Bukele and his laser eyes. Source: 

https://www.indiatoday.in/

What happened?

On June 9 2021, El Salvador’s parliament passed President Nayib Bukele’s proposed legislation to make El Salvador the first nation to make Bitcoin legal tender.

This was hailed as an epochal moment not only for El Salvador, but also for Bitcoin in general, as its proponents declared the bill to be a first huge step toward broader global acceptance of the cryptocurrency. Many others, though, were not as sure.

Indeed, this move has left many observers puzzled — why would Bukele cede control of his own policy space to a global network that can’t be controlled and more importantly, cannot be held accountable or trusted?

Is this a mere PR move to detract from El Salvador’s real issues at hand, or is this an actual and well-thought policy implementation to stimulate the nation’s economy? In this article, I will examine both these sides to their fullest extent before providing you with my value judgement.

Before that, however, let’s take a quick look at El Salvador as a nation, and what making Bitcoin legal tender will mean for her.

What does it mean to make Bitcoin legal tender in El Salvador?

El Salvador is the smallest country in Central America, and suffers from persistently low levels of growth and poverty reduction in the country has been moderate. Her national GDP, at 27 billion USD, renders her one of the poorest nations in the world. However, inequality has declined during the last two decades and El Salvador is now one of the most equal countries in Latin America.

El Salvador has two official forms of money in its local system — locally issued colons and U.S. dollars, the latter of which was adopted as legal tender in 2001 as a policy reform to curb inflation and increase trade with the US (its biggest trading partner by far).

Using Bitcoins is already legal in El Salvador, as is the case for most countries, where you can use it freely in any given transaction if both parties (buyer and merchant) are able and willing. However, making Bitcoin legal tender would mean that merchants would now be required by law to accept Bitcoin as payment, unless they can prove that they lack the access to necessary technologies that enable them to do so. People will also be permitted to pay their taxes in bitcoin.

A roadside stall that accepts Bitcoin. Source: https://www.aljazeera.com/

As the new legislation states,

Every economic agent must accept Bitcoin as payment when offered to him by whoever acquires a good or service.

Now, will this actually be a good thing for El Salvador?

An analysis of El Salvador’s Bitcoin policy: Is Bitcoin the proverbial silver bullet?

In order to come up with an answer to this question, I will start my appraisal from a certain premise, or reference point: the potential upsides that this policy implementation can bring to El Salvador, as promised by President? Bukele.

From there, I will evaluate these upsides, and critique them to the best of my abilities and knowledge, to see if they hold. If they do, then Bitcoin is the silver bullet to El Salvador’s economic woes. If they don’t, then my article title holds.

Let’s begin.

According to Bukele, there are 4 main potential upsides to this implementation:

1. An improvement to last-mile delivery processes for remittances
2. A democratization of access to financial services
3. A buffer against the US Dollar
4. The attraction of Foreign Direct Investments (FDI)

Improvement of Last-Mile Delivery Processes for Remittances

First, remittances constitute a large chunk of El Salvador’s GDP. In 2020, these remittances (money that El Salvadorians living abroad send home to help their families) totaled a sizable US$5.9 billion, or 23% of the national GDP.

However, the last mile delivery process for these remittances is often fraught with inefficiencies and severe inconveniences. Because most people receiving these remittances tend to be overrepresented in the lower-income segment, with many living below the poverty line and in rural areas without proper transportation infrastructure, there are many hurdles to clear before remittance money can actually get to them.

A rural village in El Salvador. Source: https://fernandopocablog.wordpress.com/

For example, because most of these people are unbanked (do not have bank accounts), remittance money cannot simply be wired to their accounts. More often than not, the money will have to be withdrawn as cash by the local banks, then kept there for the intended recipients to collect. But because the intended recipients usually live in very rural and inaccessible places, transportation to these banks (that are usually in the city) is a huge issue.

Further, when it comes to cross-border remittance transfers, many middle-men will take a cut of the money to keep as transaction fees, chipping away at it as it makes its way across continents. These fees may appear insignificant to those of us living in privileged conditions, but may mean much more to those in El Salvador.

This is where Bitcoin comes in.

Bitcoin will allow for the circumvention of all these aforementioned issues because it allows for direct point-to-point and peer-to-peer transactions, and thus — complete disintermediation. All the recipient needs is a mobile phone with a free Bitcoin wallet, which is easy enough to download. This way, no extra fees will be lost unnecessarily, and recipients will not have to travel long distances to physically collect their money.

Critique

Whilst all seems good so far, there are some major caveats I have to address.

Although it is undeniable and incontestable that Bitcoin solves all the aforementioned issues with last-mile deliveries and cross-border payments — are these issues even pertinent in the first place? In fact — do these issues even exist?

