Today El Salvador adopts Bitcoin as legal tender, beginning one of the biggest experiments in Bitcoin’s 12-year history. Their infamous Bitcoin Law took effect, making it the first country in the world to adopt Bitcoin as legal tender. Although the US Dollar is also legal tender there, so there’s room for the market to decide. Honestly, I’m ambivalent about this development. Pragmatically, there are some serious advantages to El Salvador, and the entire bitcoin ecosystem.
Apparently you can now buy McDonalds and Pizza Hut with Bitcoin in El Salvador. If that goes well, maybe these international corporations will accept it elsewhere… not that I ever buy McDonalds or Pizza Hut with dollars in the US. But principally I have reservations. All laws are enforced, and force is not how I want to promote alternatives. But today we’re going to go over the facts, and hopefully have a few original thoughts of our own. And, since media literacy is life and death these days, I’ll be explaining a bit about identifying bad journalism.
The criticisms were predictable. Bitcoin is highly volatile, and has high transaction fees. Concerns about money laundering and tax evasion quickly followed. The International Monetary Fund also had criticisms, seeing the potential for the move to decrease their influence. But no surprises there. That’s the basics.
What is El Salvador’s Bitcoin Law?
Here’s the text of the law if you’re curious. President Nayib Bukele proposed the law, and it passed 62 to 22 by the Legislative Assembly on 8 June 2021. Bukele made the announcement to the world at a Miami Bitcoin conference. He said he hoped it would provide financial inclusion to the 70% of unbanked Salvadorans. And it goes into effect today, on 7 September 2021.
Article 1 of the law begins, “The purpose of this law is to regulate bitcoin…” And my hackles are already up.
Article 2 affirms the exchange rate of Bitcoin will be determined by the market, which is good. Article 4 establishes that taxes can be paid with Bitcoin, which is… fine… I guess.
Article 5 is particularly promising. It assures that Bitcoin profits will not be subject to capital gains taxes in El Salvador. In the US I needed multiple specialists to determine that I owed $2.17 in capital gains taxes because I bought Chinese food with Bitcoin. This detail alone could make El Salvador a tax haven to international Bitcoiners.
Article 7 is the problem. It reads, “Every economic agent (meaning businesses) must accept Bitcoin as payment when offered…” Article 12 softens this somewhat. It excepts those who don’t have access to the necessary technology from the obligation to accept Bitcoin. But “provisional” means temporary. The law specifies that the government will promote the necessary training and mechanisms to remove these exclusions over time.
As written, the law is a mixed bag.
Forcing Businesses to Accept Bitcoin is a Mistake
Obligating businesses to take Bitcoin is a problem. It means that existing business owners will have to implement some technically challenging changes in a hurry. According to a survey by the Central American University (UCA) only 4.8% of Salvadorans understood how to use Bitcoin. The risk of human error alone is serious. Bitcoin is a trustless peer-to-peer system, and a user who accidentally loses access to their holdings has no recourse. That Bitcoin is gone forever.
It remains to be seen how businesses that refuse to comply will be penalized. But regardless, this is not the way to promote adoption. Part of the ultimate value proposition of Bitcoin is that it’s voluntarily adopted and transacted outside the prevailing regulatory regimes. In that regard, mandating its use is just as egregious as prohibiting its use. Bitcoin functions best without political meddling.
Before the Bitcoin Law there was Bitcoin Beach
Present Nayib Bukele was promoting Bitcoin back in 2017 as mayor of San Salvador. Some have reported he’s been holding Bitcoin for years. But the real experiment began in the coastal village of El Zonte in 2018.
Dubbed Bitcoin Beach, El Zonte is a surf town of about 3,000 residents. It was the first place in El Salvador to treat Bitcoin like legal tender. The program was backed by California donors that gave $50 in Bitcoin to every local family. They encouraged adoption by merchants, and paid for dozens of social projects, from lifeguarding to trash collection with Bitcoin. Residents could receive their salary, pay their bills and buy consumer goods with Bitcoin.
The experiment met with mixed success. Crypto-savvy tourists breathed new life into El Zonte and led to a real-estate boom. But only about 10% of customers actually used Bitcoin to make purchases. Most business owners held the Bitcoin as an emergency fund rather than recirculating it. This is highly analogous to my own experience. When I first began accepting Bitcoin only about 1% of my customers and clients paid with it. I’ve always tried to recirculate it by making purchases (Like Chinese food), but mostly I have saved it for emergencies.
Admittedly, this has worked out great for me. I’ve gotten out of some tight spots by having a crypto safety net. In the long run that could be a windfall for a developing economy. But, deflationary currency like Bitcoin incentivizes saving, which can slow commerce in the short run. As Gresham’s law suggests, “bad money drives out good”. In a marketplace that uses Bitcoin and US dollars, the bad money gets spent, and the good money gets saved.
El Salvador’s technical problems
More than 200 new Bitcoin ATMs were installed across the country to facilitate adoption. These enable residents to exchange US dollars for Bitcoin without commission, and vice versa.
El Salvador launched a state sponsored digital wallet called “Chivo,” which is local slang for “cool”. The government incentivized downloads by pre-loading every wallet with $30 in Bitcoin. Free money. Sounds great.
