El Salvador’s President, Bukele proved his crypto-enthusiasm last week by adopting El Salvador Bitcoin legal tender for the first time in the world.
El Salvador’s parliament passed Bukele’s proposed legislation on June 9, after he declared his plan just a few days earlier. The law will come into effect in September.
Some Bitcoin fans have hailed this as a step towards much broader acceptance of cryptocurrency. However, the changes in Bitcoin’s market value since Bukele declaring his plan gives crypto-sceptics reason for doubt.
Over the past week Bitcoin’s value fluctuated and it was as US$38,200 (about A$49,000) and as low as US$31,428. Over the past month it has down from more than US$58,000. This isn’t certainly, the price volatility any government and central bank backed currency.
Such fluctations indicates Bitcoin’s vulnerability as a viable alternative to central bank currencies; good only for untraceable transactions and as a speculative investment or an assent class.
What is Bukele’s thinking behind wanting to have Bitcoin as a legal tender for the small Central American nation (population about 6.5 million) with an economy accounts for less than 0.05% of global GDP?
Bitcoins as legal tender
The fact remains that Bitcoin is already legal not only in El Salvador, but also in most other countries. As long as you want to make a payment in bitcoins, and the recipient is willing to accept them, it could function as a legal tender.
What is the difference in making bitcoins a legal tender is that the recipient should accept it by law. As the new legislation states, “every economic agent must accept Bitcoin as payment when offered to him by whoever acquires a good or service”.
El Salvador’s legalising bitcoins would not make much change for most nations as it is one of a dozen countries like micro-states such as Andorra and Nauru without its own currency and use hundred percent convertible currencies like Euro as a common currency.
El Salvador gave up its own currency (the “colon”, named after Christopher Columbus) in 2001 and adopted the US dollar as its legal tender. This process of “official dollarisation” was perceive as a part of reform that would restrain inflation and increase trade with the US, the biggest trading partner.
So El Salvador stands less to lose than other nations in adopting a second currency as a legal tender. In that context, a controversy about losing sovereignty and monetary policy autonomy would not arise at all. So there is absolutely no loss of “seignorage”; the profit made on issuing currency that’s worth a lot more than the cost of making it.
Highly volatile
However, having two legal tenders will, eventually complicate transactions, creating hitherto un-encountered financial issues, specially, when one of those currencies (bitcoins) may subject to wild speculation and keep on fluctuating its value.
Considering the provision in the new law that “all obligations in money expressed in USD, existing before the effective date of this law, may be paid in bitcoin”.
Even that clause is complicated. How, and by whom, will the amount of bitcoins essential to pay a debt be determined? Will it be based on the Bitcoin price at the time of the debt was incurred, or when the debt lapses due?
The difference of even a few days could be crucial.
If the expectation is the price of Bitcoin on the rise, why would you want to buy things with it? Why not wait a bit? If the expectation is the price is going to decrease, why would you want to accept it? For most transactions, using US dollars will still address these issues.
The end result is that by making Bitcoin legal tender, El Salvador’s economy may destabilise.
El Salvador’s GDP
However, things would have been simpler if El Salvador had adopted a “stablecoin” with a fixed price at one US dollar – such as Tether, the third-largest cryptocurrency.
That move would not be not so newsworthy, and would have defeated the apparent reason Bukele has campaigned for this move.
Bukele’s rational behind the move, delivered via Twitter on June 6, is that Bitcoin has “a market cap of US$680 billion” and:
This argument – which appears to be the only “analysis” Bukele has made public – seems very also confusing.
El Salvador President Bukele explains his Bitcoin plan on Twitter
Bukele explains his Bitcoin plan on Twitter. Twitter
Generally, market capitalisation refers to a listed company’s valuation, based on multiplying the share price by the number of shares. The $US680 billion Bitcoin market cap Bukele mentioned represents the currency’s market value multiplied by the number of bitcoins created so far. (For comparison, the market cap of Tether’s 63 billion coins in circulation is US$63 billion.)
However, it is inconsistent logic to consider Bitcoin’s total market value is equivalent to money bitcoin owners around the globe are looking to invest anywhere.
There are a very few cases where people buy bitcoins to invest in other things. Bitcoins are their investment. Neither major funds nor average punters holding bitcoins are likely to start investing in El Salvador.
Foreign investment is not a component of GDP (which is the value of market transactions in an economy). Foreigners using bitcoins to buy assets such as land in El Salvador would bid up its price. They would not necessarily increase GDP. Influx of foreign currency in the form of foreign investment into new infrastructure and businesess would increase productive capacity and thereby, would contribute to GDP. However, Bitcoin becoming a legal tender would not alter that status.
Facilitating remittances
Another reason given by Bukele is that Bitcoin “will have 10 million potential new users” and is “the fastest growing way to transfer 6 billion dollars a year in remittances”.
This apparently is a reference to the population of El Salvador (about 6.5 million) and Salvadorans living abroad and many of them send money home to help their families. In 2020 these remittances estimated to be US$5.9 billion, or 23% of El Salvador’s GDP.
It is questionable how many vendors, street hawkers or farmers in Salvador are ready to handle cryptocurrency transactions?
It is obvious that the US dollars will more or less likely to remain the default currency.
In this context, direct and tangible benefits of making Bitcoin legal tender are not clear. El Salvador is already experiencing higher interest rates as international investors are worried about the move. Concerns have been widely raised that the use of Bitcoin will facilitate the black economy and make tax avoidance easier.
From a Commonwealth perspective, legalisation of Bitcoins would not immediately change the economies. However, it would eventually enhance the general acceptance of crypto currencies.
One of the trend that other nations in the Commonwealth may follow is the UK’s recent move to introduce Central Back Digital Currency (Britcoin). On 19 April 2021, as part of the UK’s Fintech Week, the Bank of England and HM Treasury declared the creation of a taskforce to explore a central bank digital currency (CBDC) in the UK, dubbed as ‘Britcoin’.
Nevertheless El Salavador’s legalisation of cryptocurrency is a great experiment.
