El Salvador: A Test for Bitcoin
Source: gettyimages
El Savador economy cryptocurrency Bitcoin. https://www.gettyimages.com/detail/news-photo/man-is-seen-in-a-store-where-bitcoins-are-accepted-in-el-news-photo/1235058910?adppopup=true
In June 2021, at the Bitcoin 2021 conference in Miami, El Salvador President Nayib Bukele announced that El Salvador would become the world's first sovereign nation to adopt bitcoin as its legal tender. The digital currency Bitcoin legal tender came into effect on September 7, 2021, as per the legislation published by the El Salvador government.
Bitcoin is accepted as payment for goods or services and used in any transaction in El Salvador. However, in June 2022, Bitcoin experienced the most significant monthly price drop - over 37.3% - since 2011. As of August 2022, it maintained a USD 22,602 price level, which is still much lower than the price in 2021. The cryptocurrencies' value collapse is also causing trouble in El Salvador. According to Bloomberg, the 2,381 Bitcoins the government has purchased with public funds are now worth about 50% less than what authorities paid.
So, why did President Nayib Bukele think adopting bitcoin as an official currency was a good idea?
Reasons for El Salvador to embrace Bitcoin:
El Salvador is the smallest country in Central America and has a population of 6.486 million and a GDP of USD 24.64 billion in 2020. High rates of poverty and gang-related violence are the impressions in this country. In 2001, the El Salvador government abandoned the fixed exchange rate and dollarized the economy - the U.S. dollar became its legal tender. Without monetary autonomy, El Salvador depended on the U.S. Federal Reserve Bank to change its policy rate. They had to face inflationary risk due to the inflation in the U.S.
In 2021, the government adopted Bitcoin as its official currency and invested USD 150 million from the country's reserves in Bitcoin projects. There is no doubt making Bitcoin legal tender would reduce its reliance on the U.S. dollar. In addition, since "Bitcoin has a hard cap on the total number of coins that will ever be minted," it can be a hedge against inflation, which is also one of the reasons for El Salvador to embrace Bitcoin.
There are two main reasons El Salvador adopted Bitcoin as its official currency:
1) It can increase efficiency in international remittances. According to the World Bank, 24.1% of El Salvador's GDP is from remittances. From 1990 to 2022, the average remittance in El Salvador was USD 260.38 million, reaching a peak of USD 750.09 Million in December 2021 and a record low of USD 53.1 USD Million in September 1991. About 2 million Salvadoran migrants are working in the U.S., and their remittances benefit about 360,000 households in El Salvador. However, remittance from the U.S. can be up to 30-50% of the amount of the money transfer. El Salvador is adopting Bitcoin as a legal tender to avoid high costs, which provides a quick and cheap way to send money across borders.
2) It can decrease the percentage of the unbanked population. In El Salvador, around 70% of the population does not have bank accounts. If Bitcoin is the official currency, it can reduce such a percentage since receiving and sanding Bitcoin requires people to use a digital wallet called Chivo. Bitcoin is also a technology that could make it easy for citizens to access financial services.
Moreover, since the Bitcoin price showed an upward trend before 2021 and maintained a high level in 2021, reaching its peak at USD 64,400 in November 2021, the increasing value of bitcoin can benefit El Salvador and may help pay its debt.
Current situation:
According to a survey by the U.S. National Bureau of Economic Research, after downloading Chivo and spending the initial USD 30 sign-up bonus, only 20% of respondents are currently using this digital wallet, even if around two-thirds of the population downloaded this app. Only 10% of respondents in the survey by the Central American University fully understood cryptocurrency. Most importantly, only 1.6% of remittances were received via digital wallets in February 2022.
Popularizing bitcoin in El Salvador hasn't been successful. The volatile value of bitcoin might be the main reason for it. People need their currency to be stable and maintain its value from one day to the next. Meanwhile, technical issues such as receiving error codes lost transactions and accounts created through identity fraud, and limited Bitcoin ATMs also make some Salvadorans give up on Bitcoin and revert to accepting only cash.
