Last week the bitcoiner world held a big party in Miami. Nayib Bukele, the president of El Salvador, announced by video that he would make bitcoin legal tender in his country; a few days later, his legislature passed the measure into law.
For the bitcoin faithful, this was a reason to celebrate their belief that the cryptocurrency will eventually become the world’s de facto reserve currency, displacing even the U.S. dollar.
Detractors were dismissive with equal passion, seeing Bukele’s act a desperate stunt to attract bitcoin billionaires to invest in his otherwise struggling nation.
Either way, Bukele has turned his country into an experiment on bitcoin’s capabilities and limits.
Remittances: what impact?
First, the country relies heavily on remittances, particularly from Salvadoreans working in the U.S. In 2020 the country received $5.9 billion in remittances.
According to the World Bank, the cost of sending remittances to El Salvador have been steadily falling. In 2012 it cost nearly 5.3 percent to remit to the country, but today that cost is only 2.9 percent.
This is far below the cost of remitting to most other emerging markets, because El Salvador is dollarized: in 2001, the country got rid of its own currency, the colon, preferring to tie itself to the stability of the dollar.
One of the reasons for Bukele to embrace bitcoin is because it will enable virtually cost-free remittances. It would also open the door to crypto-based financial services for people who don’t have bank accounts.
Merchants must accept
But people can do this already, so it’s not clear how, or whether, making bitcoin a legal tender will impact remittance behavior. One thing in Bukele’s favor is El Salvador’s high mobile penetration rate: as of January 2021, the country had nearly 9.5 million mobile connections, or 1.4 for each of its 6.5 million people, according to Datareportal, a website.
This compares well to Latin America’s average mobile penetration rate of 70 percent. Latin America as a whole is also massively underbanked, with only 30 percent of people properly banked, despite its high usage of mobile. El Salvador is a very heavy cash-dependent economy.
By making bitcoin legal tender, Bukele is ordering local merchants to accept payment in BTC, if a customer demands it. Businesses can then either keep their satoshis and bitcoins, or exchange them for dollars (see below). Whether there will be demand in a cash-based economy, and how well bitcoin-compliance is enforced, remain to be seen but adoption will probably be slow. The switch to the dollar in 2001 brought the discipline of a hard currency, but it also caused a recession that many poor people still remember.
One of the most fascinating questions about this experiment is whether Salvadorans will be eager to try using bitcoin. That may depend on more than just getting them to try it.
The government’s chokepoint
The president wants to set up a single point of USD-BTC conversion, through Bandesal, a government-owned bank. So far Bandesal hasn’t said how it will set exchange rates. Salvadorans may find their remittance fees going to the government in the form of exchange-rate fees.
Bukele is an authoritarian who has amassed power by undermining Congress and the judiciary, so it’s worth asking to what kind of transparency and oversight Bandesal will be subjected. Media reports have suggested unsavory ties between members of his administration and organized crime. It would be a shame if making bitcoin legal tender opened the door to drug criminals (or just rich Salvadorans who own crypto) being able to dodge anti-money laundering protocols.
That’s one reason for tension between Bukele and the U.S. Another is his profligate borrowing and spending (mostly on police and military), which has drawn criticism from the IMF (a major donor to El Salvador). The U.S. government can exploit El Salvador’s dollarization to punish people Washington deems problematic.
Before now, the only option for a country in this position would be to revive its old currency, but then it would be in the same mess that led it to dollarize. Bitcoin, however, offers the prospect of escaping the dollar in a different way.
For Bukele to succeed will require a few other things to happen.
Building reserves
First, he needs to attract a lot of bitcoin transactions. That means he will need a few whales. Will such people invest in El Salvador business or real estate, or even relocate?
Many crypto whales have domiciled themselves in Puerto Rico, which does not tax them. Puerto Rico is far more stable, safe, and predictable. It is a U.S. territory and well connected by air to the mainland. Florida, Texas and Wyoming are also welcoming of crypto. El Salvador is very poor, violent, and still recovering from a tragic history. It’s hard to see wealthy people actually set up in El Salvador when they have far more attractive options.
But there are other ways to attract bitcoin activity. Bukele immediately followed up his legislative win with a decree that the country’s state-owned geothermal electric company make itself available to mine crypto.
Bukele also needs bitcoin to circulate if it’s to play a positive role in the economy. If one day he really tries to move the monetary system to one based on bitcoin, he will be accepting a very tight constraint on money supply – far more restrictive than the dollar. The only way to avoid crashing the economy will be to build bitcoin reserves, just as governments used to hoard gold.
It’s common for countries to peg their currency to a harder one, to impose discipline that their domestic politics could not. But countries without ample reserves struggle to maintain currency pegs, whether it’s Argentina or the UK in 1992. Hong Kong narrowly survived a market assault on its currency board in 1998. El Salvador, however, is not relying on a peg: it retired the colon and made the greenback its legal tender. This allowed it to avoid these currency dramas; embracing bitcoin will throw it back into the quest for accumulating financial firepower.
This is a risk, although it’s so early in the crypto world that it’s hard to measure how big. El Salvador would be wise to grow its bitcoin reserves as quickly as possible. Taxing remittances is one way; attracting investors is a second; the third way would be to denominate exports in bitcoin. Ordering the geothermal industry to mine bitcoin is only one aspect: the government could try to export its renewable energy priced in bitcoin.
Renewable energy is not, however, a major Salvadoran export: in fact, it’s a net importer of electricity. Its exports are offshore assembly products, coffee, sugar, shrimp, textiles, and chemicals – with the U.S. as its dominant trading partner.
Unintended consequences
In theory, if the country can build up enough bitcoin reserves over time, it could then attempt the leap to making bitcoin its official currency.
That’s not on the table today, however. El Salvador is not ripping up its reliance on the dollar. Nor is this experiment relevant to the question of whether bitcoin can ever serve as a transnational currency. El Salvador will remain dollarized for a long time.
Instead San Salvador is trying to set up a parallel economy on bitcoin. Its success will depend on the speed and degree to which it can attract bitcoin reserves; get its people to remit in bitcoin (and overcome the trust issue regarding Bandesal); attract crypto whales to invest and operate in the country; and create exports priced in bitcoin, which means finding buyers willing to transact that way.
If the country can meet these challenges, then it will be time to have the discussion about whether bitcoin works as a global currency.
To get there, like it or not, Bukele will need tacit approval from the IMF and therefore the U.S., which could otherwise make his bitcoin bid extremely difficult by, say, prohibiting banks from offering on-ramps to cryptocurrency.
Just as Facebook’s Libra project galvanized many central banks to dive into digital currencies, could El Salvador focus minds in Washington about decentralized crypto? And…to what end? This might be the biggest outcome from Bukele’s bitcoin gambit.
