadorans took to the streets in September to protest against making Bitcoin legal tender as businesses are forced to accept it. Meanwhile, the government’s Chivo e-wallet was also hit by technical problems.

“I would significantly doubt that Salvadorans would be using Bitcoin to buy a cup of coffee or order pizza,” says Prof Ram Gopal, a digital finance expert at Warwick Business School.

“The fact that only about 30pc of Salvadorans even have a bank account makes Bitcoin a lot more accessible to a wider population… it does not mean that there are no risks and I think the biggest risk really is the price volatility of Bitcoin.”

The cryptocurrency has soared 200pc in the last 12 months but in that time has been on a rollercoaster ride ranging from under $20,000 to almost $70,000. Such wild swings in the price could quickly feed through to the value of household savings and thus El Salvador’s economy.

Bond investors and the IMF are also unimpressed by Bukele’s plans. The Bitcoin bond proposal sent the country’s dollar-denominated debt sinking to a record low on Tuesday as markets fret over whether it scuppers an IMF deal. El Salvador’s central bank has insisted the Bitcoin won’t stand in the way of a $1.3bn loan agreement with the IMF to shore up its struggling public finances.

The IMF argues that El Salvador embracing crypto-technologies could support growth by making payments more efficient, but warned “Bitcoin should not be used as a legal tender”. It says its volatility means “significant risks to consumer protection, financial integrity, and financial stability”.

As central bankers take their first tentative steps towards embracing new types of currencies, El Salvador’s experiment could become a cautionary tale. By the time the UK is even considering bringing a digital version of the stalwart pound, Bukele may look like a genius – or a reckless gambler.

And while the Bank of England’s ‘Britcoin’ plans put it near the front of the digital pack, they are incomparable in scope to Bukele’s bet, making any reality of the idea less economically risky. Officials may end up watching this one from between their fingers.

As El Salvador’s experiment is being viewed with keen interest across the world, many will fear its people are the guinea pigs.