Bitcoin Failed in El Salvador. The President Says the Answer Is More Bitcoin.

Salvadoran President Nayib Bukele’s experiment in making Bitcoin an official national currency alongside the U.S. dollar, which has been the currency since 2001, has not gone well. But when a con artist’s grift starts to fall apart, he knows to move onto the next one fast. The same goes for fast-talking presidents.

More than 91 percent of Salvadorans want dollars, not bitcoins. The official Chivo payment system was unreliable at launch in September—the kiss of death for a new system. Users joined for the $30 signup bonus, spent it or cashed it out, then didn’t use Chivo again. The system completely failed to check new users’ photos, relying solely on their national identity card number and date of birth; massive identity fraud to steal signup bonuses ensued. Bitcoin’s ridiculously volatile price was appreciated only by aspiring day traders. Large street protests against compulsory Bitcoin implementation continued through October. The government stopped promoting Chivo on radio, TV, and social media. Chivo buses and vans were seen with plastic taped over the company’s logo.

Bukele’s financial problems remain. El Salvador can’t print its own dollars, so Bukele urgently needs to fund his heavy deficit spending. The International Monetary Fund has not lent the country the $1 billion Bukele asked for, and has indicated its strong concerns about the Bitcoin scheme.

So Bukele, known for a populism that is half aspiring dictator, half Elon Musk, once more announced national policy from the stage: At the Latin American Bitcoin and Blockchain Conference on Nov. 20, Bukele came onstage to an animation of beaming down from a flying saucer and outlined his plans for Bitcoin City: a new charter city to be built from scratch, centered on bitcoin mining—and powered by a volcano.

Bitcoin City would be paid for with the issuance of $1 billion in “volcano bonds,” starting in mid-2022. The 10-year volcano bonds would pay 6.5 percent annual interest. $500 million of the bond revenue would be used to buy bitcoins. The bitcoins would be locked up for five years, then sold to recover the $500 million purchase price; any profit on the sale would be paid out as an additional dividend. Holding $100,000 in volcano bonds for five years would qualify investors for Salvadoran citizenship.

U.S. Bitcoin services company Blockstream first proposed the volcano bonds to Bukele in July. The bonds will be issued as tokenized securities on Blockstream’s proprietary Liquid blockchain. Samson Mow of Blockstream assured Bloomberg that all the numbers would work out, under Mow’s rosy assumption that the price of one Bitcoin would hit $1 million within five years.

Holders of El Salvador’s existing sovereign debt were unimpressed. The volcano bonds would be a strictly worse investment than buying the country’s existing bonds and hedging them with bitcoins. The existing bonds dropped from 75 cents on the dollar to a record low of 63.4 cents after the volcano bond announcement.

The bonds are set to be issued via Bitfinex Securities, a new unit of iFinex, which runs the Bitfinex cryptocurrency exchange and the Tether stablecoin. iFinex is the company that was fined $18.5 million by the state of New York in February, and $41 million by the U.S. Commodities and Futures Trading Commission in October, for repeated false statements and maladministration over several years concerning the reserves that supposedly backed Tether’s stablecoin. El Salvador and iFinex would draft new securities laws to license Bitfinex Securities to administer the volcano bonds.

The other $500 million raised from bond sales will theoretically be used to start construction on Bitcoin City, a charter city in a special economic zone. Bitcoin City would have no income, property, contract, or city tax. The only tax would be value-added tax, or VAT, half of the proceeds from which would be used to fund the city, and half to pay back the bonds.

(The original Blockstream volcano bonds proposal suggests spending the second $500 million on bitcoin mining equipment, rather than a city, and it calculates a price of $50,000 per bitcoin.)

The planned location for Bitcoin City is in the department of La Unión on the Gulf of Fonseca, at the southern end of El Salvador where the country meets Honduras and Nicaragua. The area has a history of ambitious but failed development projects.

In 2017, El Salvador’s then-Vice President Óscar Ortiz proposed a charter city in a special economic zone in La Unión. The city, which was never built, was to be based on Honduras’s “model cities,” founded with the assistance of American libertarians, such as the just-proposed city in Honduras’s Amapala municipality—which also remains unbuilt.

In 2018, then-President Salvador Sánchez Cerén tried to make a deal with China—which was spending big in Central America at the time—to set up 14 percent of the country’s land area, and about half its coastline, as a special economic zone. This would include a Chinese-operated port in the Gulf of Fonseca and, again, a charter city in La Unión. This plan didn’t get past El Salvador’s Legislative Assembly. Bukele, then in opposition, tweeted at the time that it was “the most neoliberal project proposed by a government in the history of our country. … Just like that, privatize a territory. Incredible.”

Parts of the Chinese charter city plan were recycled for the slides of Bitcoin City that played behind Bukele’s Bitcoin conference speech. The slides showed a perfectly flat, circular city, with the central plaza as Bitcoin’s crossed-B logo. A chunk would be cut out of the side of the circle for the Conchagua volcano—which has, thankfully, not erupted in recent times, though there is considerable seismic activity and both cones have active openings venting gas and steam.

Bukele promised that clean geothermal energy from Conchagua would power the whole city. There is no geothermal power plant yet at Conchagua, though El Salvador has considerable experience with harnessing geothermal power.

Shortly after Bukele’s June announcement that Bitcoin would be legal tender in El Salvador, he tweeted that the country would mine its own bitcoins via the existing LaGeo plant in Berlín, Usulután, and a 95-megawatt well that had just been opened. A shipping container of bitcoin mining rigs was set up at the Berlín plant on Sept. 29.

The trouble is that mining bitcoins in El Salvador makes no economic sense. Bitcoin mining is a process of competitively wasting electricity to guess a winning number every 10 minutes or so. Your business input is electricity; so miners are in direct competition with every other miner in the world, and go wherever reliable electricity is cheapest and the government is willing to turn a blind eye to the whole enterprise—a pressing issue since China kicked cryptocurrency miners out in May.

The world’s average price for bitcoin mining is around five cents per kilowatt-hour; but industrial rates in El Salvador are 13 to 15 cents per kilowatt-hour. In one four-day period, the Berlín operation mined $269 of Bitcoin—and was estimated to have spent at least $4,672 worth of electricity doing so.

El Salvador also has much better uses for geothermal power. As of December 2019, the country imported around 20 percent of its electricity. New domestic geothermal ventures would cut that percentage and power prices by reducing dependence on fuel oil generators.

The bitcoin mining and Bitcoin City proposals are ultimately just yet more splashy distractions from Bukele’s economic woes. Bukele has announced several large projects on short timelines that ended up being months or years late and considerably cut down from the press releases; Bitcoin City will be disastrous in direct proportion to how far Bukele pushes the project, if ground is even broken for it.

The volcano bonds will likely end up in the hands of Bitcoin holders who buy them as a participatory “meme stock,” rather than a normal investment. The everyday Salvadoran has little use for bitcoin; so the volcano bonds are Bukele’s way to get Bitcoin holders’ money into the Salvadoran economy and count it as dollars.

Bukele will brazen all of this out as long as he can, periodically throwing new plans on the table as a distraction. If he can maintain power, then the Bitcoin users will discover that he’s taken their money. If he can’t maintain power, then his successor will have no love for his failed Bitcoin schemes.

Either scenario ends with a lot of disappointed Bitcoin users—because a national economy really can’t run on a volatile and manipulated speculative commodity that’s unusable as a currency.

Both the Bitcoin users and Bukele seem to think the other is a sucker who they’ll take for everything they’ve got. It’s possible that both will lose. As, of course, will the real victims: 6.5 million Salvadorans.