Bitcoin: The Dawn of a New Monetary System? - The origins and implications of Bitcoin’s legal tender status in El Salvador
Opinion analysis by Georges Haydar, Contributor
September 14th, 2021
Latin America is a gorgeous place known for, including but not limited to, the warm hospitality of its people, its strong Spanish heritage, Che Guevara and Cohiba cigars — socialism is nice but premium cigars are nicer. It undeniably is one of the most beautiful places on Earth, leading the world in ex-banana republics, succulent tacos, and premium cocaine but lags behind when it comes to finance. As compelling as the case for the Chicago boys is, it would be a truth of La Palice to say that the juggernauts of the financial world all lie elsewhere, mainly in Europe and chez Uncle Sam. However, El Salvador, a tiny republic in Central America, has a plan; and “grandiose” is only but a glimpse into the ambitions of its president, Nayib Bukele, to redefine the fundamentals of monetary policy. This man has spearheaded, passed, and enforced a law that is the first of its kind: the adoption of Bitcoin as legal tender.
Although this is a radical monetary experiment with no precedent whatsoever that would most probably infuriate John M. Keynes for sending his cherished Bretton Woods-infused post-war international monetary system down the drain, it is by no means an overnight mishap. The legitimization of Bitcoin as legal tender, which is known as the “Bitcoin Law”, came into effect on September 7, 2021, but was passed into law a few months before on June 8, 2021, garnering 62 out of 84 votes. The purpose of this law, which was spearheaded by El Salvadoran president Nayib Bukele, is clear as day: “regulate bitcoin as unrestricted legal tender with liberating power, unlimited in any transaction, and to any title that public or private natural or legal persons require carrying out.”
While it may seem as a miscalculated monetary policy approach spun into a popularity stunt, the ambitious desire to use Bitcoin as legal tender has been in the pipeline for quite some time. Since 2019, the El Salvadoran beach town of El Zonte has been part of an experiment called Bitcoin Beach where Bitcoin has been introduced to enable small transactions. To avoid the relatively high transaction fees (especially for small payments such as buying a taco) which cripple Bitcoin, a Lightning Network was introduced. This is a second-layer payment protocol that runs over the Bitcoin network and allows for instantaneous and affordable payments, which is convenient for small payments. Although initially reluctant and skeptical about using a technology they did not understand, the 3,000 inhabitants of this small surfer’s paradise started receiving salaries, paying bills as well as buying food and other goods, all using Bitcoin. Factor in educational grants, money in exchange for community work, and universal cash transfers, among other things, and you have a fully-fledged Bitcoin microeconomy. While other Central American beach towns were hit severely by the COVID-19 pandemic which halted international travel, El Zonte was able to forge its own path thanks to its nascent Bitcoin economy. Now, this crypto guinea pig is on the verge of becoming a nationwide reality.
So, what does it look like on a national scale? Ambitious is a euphemism. Prices can now be shown in bitcoin, tax contributions can be paid with the digital currency, and exchanges in bitcoin will not be subject to capital gains tax. Now, if you love paying taxes as much as Republicans do, I’m sure you can start realizing where the attractiveness of this seismic shift lies.
On a monetary level, the exchange rate with the national currency, which has been the U.S. dollar for roughly two decades, will be freely established by the market. However, for accounting purposes, the greenback will still be used as a reference.
But how to kickstart all of this? The answer is two-fold. First, Salvador went on a $21 million spree, buying 400 coins by Tuesday, September 7, 2021. This sent Bitcoin’s price soaring to $52,682 at 12:16 AM ET Tuesday. While a dip in the price of Bitcoin to less than $47,000 on that same day (which continued down to $44,561 on Wednesday, Sept 8) might have been a sign from Providence that this was a bad idea, president Bukele did not change his course. Quite the contrary, he even announced the purchase of an additional 150 bitcoins, bringing the total number of bitcoins owned by the government to 550. Buying the dip has never been so attractive…
Second, a special wallet called the “Chivo wallet” — slang for cool — has been developed in collaboration with Strike to allow El Salvadorans to trade bitcoin and purchase goods. Citizens even have an incentive to make the switch and lean into the newly introduced currency because every user who downloads it and signs up with his identification paper receives $30 for free. Now you might ask: how can this wallet be used to seamlessly switch from the greenback to Bitcoin? The answer is an immediate conversion feature backed by a $150 million fund. Across the country, Chivo ATMs will allow consumers to buy bitcoin or convert it into cash with the government absorbing commission costs.
