El Salvador becomes the first country to make Bitcoin legal tender.  

21 June 2021

Why is El Salvador using Bitcoin as a currency? 

Shortly before the congressional vote, President Bukele Tweeted, “It will bring financial inclusion, investment, tourism, innovation and economic development for our country”.

President Bukele has also stated his belief that Bitcoin will give Salvadoreans access to financial services but who don’t have bank accounts - an estimated 70% of citizens. 

Will using Bitcoin as legal tender help El Salvador strengthen its economy?

It could do.

Bitcoin proponents and the Salvadorean government argue that Bitcoin facilitates citizens sending money into the country for far less than they pay now. More than two million Salvadoreans live and work outside El Salvador and send home $5.9bn every year, which is more than 20% of El Salvador’s GDP.

When Bitcoin officially becomes legal tender, this number will likely increase enormously. However, it will be difficult or perhaps even impossible to measure by how much, as Bitcoin transactions are pseudonymous and therefore difficult to trace.

Could this all go sideways? 

Yes, this could end very badly for El Salvador.

While Bitcoin’s price has somewhat stabilised, daily price swings of ten or fifteen percent are still common, not the sort of price volatility anybody wants in a currency they use to buy their groceries. So there’s at least a reasonable chance that Salvadorians could wake up one morning with half as much money as they had the evening before.

Additionally, financial experts are already warning that Bitcoin’s acceptance in El Salvador could complicate the countries bid for a $1bn programme from the IMF to provide COVID-19 relief.

Given how difficult it is to trace Bitcoin transactions back to a single person, it’s unlikely any organisation will hold accurate records of how much money is entering the country through Bitcoin. As a result, the IMF will be dubious of throwing El Salvador a financial lifeline any time soon.

There could also be settlement issues, as Bitcoin can only handle seven transactions per second. In contrast, VISA processes about 1700 hundred payments per second. President Bukele has proposed using Strike, a global payment system claiming to enable anyone to send money anywhere for free to get around this problem. However, plenty of media commentators are dubious of this plan, as Strike has never been tested at scale.

On the other hand, adopting the US dollar in 2001 helped curb inflation and significantly increased the county’s trade with the US. Moreover, allowing its citizens to continue using the dollar alongside Bitcoin could offer Salvadorians some financial stability, provided they only use Bitcoin to send cash to one another and not to store their wealth.

What does this all mean for cryptocurrencies? 

Many crypto investors insist El Salvador’s bold move is the first big step toward a broader acceptance of cryptocurrency. Regardless of your opinion on Bitcoin, it’s clear that this is an excellent chance for Bitcoin to prove its concept.

However, some commentators already argue that Salvadorians would be better served by their government issuing a stablecoin whose price is fixed to the US dollar, like Tether, instead of Bitcoin.

While Bitcoin fans will be excited to see the world’s first cryptocurrency in use, it could set cryptocurrencies back years if the experiment goes badly. Should Salvadorians start rejecting Bitcoin, or if citizens lose significant amounts of money from holding Bitcoin, it could spell disaster for cryptocurrencies.

From a purely practical perspective, if El Salvador’s adoption of Bitcoin does result in disaster, it probably won’t deter many crypto enthusiasts from promoting digital currencies.

After all, Bitcoin was the first cryptocurrency and is by no means the best or most efficient. If anything, failure could highlight the practical problems developers will have to solve before wealthy nations adopt any form of digital currency.

Will other countries follow El Salvador and also adopt Bitcoin?

It’s unlikely any larger economies will adopt Bitcoin due to its price volatility.

But, stablecoins and central bank digital currencies are certainly on the horizon. Additionally, many Asian countries are legislating to encourage crypto developers and blockchain startups to set up their shop in their countries.

The President of the Philippines, Rodrigo Duterte, recently approved plans for a “Crypto Valley of Asia”, which will feature specialised power plants for crypto developers and potentially an airport. The Philippines central bank has already licenced thirteen cryptocurrency exchanges to operate within the area.  

Whether El Salvador’s adoption of Bitcoin will prove fruitful in the long term remains to be seen. It could turn out to be nothing more than a PR stunt. But, it could also help many Salvadorians lift themselves out of poverty and prove Bitcoin’s viability as a legitimate day-to-day currency.

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