El Salvador y Bitcoin

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El Salvador has leapt into the international spotlight by being the first country to establish a positive multi-layered bitcoin strategy. The meat of the emerging strategy gives bitcoin status as legal tender within El Salvador. The government is looking to make bitcoin easier to use throughout the country in a variety of financial contexts while simultaneously attracting international bitcoin capital to invest, spend, and maybe even take up residence in El Salvador due to more favorable tax treatment. While the update to bitcoin’s legal status in El Salvador is historic in and of itself, the Central American country also plans to explore geothermal energy-based bitcoin mining and roll out its own wallet “Chivo” and distribute $30 worth of bitcoin to every Chivo user. El Salvador has seemingly gone “all in” on bitcoin.

Why & How

Since 2001, El Salvador has used US dollars as its official currency, decommissioning its currency, the Colon, in an effort to attract more favorable international investment and commercial relationships. According to El Salvador’s current president Nayib Bukele, the US dollar was adopted for the benefit of the country’s banks, commercial interests, and upper class, while Bitcoin is being adopted to help the 70% of the population without access to basic financial services and who often rely on remittances to supplement their income. A major source of foreign income for El Salvador is remittances flowing from Salvadorians working in the United States. According to the World Bank, remittances as a share of gross domestic product is 24% in El Salvador. Only four other countries, Tonga (38%), Lebanon (33%), Kyrgyz Republic (29%), and Tajikistan (27%) rely more on remittances. Unfortunately, typical remittance services charge hefty fees (5-10%) for these transfers, taking a considerable chunk of funds away from native Salvadorians to spend and save. In addition, these services are typically inconvenient for many, forcing some to travel up to a few hours to take possession of remittance funds. President Bukele thinks the use of the Bitcoin network can reduce these fees substantially while also being convenient, giving a boost to Salvadorians’ purchasing power, their ability to save, and reducing the time and effort taken to claim funds. The President has also alluded to the Bitcoin network’s resiliency, decentralization, and monetary soundness as strong attractors for its adoption.

The actions of specific Bitcoiners also played a key role in moving El Salvador to a high level of commitment. In 2019, American Bitcoiners worked to jumpstart a bitcoin economy in an El Salvadorian beach town, El Zonte, now known to many as Bitcoin Beach. Companies like Strike, which had a presence on Bitcoin Beach, played an instrumental role in demonstrating Bitcoin’s potential to the national government. According to President Bukele, El Zonte is very representative of El Salvador where only some have access to financial services while most in El Zonte would be categorized as unbanked or underbanked. Bukele and others were impressed with the Bitcoin Beach experiment, which showed the El Salvadorian government how Bitcoin can fill in some of the gaps left by the El Salvadorian and international financial system. 

Issues

We think El Salvador is without a doubt heading in the right direction but there is at least one clause in the proposed bitcoin law that is problematic and expectations of what bitcoin can do for the 70% of the unbanked in El Salvador should be met with tempered optimism. 

The infamous Article 7 of the El Salvadorian legal tender bill requires “every economic agent” to accept payment in bitcoin, with the exception those who “do not have access to the technologies that allow them to carry out transactions” outlined in Article 12. Although Article 12 saves the bill from being truly draconian, this bill goes beyond the reach of most legal tender laws, which mandate that creditors must accept repayments of debts in that country’s legal tender(s). The mandate in legal tender laws usually doesn’t apply to “every economic agent” yet this bill does. We recognize that Article 8 in the bill does give relief to economic agents by creating a mechanism for the agents to swap unwanted BTC for USD immediately upon request, but this doesn’t change the fact that the mandate creates room for regulatory abuse and effectively prioritizes BTC over the US dollar’s status, going beyond equaling the playing field. No one is forced by government mandate to take USD at the point of sale in El Salvador but under this proposed law, BTC would have to be accepted by a capable merchant or the merchant could face punishment for not following the government’s mandate. This potential for force is unneeded and not how we would recommend rolling out the country’s bitcoin program. Although this legislation will undoubtedly be helpful for bitcoin holders within El Salvador, Article 7 may alienate many merchants in the process and create negative interactions between merchants and regulators that blowback on the government and their greater bitcoin program. We assume the legislature of El Salvador has good intent, but Bitcoin should and can succeed on account of its utility, without government coercion. Focusing on building out infrastructure and educational opportunities, while letting citizens voluntarily use Bitcoin to solve their problems is the most effective and ethical course of action.

Although the swap program laid out in Article 8 provides relief for economic agents who don’t want to hold BTC, the swap program itself could expose the El Salvador’s state fund to a possible dollar liquidity crisis. Since almost all of the fund’s expenses are currently in dollars, a rapid influx of BTC<>USD swaps plus a quick move to the downside by BTC in the market could conceivably create a dollar liquidity crisis where El Salvador’s state fund, Banco de Desarrollo de El Salvador (BANDESAL), doesn’t have enough dollars to operate and pay its short-term debts. Granted, this would only come about if a substantial amount of redemptions happened quickly relative to their dollar holdings and BTC simultaneously took a historically massive nosedive. This type of risk will need to be managed properly by BANDEAL. We’d imagine this event is unlikely but it is possible if the program is handled poorly. However, if the fund’s expenses can be paid in Bitcoin, the possibility of a dollar liquidity crisis would be eliminated since their bitcoin holdings could be used in lieu of the US dollars. 

