The International Monetary Fund warned El Salvador on 22 November against using bitcoin as official tender given the risks associated with the cryptocurrency, a day after the country announced plans for the world's first 'Bitcoin City'.
El Salvador became the first country to adopt Bitcoin as a legal tender on September 7, 2021 .
The latest development has seen President Nayib Bukele making a statement that El Salvador plans to build a 'Bitcoin City' powered by a volcano and financed by cryptocurrency bonds.
"Given Bitcoin's high price volatility, its use as a legal tender entails significant risks to consumer protection, financial integrity, and financial stability," the IMF said in a statement ‘El Salvador: Staff Concluding Statement of the 2021 Article IV Mission'.
"Its use also gives rise to fiscal contingent liabilities. Because of those risks, Bitcoin should not be used as a legal tender."
The IMF favoured "narrowing the scope of the Bitcoin law" that made it official currency and called for "strengthening the regulation and supervision of the new payment ecosystem".
It further said in its concluding report that the new digital means of payments—the e-wallet Chivo operating in both US dollars and Bitcoin—had been introduced in El Salvador and heavily supported by the government to promote financial inclusion (each qualifying citizen who downloaded the application received an endowment of $30).
The law also guarantees the automatic conversion from Bitcoin to US dollars through a trust fund funded with $150m from the budget, and in practice the conversion is done in Chivo.
"Efforts to improve financial inclusion and raise growth are welcome, but risks arising from Bitcoin as a legal tender, the new payments ecosystem and trading in Bitcoin should be addressed.
"Crypto-technologies and digital payment systems like Chivo have the potential to make payments more efficient, thereby enhancing financial inclusion and supporting growth.
"Given Bitcoin's high price volatility, its use as a legal tender entails significant risks to consumer protection, financial integrity, and financial stability. Its use also gives rise to fiscal contingent liabilities."
The IMF added: "Because of those risks, Bitcoin should not be used as a legal tender. Staff recommends narrowing the scope of the Bitcoin law and urges strengthening the regulation and supervision of the new payment ecosystem.
"Like for other e-wallets, Chivo should be required to fully safeguard customers' funds, both in U.S. dollars and Bitcoin, by segregating and ring-fencing reserve assets.
"Stronger regulation and oversight of the new payment ecosystem should be immediately implemented for consumer protection, anti-money laundering and counter financing of terrorism (AML/CFT), and risk management.
It continued: "Banking regulation should incorporate prudential safeguards such as conservative capital and liquidity requirements related to Bitcoin exposure.
"Measures to limit fiscal contingent liabilities, such as winding down the trust fund or withdrawing public subsidies to Chivo, should also be promptly considered.
Recently announced plans to use the proceeds of new sovereign bond issuances to invest in Bitcoin, and the implications of trading more broadly in Bitcoin, will require a very careful analysis of implications for, and potential risks to, financial stability."
