INTERNATIONAL POLICY DIGEST

El Salvador made a risky bet in adopting Bitcoin as a legal tender. Surprisingly, it hasn’t been a total bust.

September 7, 2021, was an unremarkable day for most of the world. Still, it was a day to remember for El Salvador’s 6.5 million citizens because it was the day Bitcoin became legal tender in the country. Initially dismissed as a gimmick by many worldwide, Bitcoin’s recent price surge has resulted in El Salvador making a $50 million profit on its Bitcoin holding, making the rest of the world sit up and take notice. Will more countries follow El Salvador and adopt Bitcoin as legal tender?

According to the country’s president, Nayib Bukele, El Salvador has a holding of 2,381 Bitcoin, which it purchased at an average price of $44,292, making for a total cost of $105,460,444. As the world turned its calendars to March 1, El Salvador’s Bitcoin holdings swelled to almost $155 million, an increase of over 40%. Such huge gains have not gone unnoticed outside of El Salvador.
What is El Salvador’s Bitcoin law?

The Salvadoran legislature approved the country’s legislation making Bitcoin legal tender by a large majority (62 out of 84 votes) on June 9, 2021, and it came into force in September of the same year. The aptly named Bitcoin Law means El Salvadorians can legally use Bitcoin to pay for goods and services, from groceries to horse racing bets and vehicles to tax payments. Indeed, Bitcoin can be used to discharge debts in any transaction and without limitation.

Using Bitcoin to discharge debts is not only from the date the cryptocurrency became legal tender but from any previous obligation expressed in U.S. dollars. In addition, although accounting standards continue to use U.S. dollars as the reference currency, the El Salvador government is providing a system to automatically and instantly convert Bitcoin into U.S. dollars.
Why is EL Salvador so keen on Bitcoin?

President Bukele has on numerous occasions, highlighted dozens of reasons for making Bitcoin legal tender in El Salvador. However, three primary reasons stand out from the rest.

First, Bukele wants to reduce El Salvador’s reliance on the U.S. dollar. He wants his citizens to embrace Bitcoin and use it as a neutral store of value for savings.

Second, it is estimated that approximately 70% of El Salvador’s population does not have a bank account or access to traditional financial services. Bukele hopes that Bitcoin’s decentralized nature allows more El Salvadorians to gain access to financial services.

Lastly, according to figures published by the World Bank, over 20% of El Salvador’s GDP stems from remittances, meaning a significant part of the El Salvador population relies on money transfers from outside the country. Transfer costs can be high, or physical money must be collected, vastly reducing the value of those remittances. Accepting Bitcoin to settle those remittances should massively reduce costs and allow more El Salvador citizens to do business outside their country.

The International Monetary Fund and the World Bank distanced themselves from El Salvador’s Bitcoin revolution.

Rolling out new legal tender, even if it is a cryptocurrency, is a massive operation for a government. Having Bitcoin as legal tender creates unique challenges, including building a network to process transactions, ensuring businesses and consumers have secure digital wallets to store the cryptocurrency, and adapting ATMs that instantly convert Bitcoin to U.S. dollars if a user wants to withdraw.

In addition, Bukele promised every El Salvador citizen $30 worth of free Bitcoin if they downloaded the Chivo Mobile App, a wallet it wants to adopt. $30 free Bitcoin for 6.5 million residents equals $195 million; El Salvador only has $147.1 million worth of Bitcoin reserves.

El Salvador approached the World Bank in June 2021 and asked for its assistance, but it was rebuked.

“We are committed to helping El Salvador in numerous ways including for currency transparency and regulatory processes. While the government did approach us for assistance on Bitcoin, this is not something the World Bank can support given the environmental and transparency shortcomings.”

The International Monetary Fund published a blog shortly after El Salvador announced it was making Bitcoin legal tender. The detailed blog warned against any country adopting cryptocurrencies as legal tender, citing several financial, legal, and macroeconomic issues.

“Usually, when a country adopts a foreign currency as its own, it ‘imports’ the credibility of the foreign monetary policy and hopes to bring its economy–and interest rates–in line with the foreign business cycle. Neither of these is possible in the case of widespread cryptoasset adoption. As a result, domestic prices could become highly unstable. Even if all prices were quoted in, say, Bitcoin, the prices of imported goods and services would still fluctuate massively, following the whims of market valuations.”

Could other countries follow El Salvador’s lead?

On paper, adopting a cryptocurrency, such as Bitcoin, as a legal tender has many positives. However, once you scratch past the surface, it is fraught with complications and issues. Cryptocurrencies are unlikely to catch on in countries with stable exchange rates, stable inflation, and credible financial institutions because their value is far too volatile and unrelated to the real economy. Because of that volatility, businesses and households would have little incentive to price or save in Bitcoin.

Furthermore, Bitcoin’s anonymous nature could compromise a country’s financial integrity. Stable and credible financial institutions have robust anti-money laundering measures, but employing such measures is next to impossible when cryptocurrency is involved. This risks a country’s economic system and erodes relationships with foreign countries.

President Bukele should be applauded for thinking outside the box as he attempts to improve the lives of his people, but his plan seems far-fetched. El Salvador has a gross national debt of over $25 billion, and over 22% of its citizens are living in poverty. Bukele seems to be putting all his eggs in one basket to change those figures, but one cannot help but think his dedication and determination are misplaced.