In addition, El Salvador's bitcoin experiment is facing many criticisms. The plummeting value of bitcoin has hurt the government's ability to pay back its debt - more than USD 20 billion. The International Monetary Fund (IMF) warned that the adoption of Bitcoin would raise many macroeconomic, financial and legal issues, and the prices of imported goods and services would fluctuate massively due to the volatility of Bitcoin. Bitcoin became one issue in the discussion between the IMF and El Salvador, causing difficulty for the El Salvador government to get a loan from the IMF. Meanwhile, the World Bank rejected to help El Salvador's implementation of Bitcoin as a legal tender. On May 4, 2022, Moody's downgraded El Salvador's debt because of its high risk of default. Due to Bitcoin adoption, Fitch Ratings lowered El Salvador's long-term Issuer Default Rating from B- to CCC. Bitcoin adoption seems to worsen the country's financial situation. Citizens' reaction, such as discontinuing using Chivo, also indicates that Bitcoin adoption is not a popular idea in El Salvador.
However, El Salvador tourism benefited after Bitcoin adoption. Despite the drop in Bitcoin price, tourism in El Salvador shows an increase of 82.8% in the first half of 2022. 1.1 million people visited this country in six months, compared to 1.2 million last year. The tourism boost made El Salvador become "one of the countries with the best rate of tourism recovery in the region as of January 2022".
El Salvador is now planning to build the world's first "Bitcoin City" - a global hub for cryptocurrency users and entrepreneurs powered by geothermal energy from the Colchagua volcano. Such a project requires massive amounts of electricity. Although there are 23 volcanoes in El Salvador, the country still imports about one-fifth to one-quarter of its electricity. Its renewable resource remains largely untapped. Cheap power is not available now in El Salvador. Luis González, the public policy director at the nongovernmental organization Salvadoran Ecological Unit (UNES), warned that geothermal energy would impact local habitats and contaminate aquifers even if it’s cleaner than burning fossil fuels.
Meanwhile, President Nayib Bukele is planning to issue USD 1 billion worth of "bitcoin bonds" that were initially scheduled to be introduced in March but postponed due to the Russia - Ukraine conflict. These bonds will be used to improve their financial situation and may be challenging to sell due to their downgrading rating and high risk of default.
The Bitcoin experiment in El Salvador will continue. It's worth observing what will happen in the future.
References:
Fear and excitement in El Salvador as Bitcoin becomes legal tender. https://www.bbc.com/news/technology-58473260
Six months in, El Salvador’s bitcoin gamble is crumbling. https://restofworld.org/2022/el-salvador-bitcoin/
Explainer: What we know so far about El Salvador’s volcano-powered bitcoin bond. https://www.reuters.com/markets/us/what-we-know-so-far-about-el-salvadors-volcano-powered-bitcoin-bond-2021-11-22/
El Salvador’s Bitcoin bet is working, Finance Minister Says. https://www.bloomberg.com/news/articles/2022-07-28/el-salvador-s-bitcoin-bet-is-working-finance-minister-says
What the crypto collapse means for El Salvador’s economy. https://www.npr.org/2022/06/19/1106168947/what-the-crypto-collapse-means-for-el-salvadors-economy
Remittance inflows to GDP for El Salvador. https://fred.stlouisfed.org/series/DDOI11SVA156NWDB
El Salvador citizens mostly avoid bitcoin, despite government adoption. https://www.marketplace.org/shows/marketplace-tech/el-salvador-citizens-mostly-avoid-bitcoin-despite-government-adoption/
Are crytocurrencies currencies? Bitcoin as legal tender in El Salvador. https://www.davidargente.com/_files/ugd/b05023_7825615207654784864b4c4cc4ec6550.pdf
El Salvador explores bitcoin mining powered by volcanoes. https://apnews.com/article/cryptocurrency-technology-business-bitcoin-central-america-e0074a2343a3e3a9beb08723ff65ecf5
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