Unfortunately Salvadorans trying to download the Chivo digital wallet found it was unavailable in popular app stores. Bukele initially blamed the Apple, Google and Huawei app stores for the delay. Later he admitted the government had to temporarily pull it down to deal with unexpected demand. Early Tuesday he tweeted:
“Any data they try to enter at this time will give them an error.
This is a relatively straightforward problem, but it cannot be fixed
with the system connected.”
After the crash of the Obamacare website in 2013, this is just what I expect from any government roll out. Although the Chivo wallet is reportedly back on Huawei.
Compounding these hurdles is the fact that nearly half the population has no internet access. Many more have only intermittent access. So, while these efforts are highly ambitious, they aren’t really ready for prime time. This wasn’t a launch of a functioning crypto economy. This was the beginning of the long and complex process of building one.
Bitcoin’s volatility problem
Many Bitcoin holders watched eagerly to see how El Salvador’s news changed the price. Today the price slipped from $53,000 to $43,000 and then bounced back to $47,000 in a few hours. That’s a wild swing, but nothing unusual. Last April it was $65,000. This is an expression of the psychology of the market, not the fundamentals. It’s too soon to have any idea what long term effect this will have on El Salvador’s economy. So this fluctuation really represents international gambling. And the El Salvador government is still betting on Bitcoin. They reportedly purchased 200 BTC before the law took effect, and another 150 after the price dipped. So from their perspective the price drop is just a clearance sale.
If the experiment fails we’ll likely see a long slump in the price as confidence wanes. But if it succeeds El Salvador’s national wealth could be 10 times what it is now in a year. That would pave the way for more countries to follow, starting with other South American countries. Gabriel Silva, a politician in Panama is already proposing his own “Crypto Law.”
What about the Bitcoin protests?
Public backlash is one of the inevitable consequences of state adoption.
Hundreds took to the street in San Salvador afraid that the government would begin paying their pensions in Bitcoin. Although the protests are piggybacking on a wider campaign to increase pension payments generally. The law recognizes both currencies, but the volatility may be more dangerous at this scale. It’s one thing for investors with a mixed portfolio to weather the wins and losses. It’s another for people on fixed incomes to manage such wild fluctuations.
Consumers will likely keep a mix of Bitcoin and US dollars based on their own risk calculations. It’s just like investors who keep a mixed portfolio of high and low risk investments. It’s a bit like the Titanic. The US dollar, like the ill fated ship, is functionally stable, but it fluctuates in one direction. Cryptocurrencies, like life rafts, are subject to the peaks and troughs of ocean currents, but they stay afloat. The question is when to abandon ship. None-the-less, imposing this decision on people is unconscionable. Consumers should be free to diversify their currency portfolio as they wish.
So far, Bukele is reassuring Salvadorans that they are free not to use Bitcoin if they don’t want to. So long as they have that choice these protestors have nothing to worry about. They can continue using the US dollar as long as they like… Or at least as long as it remains afloat.
Most people in El Salvador don’t want to adopt Bitcoin
The real problem is that the people of El Salvador don’t seem to want this law. They’re already agitating to repeal it. The Central American University (UCA) survey found 67.9% of respondents disagreed with using cryptocurrency as a legal tender. The survey also showed most Salvadorans think Bitcoin will mostly benefit the wealthy, the government, and foreign investors. And they’re probably right, simply because someone with expendable wealth to risk on crypto markets will see greater returns. Bitcoin could also benefit the countries substantial poor population. But if people want to ignore those opportunities because the rich might benefit more, that’s their prerogative.
Their president may be otherwise popular. Their legislature may have passed this law with their economic interests in mind. It doesn’t matter. Currency only works if people actually use it. And most of them simply don’t want to, and shouldn’t be forced to.
Remittances are the real advantage
Remittances are sums of money sent internationally as payments or as gifts. For example, Salvadorans working outside the country frequently send money back to support family inside the country. In legacy systems this is done with bank transfers, or with wire transfer services like Western Union. These of course can carry heavy fees, and long delays.
Supporters argue that Bitcoin makes it cheaper and easier for migrants to send money home to El Salvador. That’s important given such remittances account for over 24% of the country’s gross domestic product, according to the World Bank. Bukele estimates that using Bitcoin could help Salvadorans save $400 million a year on commissions for remittances.
In the Bitcoin economy the concept of international transactions is technically non-existent. The distinction only exists where jurisdictions interface with local laws. The blockchain is a ledger that is proliferated across the internet without geographic distinction. There’s no difference in fees or confirmation times between sending Bitcoin across the world or to your neighbor. Using Bitcoin would make it faster and cheaper for Salvadorans to get remittances from anywhere in the world. It could free the indebted nation from the hold of legacy financial systems.
Fox Business offers a one-sided debate
Fox’s coverage focused on quotes from Mark Mobius and Broke Pierce pulled from the coverage of other networks. Kinda lazy. But worse, although their headline promises debate, they admit that Pierce and Mobius don’t really disagree. They both just parrot the obvious criticisms with no serious analysis. Worse still, the end of the article prompts readers to click forward to the article, “Trump warns crypto ‘potentially a disaster waiting to happen’” Real Fair and Balanced. Frankly, I don’t give a bit what Trump thinks about crypto. The man barely understands addition. Why would I expect him to offer meaningful criticism of encryption? But the motivation is clear. Fox is using news coverage to funnel readers toward bad arguments against crypto that appeal to their patriotism. In other words, they’re shilling for the US dollar.