First, sending remittances to El Salvador is already relatively inexpensive, because the utilisation of U.S. dollars in cross-border transactions means that payments don’t have to go through currency exchanges. If one insists on transacting with the colon, there is also Wise (formerly TransferWise), which is devoid of any hidden exchange rate markups. The transfer time is also less than a day, and it is very safe to use.

From this, we realise that the ‘problem’ of exorbitant middle-men fees that Bitcoin is ostensibly solving, may not even be a problem at all. Even if it was, there are already extant central solutions like Wise, that are working just fine, if not perfectly. Intermediation does not seem to be a problem in this case, because the impacts are negligible — if any.

A road linking a rural El Salvadorian town to the city. Source: https://www.icwa.org/

Second, the transportation infrastructure in El Salvador is not as backward as many may think. Sure, it does not compare to those in countries America, Singapore, or Germany, but it is not dysfunctional. The Rural Road Program was initiated by the Latin America Investment Facility in 2011 to improve rural road infrastructure in El Salvador so that these areas will be better linked to the major cities. This does go a long way in mitigating the friction that recipients from rural areas will face with regard to the collection of their remittance money and divulges to us that Bitcoin may not really be that necessary after all.

There is no silver bullet for a problem that doesn’t exist (or is not a huge issue), because there is no need for one anyway.

Democratization of access to financial services

Next, in El Salvador, some 70% of citizens are unbanked, meaning they lack access to a basic bank account. Concomitantly, they are also isolated from all the financial instruments that come with said bank account (loans, investments etc.).

Bitcoin can provide financial inclusion to this group of people because once again — you do not require a bank account to access Bitcoins; you only need your phone, and a digital wallet to do so.

These citizens can then invest these remittance Bitcoins into decentralized financial instruments like liquidity pools and decentralized exchanges (DEX) — all without a bank account.

Critique

However, there is a need to be realistic here. El Salvador is a country with one of the lowest rates of internet use in the Americas — 33% in 2017, according to World Bank data. How many of these unbanked individuals do you think, are equipped to handle cryptocurrency transactions?

An El Salvadorian household in the rural countryside. Source: https://blog.compassion.com/

If they are unable or unwilling to even open up a bank account in the first place, what makes you think they will have the capacity, or even willingness, to set up a digital Bitcoin wallet?

Heck, even many of us in these so-called ‘first world countries’ also struggle to do so! As a result, Bitcoin may actually even widen the gap between the unbanked and the banked, because it is usually the latter that will be the ones that are more able and willing to utilise it anyway.

Herein lies the inherent paradox of this silver bullet that will severely inhibit the potential of what Bukele has promised to the world.

A buffer against the US Dollar

According to what appeared to be an excerpt from Bukele’s proposed legislation, included in a slide from Mallers’ Miami presentation,

“Central banks are increasingly taking actions that may cause harm to the economic stability of El Salvador.”

“In order to mitigate the negative impact from central banks, it becomes necessary to authorize the circulation of a digital currency with a supply that cannot be controlled by any central bank and is only altered in accord with objective and calculable criteria.”

Unlike the dollar, the supply of bitcoin today, next month, and 20 years from now will always be known in advance, and cannot be changed. A fixed amount of new bitcoins are created every 10 minutes. Every four years, the number of bitcoins created are cut in half. There will never be more than 21 million bitcoin and that eventual number will be reached more than 100 years from today.

A US Dollar Note. Source: https://www.dailyfx.com/

Twenty years ago when El Salvador ‘dollarized’ their economy, they effectively put themselves in a position (although necessary) where they were beholden to the whims and decisions of US policy makers with regard to the currency.

Twenty years ago, this was a nonissue. The US dollar was managed primarily for the benefit of, but in comparison to other currencies was a rock; consistent, reliable and the ‘lesser of all evils’. El Salvador looked to the dollar for relative stability and predictable monetary policies, and twenty years ago, they got just that.

Since the 2008 global financial crisis, however, the US has been undertaking a very experimental form of monetary policy involving tools like quantitative easing and a central bank that now directly monetizes, or purchases, government-issued debt to purposefully keep interest rates low.

Although these ‘experiments’ may yield very positive results just yet, the stability and predictability that El Salvador was looking for when they dollarized their economy all but disappeared.

To put this into perspective — the supply of USD has more than doubled over the last 10 years from $8 trillion to $20 trillion as of April, according to the Federal Reserve Bank of St. Louis’ data. In fact, close to half of that $11 trillion increase happened just in the last 18 months, as the US government sought to counter the negative economic impacts that the coronavirus pandemic inevitably brought about.

Seen in this light, and in a world where the global reserve currency is almost wholly dictated by short-term government needs, Bitcoin — ironically — becomes the more ‘stable’ form of currency that can better serve El Salvador’s monetary policy planning interests.

Critique

However, this is ultimately still Bitcoin that we are talking about. Although Bitcoin may arguably be more stable than the USD in terms of its role in monetary policy-making, there is no denying the fact that the price of Bitcoin is volatile, to say the least.