Aside from the specific laws and mechanisms, we should also all keep in mind that although bitcoin and bitcoin-powered apps will provide cheaper alternatives to many remittance services, on-chain bitcoin transactions are still expensive in most retail contexts. Luckily, the lightning network has matured over the past few years with increasing economic capacity/reliability and a growing suite of applications that make it easier to use in retail transactions. Unfortunately, lightning is typically more difficult to use non-custodially than an on-chain bitcoin wallet. Many users will opt for a custodial lightning wallet, creating counter-party risk for those users. Add in unfamiliarity with bitcoin, lack of quality hardware, and spotty internet connectivity, and there will undoubtedly be some growing pains as expected with the growing use of any novel technology. We expect much of the mainstream financial media to focus on the negatives and hiccups while the crypto media will largely focus on the successes. The truth, in the beginning, will likely be a mixed bag of success stories, a lot of in-difference, and some negative experiences.

And lastly, everyone’s life and every country’s population have problems that exist outside of what money by itself can fix or ruin. Observers should not expect a utopia nor dystopia to form. Bitcoin’s positive impact for some should be immediate, but the deepest seeded and widely experienced benefits from a country anchoring itself to a reliable and accessible sound money occur over long periods of time. The fruits of patience, thrift, proof of work, and long-term thinking take some time to ripen. 

Implications

As a result of El Salvador treating bitcoin as legal tender, bitcoin is more likely to be treated as another foreign currency by the international banking system. According to Caitlin Long, this would confer bitcoin with more favorable accounting treatment as “cash” making it more attractive and less punitive for institutions around the world to hold bitcoin. Caitlin also pointed out that under US commercial law, money is defined as “a medium of exchange currently authorized or adopted by a domestic or foreign government.” This implies that US banks and commercial entities should recognize bitcoin as money like any other foreign currency, and where the US goes commercially much of the world likely follows. The United States, international banks, and other global institutions might try to fight bitcoin’s integration into the international system as money but if there are more follow ons to El Salvador in other countries, the task of routing around these changes to bitcoin’s status as money, gets much harder.

As mentioned earlier, El Salvador is also in the process of exploring the use of its geothermal energy for Bitcoin mining. Because of the nature of geothermal energy and many other renewables, they have to be consumed as close to the source as possible. Many energy-rich areas on Earth have very little local demand around them and the operators can’t export the supply. It just so happens, bitcoin mining monetizes any form of stranded energy that doesn’t already have intense local demand and can’t be easily transported. We don’t know the details of what this particular setup would look like, as the country is currently in negotiations with miners and exploring this possibility, but the bitcoin community has known for quite some time that it would be economically rational for nation-states with energy assets to at least seriously explore mining. Having a head of state like President Bukele actively and publicly exploring this option opens the door for other heads of state to also explore this line of thought and apply it to their own situations. Many heads of state will come to realize they can export energy to a digital sovereign (bitcoin) and that digital sovereign will pay somewhat consistent dividends in a censorship and inflation resistant asset with no threat of military force hanging over them. Paraguay, a country with voluminous amounts of hydroelectric energy, is starting to explore this line of thought. We expect more countries to explore mining as well as treating bitcoin as legal tender.

It’s also no trivial matter that a twelve year old digital entity earned the same status and trust that the United States Dollar is given. Computing is eating the world and as Microstrategy’s Michael Saylor would say, software-based services are “dematerializing the world”. Bitcoin is at the forefront of these trends. Not only was the substance of El Salvador’s actions significant, but the medium(s) in which a lot of discussions have taken place is also significant. Social media, and in particular, the new Twitter spaces, has been used very effectively by members of the Bitcoin community and representatives from El Salvador to communicate what is happening and solicit different perspectives and listeners from around the world. We should expect to see more intersections between digital collectives, nation-states, and social media channels going forward that produce similarly novel events. 

As a consequence, it will become harder and harder for less computationally competent leaders and institutions to operate as effectively in a world increasingly dominated by the digital. Bitcoin has been a relatively youthful movement, and it might not be an accident that the first head of state to champion it is a young man compared to much of the world’s current political leadership. Other young, ambitious political leaders could now look to President Bukele’s example and emulate it within their own political context. President Bukele has shown that there are other tools, networks, and organizations outside the World Bank, BIS, Central Bank, and international banking axis that countries can consider to help them achieve some of their goals.

Coda

We have cautious optimism about the developments in El Salvador. Most of the country does not have adequate financial resources, and software-based solutions like bitcoin can be used to fill in the gaps left by the legacy systems while also giving every country a way to monetize their stranded energy resources. The combination of providing better financial tools for everyday people, attracting more capital, and adding new revenue streams are overwhelmingly positive for any group of people. We hope El Salvador’s leadership can incorporate the benefits of bitcoin in a way that is as non-coercive as possible. Bitcoin will be more than fine without it. 

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