El Salvador’s move to turn Bitcoin into a legal tender created a sense of optimism for market improvement for those who have a close eye on cryptocurrencies. The president of El Salvador, Nayib Bukele, sent the “Bitcoin Law" to the Legislative Assembly on June 9. It takes effect in September, hoping to turn El Salvador into a utopia of Bitcoin lovers.
Passing the Bitcoin Law may indicate the desire of a former businessman and a current president to make El Salvador a leading country in adopting cryptocurrencies as a legal tender. However, the initial excitement around this law has now subsided, and we can take a wise and analytical look at the Bitcoin Law in El Salvador.
According to the law, “every economic agent must accept Bitcoin as payment when offered to him by whoever acquires a good or service,” and “all obligations in money expressed in USD, existing before the effective date of this law, may be paid in Bitcoin.”
The truth is, El Salvador is not the first country that is allowing its people to use Bitcoin for regular payments. Since 2010, when a software programmer paid 10,000 Bitcoins for two pizzas, until today, Bitcoin has been a common currency for specific payments — especially for those who do not want their payments to be tracked.
El Salvador has never had a stable economy and is now one of the poorest countries in Central America. By accepting Bitcoin as a legal tender, the government intends to create an economic stimulus. However, this ambitious program does not seem to be as it sounds. Here’s why.
A little about El Salvador and its Bitcoin plan
El Salvador is a small economy in Central America with a population of 6.5 million, and it has one of the lowest GDP rates in the world and its region. The country started to adopt the US dollar in 2001 as its official currency. Before beginning the dollarization process, the Colón was their currency since 1892. Other neighboring countries, such as Panama and Ecuador, also adopted the US dollar, intending to reduce inflation and hope for closer ties with the United States.
El Salvador has seen many civil wars, most notably in the 1980s. It has also been a Spanish colony for many years. The unstable economic situation, along with the wars, has now led to more than two million El Salvadorans working abroad and sending their income to their families in the country. El Salvador has a meager GDP rate compared to neighboring countries, and the country is struggling with growing poverty.
Accepting remittances from El Salvadorans working abroad is one of the primary sources of livelihood for the people. According to officials, Coronavirus had reduced remittances by 40%, but now the downturn has stopped, and El Salvadorans who are abroad have sent $5.92 billion to the country. This figure is equivalent to 23% of the country's total GDP.
President Nayib Bukele hopes to be able to use Bitcoin as a way to facilitate sending remittances to the country. This is a good intention, but only 33.8% of the population have access to the internet, and accessing the required technology to process payments is challenging.
The lack of access to bank accounts is another challenge in implementing the Bitcoin plans in El Salvador. It is estimated that only between 30-40% of adults in the country have access to a bank account. For a country that wants to use Bitcoin as an economic advantage, this is an abysmal rate.
Another misconception around Bitcoin in the plan is that President Bukele believes the Bitcoin market cap is the same amount of money that owners want to invest. Bukele wants to use Bitcoin as a GDP stimulus. But the problem is the US$680 billion market cap of Bitcoin doesn't guarantee investment in the country. "If one percent of it is invested in El Salvador, that would increase our GDP by 25%," President Bukele said.
Bukele probably does not know much about Bitcoin because Bitcoin itself is essentially an investment, and few people are willing to invest their Bitcoin in other sectors. Just ask yourself: Why should a Bitcoin owner invest in a country with an unstable economy where less than 50% of its people have a bank account?
Even adopting Bitcoin as a legal tender is unlikely to motivate investors to bring their money to El Salvador and contribute to its GDP. Before implementing any plan, the government needs to develop infrastructures and increase people's knowledge about Bitcoin to prevent future scams. Providing technology to process payments and expanding bank accounts among people should be priorities for the government.
Unstable and perishable value of Bitcoin
One significant problem with cryptocurrencies is they don't have a fixed rate, and their value is very volatile. The value of a country's currency is usually raised or lowered by factors such as inflation, interest rates, or the policies of that country's central bank. But Bitcoin is an exception, and its value may drop even with a tweet from Elon Musk.
A legal tender that loses its value with a tweet and does not follow economic norms can not be very reliable and may cause people to lose assets. Because of the volatile market, experts often warn people about blindly investing in the cryptocurrency market.
The vague regulations by governments and the negative attitude of some governments towards Bitcoin affect its value. Governments like China and the United States have a considerable impact on the market. Just recently, China banned Bitcoin mining, and in the US, the Federal Reserve announced it wants to regulate Bitcoin. These two news stories caused a massive crash in the market.
The significant danger with announcing Bitcoin as a legal tender is its valuation is out of government control and is subject to extraterritorial factors. This is dangerous for economic stability. When the value of a country's national currency is determined by tweets or laws passed by other countries' central banks, this can be a serious threat to a country's independence. This is why some conservative countries like China and Russia are strong opponents of Bitcoin and intend to develop domestic rivals.
The government and the central bank should protect the people's assets. Still, when extraterritorial agents determine the currency's value, there is a risk of losing assets.
Transparency and money laundering
Due to the non-transparency of transactions, many governments refuse to accept Bitcoin and may even prosecute Bitcoin owners. For them, Bitcoin is a financial asset and not a currency for making payments.
The current problem with Bitcoin payments is that it is challenging to track transactions, and it provides a secure environment for money laundering and fraudulent activities.
Also, some global organizations are worried about using Bitcoin in non-transparent transactions. Recently, the El Salvador government asked for help from the World Bank to support its plans. However, the World Bank rejected El Salvador's request. Moreover, the International Monetary Fund (IMF) warns about the problems that Bitcoin may cause for El Salvador.
"We are committed to helping El Salvador in numerous ways, including for currency transparency and regulatory processes," a World Bank spokesperson told Reuters. "While the government did approach us for assistance on Bitcoin, this is not something the World Bank can support given the environmental and transparency shortcomings."
If the El Salvadoran government fails to develop strict rules to track and record Bitcoin transactions, the country will soon become a haven for money laundering and illegal activities. This will damage the international reputation of this country. Other countries may also limit their financial ties with El Salvador for this reason.
Even the United States is worried about the El Salvador Bitcoin plan and encouraged the country to regulate it. "I did suggest to the President that whatever El Salvador chooses to do, you ensure that it is well regulated, that it is transparent and that it is responsible, and you protect yourself against malign actors," said Victoria Nuland, the under secretary of state for political affairs after a meeting with the leader of El Salvador, president Nayib Bukele.