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El Salvador has just decided to increase its bet on the blockchain industry, one of the most crypto-friendly economies globally. After recognizing Bitcoin as a legal tender, the country looks to reform its credit market.
The government has promoted a strategic partnership with a company specializing in crypto loans. Understanding the implications of this decision can be tricky, and this article aims to shed some light on the subject.
Shaking up the credit market
The National Commission for Micro and Small Enterprises (Conamype) in El Salvador is looking for new ways to boost internal credit. The reason behind the decision comes from the issue of high-interest rates for loans to SMEs.
While the World Bank does not cover, at the moment, the nominal interest rate on loans in El Salvador, the Conamype is reporting problems on the matter. Paul Steiner – Conamype’s President – frequently says that companies in the country can only obtain loans at very high-interest rates.
We can also find this in other independent reports completed out of the country. The Inter-American Development Bank, for example, has recently mentioned yearly interest rates being over 100% in some cases.
For this reason, the policymakers hope that a partnership with a Solana-based company named Acumen will improve its credit situation. The deal allowed Acument to become the first DeFi protocol to receive a credit authorization by a central bank.
About the deal
Before proceeding, let us spend a few words about Acumen and its credit plan in El Salvador. The deal will let Acumen lend $10 million by the end of Q1 2022, a first critical step in a $24 billion country.
The operation aims to grant loans at 6-7% annual interest rates to small and medium-sized enterprises. The whole process will work as follow:
- Once the loans receive approval from all the parties involved, Acumen will take care of collecting the necessary liquidity
- In practical terms, Acumen will use some of its cryptocurrencies and convert them into stablecoins (USDT or USDC)
- The stablecoins will go through another conversion operation to become fiat money (in this case, U.S. Dollars) that Acumen will transfer to El Salvador’s Conamype.
- In the end, it will be Conamype to distribute the money in the country.
While we expect more details in the coming weeks on this story, the information above is what the market knows at the moment.
Crypto-based loans vs. crypto loans: what is the difference?
If you are following our reasoning, you will have understood that, in the end, Salvadorian companies will not receive cryptocurrencies. This conclusion is correct, and, at this point, it is worthwhile to make a distinction:
- Crypto loans: debtors receive cryptocurrencies, provide coins as collateral, and repay the debt in cryptos
- Crypto-based loans: a crypto company offers loans to debtors by converting currencies into fiat money.
The deal struck by El Salvador falls into the second category mentioned above. One could wonder why such a crypto-friendly country would not go as far as to allow crypto loans to businesses.
While we have no official answers on the matter from the Salvadorian side, the answer may consist of a risk assessment operation. Therefore, the following section will develop the topic, starting from a recent issue on Solana-based loans.
A note about crypto loans – lessons from the past
Acumen is a Solana-based DeFi company, and Solana is aware of the common issues from crypto loans. Earlier this month, the network had to deal with an extensive system outage due to data congestion.
The core of the problem arose in the lending system of the platform, with the following mechanism:
- Several clients obtained crypto loans by offering $SOL as collateral
- Solana ($SOL) price experienced several weeks of decline earlier in January
- As a result, the market value of collaterals declined, putting clients at risk of seeing their position liquidated
- To avoid liquidation, clients attempted to increase the amount of $SOL they gave as collateral
- At this point, several bots attacked the system, inserting double transactions in the order books
- Consequently, the system experienced an outage, and many clients could not integrate their collaterals to avoid the liquidation of their position.
While it is still hard to understand how many clients lost money due to the outage, the damage is evident. Even worse, the reputation of DeFi may suffer from these issues, with blockchain-based lending platforms seeing a potential decline in their business.
In this context, it is not shocking that El Salvador decided to initially focus its attention on crypto-based (rather than crypto) loans.
Final thoughts and future implications
While we do not know whether El Salvador will plan to upgrade crypto-based to crypto loans in the future, the deal has historical relevance. Only a few years ago, it seemed unthinkable to imagine a future where central banks would accept DeFi protocols to manage the credit market.
Going beyond the single story, one may wonder whether, in the future, we will see more countries striking similar deals. The DeFi world is a crowded industry, and this new trend would undoubtedly lead to a further growth boost in the sector.