Volatile Bitcoin to become legal tender in El Salvador

President Nayib Bukele's latest surprise for El Salvador is a new currency.  The cryptocurrency Bitcoin will join the US dollar as legal tender in the country.  Soon you may be able to buy pupusas from a digital wallet on your cellphone filled with Bitcoin.   

In a video broadcast to a Bitcoin conference in Miami on Saturday, June 5  President Nayib Bukele announced that El Salvador was going to make Bitcoin legal tender in the Central American county and that El Salvador would use the digital wallet company, Strike, to build the country’s modern financial infrastructure using bitcoin technology.

Three days later, Bukele introduced a law in the country's legislature. In a show of its lack of independence from the executive branch of government, the Legislative Assembly passed the bill with 62 out of 84 votes, a little more than three hours after it was presented to them by Bukele's team. The ramifications of such a changeover were either dismissed or barely questioned in the limited debate.  (This article took much more time to research and write than the time the deputies spent considering the bill).

A group of economists, under the name "Economists for Life" issued a statement protesting the change made so rapidly and with so little public input or study. They wrote:
1) It is regrettable and reprehensible that a decision of such importance is taken with such lightness, with its back to the population, without plural, open discussion, and rigorous enough analysis to foresee the effects it can have on people's daily lives, and on different economic sectors and activities. 
 2) It is equally irresponsible for deputies and government officials, in the full exercise of their functions and in the face of the lack of information on the measure, to declare themselves unconditionally in favor, without analysis nor signs of opening the debate to different sectors of the country.
Let's first share a definition. From What Is Bitcoin And How Does It Work?:
Bitcoin is a decentralized digital currency that you can buy, sell and exchange directly, without an intermediary like a bank. Bitcoin’s [pseudonymous] creator, Satoshi Nakamoto, originally described the need for “an electronic payment system based on cryptographic proof instead of trust.”

Each and every Bitcoin transaction that’s ever been made exists on a public ledger accessible to everyone, making transactions hard to reverse and difficult to fake. That’s by design: Core to their decentralized nature, Bitcoins aren’t backed by the government or any issuing institution, and there’s nothing to guarantee their value besides the proof baked in the heart of the system.
There's much more explanation in the rest of the article

The new law passed in El Salvador makes Bitcoin legal tender in the country for all new and old financial obligations and will go into effect 90 days from now after implementing regulations are passed. Any amount owed in dollars can be paid in the market equivalent quantity of Bitcoin.  Salvadorans can pay their taxes with Bitcoin.  Anyone offering an item for sale with a price in US dollars must accept Bitcoin in payment.   As Bukele described in an online live forum, McDonald's will need to accept Bitcoin for its hamburgers and fries in El Salvador.   The exchange rate for Bitcoin to dollars will be freely set by the market without government control or intervention.

From Bloomberg:
1. What did El Salvador do?

El Salvador’s 39-year-old president Nayib Bukele got congress to green light his plan to make the country the first to use Bitcoin as legal tender. According to the bill, Salvadorans can now pay taxes in Bitcoin, and “economic agents” will be obliged to accept the cryptocurrency as payment for goods and services. The U.S. dollar will continue to circulate alongside Bitcoin as the national currency in the Central American nation.

2. How would Bitcoin work as legal tender?

There’s a lot that’s unclear. In theory, Bitcoin will create a parallel payments channel alongside the U.S. dollar. Prices may be quoted in the cryptocurrency, and exchanges using it will be exempt from capital gains tax. The bill passed by congress calls for the creation of a fund that will be used to guarantee the convertibility of Bitcoin into dollars.

3. What’s the thinking behind this?

Remittances account for roughly 20% of the nation’s gross domestic product, and mostly come from Salvadorans working in the U.S. Bukele says that a large chunk of this gets lost in transfer fees, which Bitcoin can help to reduce. El Salvador is a so-called dollarized economy, which means that the fiscal and monetary decisions of the U.S. government and Federal Reserve have a tremendous impact. Adopting Bitcoin could give the nation more independence.

