El Salvador – the first country to make Bitcoin a legal tender
On 8 June 2021 the Central American country El Salvador accepted a law which officially made bitcoin a national currency. You may be wondering, given the controversy surrounding the cryptocurrency, why El Salvador became the first country to adopt it as legal tender?
Around 70% of the country’s population does not have access to banking services as of 2017, according to the World Bank. Because of this, one aspiration of adopting bitcoin as a national currency is that it will improve financial inclusivity. This idea is often referred to by cryptocurrency advocates as ‘banking the unbanked’.
In addition, almost a quarter of El Salvador’s GDP comes from remittances, money sent home by Salvadorans working abroad. A potential benefit of adopting bitcoin as legal tender is the cost and time it takes to make these international transactions will likely fall. According to the country’s president, Mr Bukele, this will save Salvadorans around $400 million annually.
On the other hand, the adoption of bitcoin has had some negative economic implications for the country. In the first instance, the high risk associated with the cryptocurrency, given its high volatility, led to challenges with the country’s credit score. At the end of July 2021 Moody’s, one of the main credit rating agencies, downgraded El Salvador from B3 to Caa1 rating.
Secondly, according to news agency Reuters, the price of El Salvador’s dollar denominated bonds fell after the adoption of bitcoin, further highlighting the credit implications. The inverse relationship between bond prices and yields means that as bond prices decrease, the yield spikes. As a result it becomes more expensive for the El Salvadoran government to borrow money.
The very same volatility that influenced Moody’s decision to downgrade the nations credit rating had a direct impact on day one of the bitcoin rollout in El Salvador. A day before officially accepting bitcoin as a legal tender the government of El Salvador bought 400 bitcoins, amounting to around $20.9 million. One day later on 7 September, the price of bitcoin fell by more than 10%, costing El Salvador almost $3 million, further fuelling concerns that the currency was too volatile.
Nevertheless, since its adoption, some gains have been realised from making bitcoin a means of payment. In October, the cryptocurrency saw a steady recovery and has recently passed its all-time high, currently trading at almost $65,000 as of the 10 November 2021.
What does this mean for El Salvador?
The price increase of bitcoin translates to a gain of approximately $4 million for the country, some positive news that Mr Bukele was quick to share over Twitter. The President then announced that some of the proceeds would be invested in the construction of a veterinary hospital. A month later, the country’s press secretary confirmed another key project, funded by the profits made by the government’s Bitcoin Fund – the building of 20 schools. These investments, made possible by the adoption of bitcoin, are positive for El Salvador’s economy. However, the volatility of the cryptocurrency makes such projects risky and their future highly uncertain.
According to the President, at the end of September almost half of the population have downloaded the Chivo app, El Salvador’s digital bitcoin wallet, which is more than the people that have an open bank account. However, payments with bitcoin are still rare. The Salvadoran Foundation for Economic and Social Development found that 93% of surveyed companies reported no payments using the cryptocurrency.
The government has introduced programs aimed at incentivising the use of bitcoin, such as giving $30 worth of bitcoin upon the initial download of the Chivo app. In addition, at the end of September the president announced that those that buy fuel at some of the largest gas stations in the country using bitcoin will receive a $0.20 discount on each gallon.
In conclusion, despite some initial pullbacks, the acceptance of bitcoin in the country is growing, supported by government programs. However, there is still a high degree of uncertainty regarding what the future holds for using bitcoin as an official means of payment.