El Salvador buys more bitcoin after ratings agency downgrades its debt

Nayib Bukele, president of El Salvador.
Enlarge / Nayib Bukele, president of El Salvador.
Kellys Portillo/APHOTOGRAFIA/Getty Images

Bitcoin’s price has plunged in recent days, briefly falling below $30,000 on Monday evening and again on Wednesday morning. Nayib Bukele, the bitcoin-boosting president of El Salvador, sees bitcoin’s low price as a buying opportunity. He announced on Monday that El Salvador had purchased another 500 bitcoin. With one bitcoin worth around $31,000, this represented a $15.5 million bet.

Bukele has made the embrace of bitcoin a signature of his presidency. Last year, El Salvador became the first nation in the world to make bitcoin legal tender alongside the US dollar. In an effort to encourage adoption of bitcoin, El Salvador launched wallet software called Chivo and offered Salvadorans $30 if they gave it a try.

Bloomberg calculates that El Salvador has accumulated a total of 2,301 bitcoins since it started buying them last September. Most were bought at prices above $45,000, so this nation of 6 million people has lost tens of millions of dollars speculating on bitcoin.

A precarious financial situation

The government of El Salvador is heavily in debt and has an $800 million debt payment coming due in January. Last week, ratings agency Moody’s downgraded El Salvador’s debt, warning that the Central American nation may be forced to default. El Pais reports that Salvadoran bonds are trading at around 40 percent of their face value, a sign that traders see this as a serious risk.

El Salvador’s bitcoin experiment has worsened the country’s already precarious financial situation. That’s not only because Bukele has tied up tens of millions of dollars in the volatile cryptocurrency. It has also damaged Bukele’s relationship with the International Monetary Fund, which is currently considering whether to offer El Salvador a $1.3 billion line of credit.

In January, the IMF recommended that El Salvador liquidate its bitcoin holdings in order to shore up its fragile balance sheet. The Bukele administration reacted angrily, with Treasury Minister Alejandro Zelaya declaring that “no international organization is going to make us do anything, anything at all.” Bitcoin’s price has fallen by about 17 percent since the IMF made its recommendation.

Bitcoin City

Bukele is also pushing forward with plans to construct a new “Bitcoin City” in the shadow of El Salvador’s Conchagua volcano. The idea would be to create a global hub for cryptocurrency users and entrepreneurs—all powered by geothermal energy from the volcano. On Monday, Bukele tweeted photos of himself reviewing a scale model of the planned metropolis.

To jumpstart the project, Bukele is planning to sell $1 billion worth of “bitcoin bonds.” In an unusual financial arrangement, half the proceeds would be invested in bitcoin, while the other half would be spent on infrastructure projects for the new city. If bitcoins gain value over the 10-year life of the bond, bond investors would get half the gains.

Critics pointed out that this arrangement makes little sense, since people who want to invest in bitcoin can invest directly in bitcoin and get 100 percent of any gains. But Bukele is counting on the novelty of the bonds—which are slated to be tokenized and sold on a blockchain—to attract investors.

These bonds were initially scheduled to be introduced in March. But that month the government postponed the debt issuance, citing the economic turmoil caused by Russia’s invasion of Ukraine. El Salvador’s finance minister said that the bonds would be introduced in September at the latest.

But if El Salvador doesn’t improve its financial position, it may become increasingly difficult to issue debt of any kind, since investors will be worried about the risk of an impending default.

Terra implodes

At least two other events have contributed to a sense of general chaos in the cryptocurrency world this week.

First, the value of a cryptocurrency called Terra has imploded over the last 48 hours, falling from $1 on Monday to a low of 30 cents early Wednesday morning. That’s a big problem because Terra is a “stablecoin”: Its whole purpose is to remain pegged to the US dollar in a one-to-one ratio.

Conventional stablecoins like Tether or USD Coin are backed by companies that hold (or at least claim to hold) enough cash to defend the peg. By contrast, Terra is an “algorithmic stablecoin.” Its value was supposed to be supported automatically by smart contracts.

Terra was paired with another cryptocurrency called Luna, whose price would rise and fall with market demand. If Terra’s price fell below $1, traders could exchange them for $1 worth of Luna, maintaining a fixed exchange rate between Terra and the US dollar. Conversely, if demand for Terra rose, people could convert Luna into Terra using a smart contract.

The hope was that growing use of Terra would push up the value of Luna, providing a powerful backstop for the stablecoin. For a while, this all seemed to be working. In April, there were $18 billion worth of Terra in circulation, making Terra the world’s third-largest stablecoin.

But as cryptocurrency values fell in the last week, this scheme started to unravel. Luna’s “market capitalization”—the value of all Luna in circulation—fell below that of Terra. This made Terra’s peg unstable, further weakening confidence in the whole scheme.

Coinbase: “No risk of bankruptcy”

Meanwhile, Coinbase caused a bit of a market panic with a regulatory filing disclosing the possibility that customer funds could be tied up in court in the case of a bankruptcy filing. That led to worries that Coinbase might be at risk of bankruptcy.

But CEO Brian Armstrong assured customers that wasn’t the case. “We have no risk of bankruptcy,” Armstrong wrote. Coinbase only made the disclosure to comply with new rules for companies that hold cryptocurrency assets.

“It is possible, however unlikely, that a court would decide to consider customer assets as part of the company in bankruptcy proceedings,” Armstrong wrote. He vowed to revise Coinbase’s terms of use to ensure customer funds were protected in the event of bankruptcy.

Tim Lee was on staff at Ars from 2017 to 2021. In 2021, he launched Full Stack Economics, an independent email newsletter about the economy, technology, and public policy. You can subscribe to his newsletter here.

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