One of the frequently mentioned benefits involves using Bitcoin to facilitate sending remittances to El Salvador.   Bitcoin transactions happen almost instantaneously at very low cost without using the banking system.  This could be a benefit to Salvadoran families currently paying high transaction fees to companies like Western Union to send money home from abroad.

A digital wallet in one's cellphone would offer an alternative to banks for the majority of Salvadoran families who today do not have bank accounts. 

An article at DW.com titled El Salvador wants to adopt Bitcoin as legal tender — here's why explores more of the issue:

No [other] national government currently recognizes Bitcoin as legal tender, but there are still a few ways to spend it: Holders of the cryptocurrency can exchange it between themselves via digital wallets that store their Bitcoin. They can use a third-party service to convert it into a government-issued currency, like the US dollar. And more and more companies, including payment service PayPal, have started or plan to start accepting Bitcoin as payment.

Is it a good idea?

Bitcoin has some properties that make it well suited to the financial landscape in El Salvador and other countries whose economies rely on remittance payments from abroad. For one, money can be transferred on Bitcoin's network instantaneously, at little or no cost....

The cryptocurrency's value remains volatile. This makes it unsuitable as legal tender people can rely on to pay for necessities like food and rent. The value of Bitcoin has fallen by more than $25,000 since hitting highs of nearly $65,000 earlier this year.

As the DW article notes, one of the most frequent concerns over El Salvador's decision to use Bitcoin as legal currency in the country is the volatility of its price in the market. In recent months, the value of a Bitcoin has moved in large swings. For example, here is a chart of the value of Bitcoin over just the past 30 days.  As illustrated, someone holding their wages in Bitcoin could see the value of their savings drop very quickly.    

Here is another chart showing bitcoin's value since the first of the year.

Under the new law, an employer could pay its employees in Bitcoin.  Because of the currency's volatility, it is possible that a worker could see their two weeks salary lose ten percent or more in value in the 24 hours after payday, or a family receiving remittances from the US could see the worth of that money transfer tumble before it could be spent.  This suggests that Bitcoin would not be the best choice for a Salvadoran family living payday to payday (as most do).   It's also true that the worker or family could see their salary or remittance value increase ten percent -- that's the meaning of volatility.

Bitcoin has many advocates, and they were effusive in their praise of Bukele's initiative.  It's worth noting, however, that many of these advocates have large holdings of Bitcoin themselves and they may simply want to create buzz around the currency decision as a way to push the value of Bitcoin and their holdings up. (Bukele has not disclosed if he held significant sums of Bitcoin prior to making his announcement).    

There are harsh critics of the cryptocurrency as well.  From CNBC

“Black Swan” author Nassim Nicholas Taleb on Friday criticized bitcoin as a “gimmick,” telling CNBC he believes it’s too volatile to be an effective currency and it’s not a safe hedge against inflation.

“Basically, there’s no connection between inflation and bitcoin. None. I mean, you can have hyperinflation and bitcoin going to zero. There’s no link between them,” Taleb said in a “Squawk Box” interview.

“It’s a beautifully set up cryptographic system. It’s well made but there’s absolutely no reason it should be linked to anything economic,” added Taleb, whose bestselling 2007 book examined highly improbable events and their potential to cause severe consequences. He said bitcoin has characteristics of what he calls a Ponzi scheme that’s right out in the open.

Advocates of Bitcoin becoming part of everyday life in El Salvador envision a much rosier picture, where this digital currency permits wide swaths of Salvadoran society to have access to inexpensive, secure digital transactions using only a cell phone.  A vision for this best case scenario comes from this pilot project in the village of El Zonte, a surfing location along El Salvador's Pacific coast.  The project and adoption of Bitcoin in El Zonte is described in this article in Forbes last year: This El Salvador Village Adopts Bitcoin As Money.  The pilot project shows the possibility of getting a level of acceptance and use of Bitcoin not just in the technology centers of the world, but also in a small town in El Salvador.   

Another potential risk to El Salvador's Bitcoin gambit is the reaction of the International Monetary Fund with whom the government of El Salvador is currently negotiating for financing Bukele's big spending plans. This risk of alienating the IMF was highlighted in an article from Reuters:

“Recent tweets from President Bukele to fully embrace bitcoin as legal tender will likely further complicate and delay IMF technical discussions,” said Siobhan Morden, head of Latin America fixed income strategy at Amherst Pierpoint Securities.