Indeed, at the time of this writing, the price of Bitcoin has already drastically dropped from the April 2021 high of nearly US$65,000 to the high 30s. This presents a fresh new set of problems when it comes to monetary policy making.

For example, when it comes to debt: How, and by whom, will the amount of bitcoins necessary to pay a debt be determined? Will it be based on the Bitcoin price at the time the debt was incurred, or when the debt falls due?

Because of how volatile the Bitcoin price is, a few days — even hours — could make a world of difference.

Further, the nature of Bitcoin renders it extremely unsuitable for transactions that need a fast confirmation time. To evince — imagine you want to buy a coffee from a coffeehouse. If you were to pay in USD, the exchange would take place almost instantaneously. You hand over the cash in return for the coffee, the cashier stores the cash away, and the exchange of value is complete.

If you were to use Bitcoins, however, now that would be a different story altogether. In the Bitcoin blockchain, a block is minted to the network every 10 minutes. For transaction finality (or the best semblance of it), 6 confirmations are required (6 blocks need to be appended to the block that your transaction is a part of). That would mean your transaction can only be confirmed and finalized after 1 whole hour! That is definitely no way to purchase a coffee.

This impracticality of using Bitcoin for fast, day-to-day transactions thus further point us to the possibility that making Bitcoin legal tender could in fact destabilise El Salvador’s economy more than it helps it.

Moreover, let us not forget that because of Bitcoin’s deflationary design (fixed supply with supply ‘halving’ every four years), the price per Bitcoin will eventually rise (assuming it does not become obsolete). Why would anyone want to purchase something in the present, with a currency that they know will definitely be worth more in future? El Salvadorians with Bitcoins are thus more likely to hold on to them, as compared to spending them.

This could pose even further problems to El Salvador’s economy, as the income fissure between the haves and have nots, of which the former can probably afford to purchase and hold (many) more Bitcoins now, will likely widen exponentially in future when Bitcoin prices eventually and inevitably soar.

Additionally, the enhanced ability to remain anonymous when transacting with Bitcoins will present the El Salvadorian administration with many serious issues. Money laundering, tax evasion, and black-market economies are all more likely to flourish and thrive even more in El Salvador with Bitcoin becoming legal tender, as authorities will find it much harder to track ‘dirty’ money and their movements.

Therefore, until solutions to all the above have been found, Bitcoin will unfortunately never be a better alternative to the USD in El Salvador.

The Attraction of Foreign Direct Investments (FDI)

Finally — according to Bukele,

“If 1% of it (Bitcoin) is invested in El Salvador, that would increase our GDP by 25%”

Visual Representation of an FDI. Source: https://www.business-standard.com/

Critique

Of all the benefits of Bitcoin that Bukele purported, this one is the most bewildering of them all.

It is extremely flawed logic for Bukele to think that Bitcoin’s total market value (total Bitcoins in circulation multiplied by the price of Bitcoin) directly equates to money that bitcoin owners all around the world are looking to invest at all.

As already mentioned above, most people see Bitcoin as an investment asset in and of itself. In other words, there are very few people — if at all — who purchase bitcoins to then invest in other things. That is just not the logic that most Bitcoin holders follow.

In essence, it is highly unlikely that the many major funds or individuals around the world holding Bitcoins will suddenly be attracted to start investing in El Salvador just because its made legal tender there.

That is just one assumptive leap too far.

Further, one must also remember that FDIs do not directly contribute to the GDP of a nation. In other words, foreign investors who use Bitcoins to buy tangible assets such as land in El Salvador may not necessarily increase GDP; it will merely bid up the price of said land.

The only way that FDIs can really boost El Salvador’s GDP is if a huge injection of foreign capital into new infrastructure and/or businesses substantially increases the overall productivity of the workforce. However, whether Bitcoin is to be the spark that instigates this remains to be seen, and at this moment — seems highly unlikely.

The Verdict

From all the above, I think I can safely and definitively say: Bitcoin is not the silver bullet for El Salvador’s economic woes.

In fact, I would go so far as to say that there is no such thing as a silver bullet when it comes to a nation’s economic planning.

Economic problems are solved over time by meticulously-planned, citizen-centric, diligently-executed, and substantively-effective governmental policies. There is simply no lazy way around that.

Recently, and in the wake of his party’s expulsion of El Salvador’s attorney general and several top judges, Bukele has come under heavy fire for being overly authoritative in his administration. For all we know, this whole Bitcoin saga might just be a PR ploy by Bukele to detract attention from these real issues at hand.

Whatever the case, El Salvador’s Bitcoin experiment will certainly be watched by the world with bated and anticipatory breaths.

For the sake of the 6.5 million people living there, let’s hope that one day we can all come back to this article for a good collective laugh at how wrong my prediction really turned out to be.

The alternative would be too upsetting to imagine.