El Salvador’s bitcoin experiment is off to a rocky start

A week ago, the tiny Latin American country El Salvador embarked on a radical experiment with its currency, becoming the first nation to adopt bitcoin as legal tender. It hasn’t gone smoothly.

Continual technology glitches, protests in the streets of its capital, San Salvador, a steep sell-off of El Salvadorian government bonds and gyrations in the bitcoin price have marred the rollout and the government’s attempt to promote acceptance of the cryptocurrency has had some unintended results.

Farmers hold signs emblazoned with messages against the country adopting bitcoin as legal tender in San Vicente, El Salvador.Credit: AP

The government kick-started the rollout by depositing $US30 of bitcoin into a digital wallet called “Chivo” (Salvadorian slang for “cool”), intending that the funds should be used to pay for goods or services. Initially, at least, those few able to access the wallets appeared more interested in exchanging their bitcoins for US dollars.

The launch wasn’t helped by the rollercoaster ride bitcoin has been on over the past week, dropping nearly 14 per cent even as the cryptocurrency experiment got underway before bouncing back about 9.5 per cent.

Glitches were to be expected, given the unexplained haste with which the El Salvador government and its authoritarian president, Nayib Bukele, implemented the project. It took just 90 days between parliament’s sanctioning of the country’s new currency and its launch.

El Salvador, highly indebted (a debt-to-GDP ratio approaching 100 per cent) and tiny (a population of about 6.5 million in a $US25 billion economy) is an unlikely venue for a world-first trial of a cryptocurrency as legal tender.

While El Salvador’s decision to introduce bitcoin as legal tender has ignited enthusiasm among cryptocurrency true believers – a factor in the bounce-back of bitcoin’s price may have been a meme stock-like campaign by bitcoin enthusiasts for $US30 purchases of the coins in solidarity with El Salvador – Bukele’s motives for undertaking such a peculiar experiment remain unclear.

El Salvador abandoned its currency, the Colón, in 2001 in favour of the US dollar. The decision has served it well. While much of Latin America has been ravaged by inflation and hyperinflations, El Salvador has averaged an inflation rate of only about two per cent since dollarisation.

Bukele has cited the economy’s reliance on remittances from the El Salvadorian diaspora – about $US6 billion a year, or more than 20 per cent of GDP -- and the cost of those transactions as a major factor in the decision, presenting bitcoin as a costless medium of exchange.

While the transfer of bitcoin may not cost much, if anything, the conversion of fiat currencies into cryptocurrencies is, of course, anything but costless and the wild fluctuations in bitcoin’s price – roughly once a month it experiences a daily movement of 10 per cent or more – makes it anything but a stable or efficient medium of exchange.

Salvadoran President Nayib Bukele.Credit: AP

El Salvador, highly indebted (a debt-to-GDP ratio approaching 100 per cent) and tiny (a population of about 6.5 million in a $US25 billion economy) is an unlikely venue for a world-first trial of a cryptocurrency as legal tender. Only about third of the population has internet access and surveys have found that less than five per cent of Salvadorans know what a bitcoin is and that 70 per cent oppose designating it legal tender.

Despite that Bukele has talked up the prospect of the country being a centre for bitcoin mining and cryptocurrency innovation attracted by the experiment.

That experiment has cost El Salvador about $US200 million so far to develop the digital wallet, establish a network of bitcoin ATMs and distribute about $US60 million for the $US30 per head give-away, with another $US150 million dedicated to a fund that will acquire bitcoin. About $US26 million of that fund has been already invested.

The new laws require businesses and banks to accept bitcoin as payment but don’t force individuals to use the cryptocurrency. The US dollar remains an alternate medium of exchange.

How the government, and businesses, will cope with liabilities denominated in US dollars but some revenues in bitcoin – particularly if the app continues to malfunction – will be a critical test of the appeal of cryptocurrencies generally. That mismatch and the sheer volatility of bitcoin, makes a potentially combustible combination.

The attitude of the rest of the world, and the US in particular, will also help determine whether the experiment is successful. The International Monetary Fund and World Bank opposed El Salvador’s decision, raising concerns about the economic and legal risks, not the least of which would be the potential threat to financial integrity in a country with weak money-laundering and counterterrorism financing regimes.

The vulnerability of El Salvador as a haven for money launderers exploiting the new status of bitcoin could attract financial and economic sanctions from the US and others. The US State Department had previously put a number of high-level El Salvadorian government officials on a list of people “credibly alleged” to be corrupt.

Other Latin American countries are watching the Salvadoran experiment closely (Venezuela actually created its own cryptocurrency a few years ago, but it failed to gain acceptance) as will others concerned about the US dollar’s dominance of the global financial system and the influence and power that gives the US over their institutions and economies.

Bitcoin, however, isn’t the answer. A stablecoin, however, might be. Indeed, because the US dollar remains legal tender in El Salvador that is effectively what it has created.

While the government has promised instant convertibility of the bitcoins into US dollars, in effect on conversion the owner of the bitcoins would receive a US dollar-denominated stablecoin.

How that is going to work in practice is unclear but once the infrastructure for a cryptocurrency payments system has been built and digital payments widely accepted, it would be feasible to shift the exchange medium from dollars to some other form of currency – a digital basket of currencies or the return of the Colón, perhaps – and reduce the reliance on the dollar and vulnerability to US sanctions.

The introduction of bitcoin as legal tender isn’t only being closely watched, and cheered on, by cryptocurrency zealots but by many nations that have an interest in shrinking the dominance of the US dollar in the global financial system and reducing the hegemonic power that dominance confers.

El Salvador, however, probably isn’t the best place to run the pilot program to promote their ambitions.

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