“This may just reflect a long-term initiative or maybe even just a flashy PR tactic; however it shows lack of coordination with impulsive announcements that contradict a cohesive economic plan,” she said, adding Salvadorian bonds faced a Bukele risk premium of as much as 75 basis points over comparable Costa Rica bonds....

Carlos de Sousa, a portfolio managers at Vontobel Asset Management, said the Bitcoin push looked ill-thought through with Bukele potentially shooting himself in the foot by making the raising of tax revenue more difficult.

One of the things which might make the IMF nervous is the usefulness of Bitcoin for those who want to commit fraud, launder money, or evade taxes. Some of these possibilities were set out in a New York Times article last year titled Bitcoin Has Lost Steam. But Criminals Still Love It.

One frequent criticism of Bitcoin is the consumption of power (comparable to the energy consumption of a small country) needed to generate new Bitcoins and to keep the system functioning.  New Bitcoins are generated in the system through "mining."  Mining involves powerful computers performing hugely complex mathematical calculations for creating new Bitcoins and storing the transactions of the Bitcoin ecosystem. The compensation to miners for performing the calculations are newly minted Bitcoins. The computations themselves require very large quantities of electricity to run the computers, raising the question of the environmental impact caused by the need to generate all this power. This statistic appeared in the Harvard Business Review last month:   

According to the Cambridge Center for Alternative Finance (CCAF), Bitcoin currently consumes around 110 Terawatt Hours per year — 0.55% of global electricity production, or roughly equivalent to the annual energy draw of small countries like Malaysia or Sweden. 

If that electricity were produced by fossil fuels like coal or oil, the climate change impact would be significant, but Bukele is trying to attract "miners" to come to El Salvador and use electricity from environmentally friendly geothermal power:

The president's actions in the past week suggest that his focus is not so much on Bitcoin's use by the vast majority of working Salvadorans.  He has not given a national address or one of his trademark Facebook Live videos to explain the change to the population.  At the time the Assembly was passing his bill, he was online speaking in English in a live forum with Bitcoin enthusiasts.  He has been aggressively tweeting in English about the future of El Salvador as the first country to embrace Bitcoin as one of its currencies, and seeking to get Bitcoin-related firms to invest or relocate there.


El Salvador's Bitcoin gambit has the feel of many actions taken by Bukele over the past two years: improvised and hyped and as much about Bukele's image as the merits of the proposal. Previously seen by most as a speculative asset which can have value in the qualified investor's portfolio, Bitcoin now becomes legal tender in El Salvador. It's new and cool, but is it worth the risk?


Greg said…
Interesting trajectory -

The United States supports the El Mozote trial massacre trial process, a process first endorsed by Bukele until he reversed himself this past year in favor of derailing the judicial process.

Today he joins Guatemala and Honduras in seeking to set up a kleptocracy with all such a criminal enterprise represents. Unlike Guatemala and Honduras, El Salvador uses the U.S. dollar as the foundation of its currency. Because of this and in conjunction with the advantages Bitcoin transactions offer to criminal enterprises, those standing to benefit from El Salvador's corruption / impunity challenges can and will launder money quite easily from here on out.

That is a given.

When any nation's president or "Jefe" offers he or she "talks with God and God tells me what to do", that nation is in trouble. This is exactly where Bukele is right now in his self-perception, self-promotion efforts within the country. "God told me to go Bitcoin" should be the next presidential announcement we hear from him.

In the meantime, justice for those who suffered and continue to suffer in the multi-decade long aftermath of the massacre at El Mozote can only pray that God "tells" President Bukele to allow the trial to go forward so they might at least have their day in court.
The corruption element is certainly appealing to Bukele. I have thought of another possible factor. El Salvador has used the US dollar for a decade, but now Buekele is creating friction with the US government. The adoption of Bitcoin might be a way to reduce the risks associated with the worsening relationship, especially as Bukele makes gestures to China.