A new digital currency “arms race” ensues as El Salvador is poised to be the first country that adopts Bitcoin as legal tender. Unsurprisingly, numerous economists and officials disapprove of this move. Many believe that the plan could falter due to the lack of a progressive financial infrastructure for adopting Bitcoin.
Leap of Faith Into Action
President Nayib Bukele is confident of adopting Bitcoin, citing the success of the Bitcoin Beach Wallet experiment — representing a mere sliver of the country — but giving consideration to 70% of El Salvador’s citizens who are unbanked.
As the saying goes, you can never reach the sky in one leap. Dubbed by many as a move to “forced tender,” El Salvador’s action requires every merchant or economic agent to accept Bitcoin if offered during a transaction.
Since the 1940s, the country has been using the U.S. dollar as its dominant currency. Increased interest rates have decreased the money supply of the greenback in El Salvador, compared to the previous year. Although the country is subject to a spillover inflation effect from the U.S., throwing the U.S. dollar out the window overnight will lead to more financial instability in its economy.
El Salvador MoneyLastPreviousUnitInterest Rate3.823.79Percent (%)Money Supply (M0)1.61.6USD MillionMoney Supply (M1)4,825.504,962.80USD MillionMoney Supply (M2)16,41416,545.10USD MillionMoney Supply (M3)17,230.4017,372.10USD Million
Source: Trading Economics
Besides, Bitcoin has a higher volatility range compared to the greenback; the crypto volatility index currently stands at 91.8, indicating a highly volatile market in the next 30 days. Safeguarding the common folks who don’t have a huge risk appetite remains a major consideration.
Will Bitcoin Do More Harm Than Good to El Salvador’s Economy?
It’s not hard to understand why President Bukele is honing in on BTC, when El Salvador’s remittance fee has fallen to under 3% after the 2018 rise in the adoption of Bitcoin. With lower fees, the number of remittances into the country has increased and represents 21% of its gross domestic product (GDP).
El Salvador dollars were pegged at a rate fixed to the U.S. dollar in 2001, and BTC will challenge the very concept of traditional foreign currency exchange. With the adoption of Bitcoin as legal tender, the country aims to curtail its currency’s dependence on the greenback, which has been subject to macro and political stipulations. The King of Crypto could also act as a lighthouse to attract wealthy crypto whales and entrepreneurs to the shores of El Salvador — effectively transforming it into the next Cayman Islands.
Here’s the real kicker, laid out in point #3 of President Bukele’s June 2021 tweet: taxes — or the lack thereof. In the United States, trading of Bitcoin incurs capital gains taxes in the event BTC appreciates against the U.S. dollar. In El Salvador? Nada. No capital gains tax — although tax contributions still apply, and are to be paid with bitcoins.
Source: Trading Economics
Roadblocks Ahead Require More Than Just Faith
President Bukele famously said, “Let Bitcoin flourish on its own merits.”
The Bank of International Settlement (BIS) — a global body for central banks — said that up to 85% of the central banks are planning or piloting digital currencies, in large part due to a global movement toward less cash and more digital currency.
To manage the wild swings, institutions should also be involved in mitigating the trade risks of Bitcoin and cross-sharing information — thus allowing greater financial and regulatory visibility. In fact, BIS is calling banks to cooperate on a global level to implement international payment standards for digital currencies.
Global powerhouses the U.S. and China have been experimenting with digital versions of their own currencies — a move seen by observers as a progressive approach with better chances of stabilizing the global economy.
As for El Salvador, their journey to becoming the world’s first Bitcoin-denominated country will be one to watch, exciting on its own merits but not without speed bumps. First and foremost, its citizens will need to have access to either bank accounts or mobile internet.
Foundational infrastructure aside, the country will need to work closely with its central bank and beyond to better manage the volatility of Bitcoin, in ways akin to the Central Bank Digital Currency (CBDC) — a small step, but a move forward, nonetheless, to demystifying the complexity of cryptocurrencies on a national level.