While this undeniably looks like an ambitious attempt to overhaul an almost 70-year long monetary system on a small scale, the benefits of such a move might not be clear at first, especially given the fact that the transition for older generations — also known as tech dinosaurs — is an excruciatingly painful task that is staring the country right in the face. While it is actively setting up educational centers to help ease the transition, the upside of such a move is undeniably attractive. First, the shift to a Bitcoin-based economy will help in raising financial inclusion given 70% of the country has no access to traditional financial services. Second, president Bukele said he hopes the initiative will boost foreign investment and financial inclusion as well as generate jobs, and bitcoin can be used to make purchases and pay tax. Third, most importantly, proponents say it will cut the fees Salvadorans pay to send home remittances. It stood as a $5.92 billion industry in 2020, covering 360,000 households and representing 23% of the country’s GDP. This is the biggest advantage of using Bitcoin: promote financial inclusion for those without bank accounts and facilitate access to a potentially high-yielding asset. Given most of the country’s inhabitants do not have bank accounts, services such as Western Union are typically used to transfer such remittances, often at a high cost of 5-10% in fees. Hence, the switch to Bitcoin represents a way to circumvent this inherent loss and allow more money to end up in the pockets of local households.
Does all the above mean this is a foolproof idea? Not at all. This experiment can range from being the precursor of a 21st-century monetary system to a Pandora’s box begging to be unleashed. As attractive as it is, a few dangerous pitfalls lie ahead. First, the $150 million fund that allows immediate conversion on the Chivo wallet. Some economists question whether that is big enough and say that a fall in the price of bitcoin would put the government under broader fiscal pressure. “If, for example, taxes are paid in crypto assets, while expenditures remain primarily in dollars, there would be significant pressure on the exchange market, and on the level of international reserves,” Torino Capital said in a note.
Second, Steve Hank, an economics professor at Johns Hopkins (in)famous for his Bulgaria currency board, stated that Bitcoin “isn’t a currency, it’s a very speculative asset. There is a lot of risk associated with Bitcoin and that risk will be borne by the taxpayers. It also made it virtually impossible for banks to comply with “know your customer” rules and that the country risked a red flag from the anti-money laundering Financial Action Task Force.”
Third, the ambitious transition got to a rocky start. Not only was the product launch disastrous with the wallet unavailable on certain platforms including Apple’s and Huawei’s but protests also erupted in front of the Supreme Court, resulting in the setting off fireworks and the burning of tires. Also, polls suggest people are against the idea, fearing its volatility and not understanding how it works. Speaking of the devil, this is also a timely reminder of Bitcoin’s strong volatility, which dropped 9.1% on Tuesday, September 7 alone. Although it has gained tremendous value over the last year, rising by 340%, Bitcoin has repeatedly proved itself as a quick and easy way for a heart attack.
However, this plan’s biggest risk lies beyond its borders. It is a crux that is threatening a $1 billion deal with the IMF. "How do we know what we collect in taxes when bitcoin goes up and bitcoin goes down? How do we plan for expenditures? Remember in April, bitcoin crossed $65,000, and then it dropped almost half of it. That is a problem that the ministry of finance is going to be wrestling with. And it is not an easy one," Kristalina Georgieva, managing director of the IMF, recently said. Furthermore, in late July, Moody's Investors Service pushed El Salvador's debt rating deeper into junk territory, citing "a deterioration in the quality of policymaking" including the government's decision to adopt Bitcoin as legal tender. In addition, critics say the rushed plan could cost poorer Salvadorans when the price falls, raise costs for banks and insurers, provide a shield for money launderers and risk economic stability.
Finally, the use of Bitcoin as legal tender also carries the risks of using Bitcoin itself which include a high environmental impact as well as the possibility of El Salvador becoming a haven for financial crime - a crypto Panama - given Bitcoin’s allegedly untraceable nature.
So, what do we make of all of this? The answer is all but clear. This idea is an ambitious one, with attractive upsides. It is undeniably a guinea pig for a long-overdue overhaul of the international monetary system, paving the way for a less dollarized and more digital alternative to barter. Bitcoin has an undeniable potential: it is up 340% over the last year and Standard Chartered sees it hitting $100,000 by early next year according to its latest report. Also, other countries are slowly starting to realize we might be at one of the most important crossroads in the history of finance, with the Ukrainian Parliament adopting a law that legalizes and regulates cryptocurrency. This paves the way towards a global unified currency, a dream the greatest minds of the 20th century could not fathom. However, blindly adopting Bitcoin as legal tender would be the equivalent of walking into the lion’s den. This shift has its dark side but only time will tell whether this is a guinea pig, or something more. In the meantime, one statement is true: the force is strong with Bitcoin.
Sources:
https://ycharts.com/indicators/bitcoin_price
https://edition.cnn.com/2021/09/06/business/bitcoin-price-el-salvador-intl-hnk/index.html
https://www.ft.com/content/56588fee-dca8-450d-a848-80d29f02f45e
https://www.forbes.com/sites/tatianakoffman/2020/07/14/this-el-salvador-village-adopts-bitcoin-as-money/?sh=76c3dbe02044
https://www.cnbc.com/2021/09/08/ukraine-legalizes-bitcoin-and-cryptocurrencies.html