El Salvador recently made headlines for becoming the first-ever country in the world to adopt the cryptocurrency Bitcoin as a legal tender. The President of El Salvador, Nayib Bukele, and the Legislative Assembly of El Salvador voted to pass the Bitcoin Law in June 2021, which aimed to encourage the citizens to adopt using Bitcoin to make everyday transactions and make cross-border transactions rather than use its official currency, the US Dollar.
The Dollarization of El Salvador and its effect on the population
Unfortunately, the country of El Salvador doesn’t have the best track record when it comes to the introduction of a new currency.
El Salvador used the colón as its official currency until 2001, when former President Francisco Flores helped the Legislative Assembly of El Salvador pass the Monetary Integration Act. Under the Act, the colón would be removed from circulation and replaced by the US Dollar as the country’s official currency. The government took this step to increase the ease of international trade, which is extremely dollar-heavy, and encourage foreign investment. Switching over to the dollar would also substantially reduce transaction costs, as most imports and exports are done based on costs in US dollars, also relieving the country of foreign exchange costs.
However, the change in El Salvador’s official currency did more harm than good, especially for its citizens. The entire economy and costs of the simplest items had to be restructured around the US Dollar, which was fixed to around 8.75 colones. This also led to decreased purchasing power for the citizens, as the value of the US Dollar was dependent on the United States Federal Reserve, meaning that El Salvador had no control over the factors behind its fluctuation or any monetary policy tied to it. The citizens themselves were also unable to adjust to the change in currency and could not grasp the true power of the dollar compared to the colón. This led to financial distress and chaos among the population, who were unable to manage their finances properly.
Though the change was made to positively influence El Salvador’s trading with the rest of the world, it ultimately ended up slowing down the country’s exports instead, as other developing countries like India and China offered cheaper goods in comparison due to their undervalued currencies.
Bitcoin and El Salvador
The first instance of the mass usage of Bitcoin as currency in El Salvador was in 2019 after an anonymous donor presented $10,000 worth of Bitcoin to the residents of El Zonte, a village in the country. However, the donation came with the stipulation that the residents of the village educate themselves and adopt Bitcoin as the primary means of exchange, essentially creating a circular economy based on the cryptocurrency.
Though many of the villagers did not have bank accounts of their own at the time of the donation, they were able to adapt to using Bitcoin by accessing the virtual currency through Bitcoin ATMs or through exchange platforms on their mobile phones. The experiment was relatively successful, and today El Zonte is known as the ‘Bitcoin Beach’ and cited as a successful example of an economy where Bitcoin is treated as legal tender.
Following the success of the village, President Nayib Bukele decided to draw up and implement the ‘Bitcoin Law’, which would make Bitcoin legal tender in the country. Bukele stated that this would help underbanked citizens (i.e., citizens who may not be able to open or operate their own bank accounts and hence access bank-related services) partake in making digital transactions due to the ease of buying and trading in Bitcoin, as well as make it easier to make cross-border transactions. The Legislative Assembly of El Salvador adopted the act on June 9, 2021, and hence El Salvador’s tryst with the cryptocurrency Bitcoin came into being.
The road to implementation, however, was a long and difficult one. Though the government had prepared $150 million in cash reserves to back the Bitcoin it intended to put in circulation; it faced criticism for its decision from both its people as well as other countries. It was also denied assistance from the World Bank, which stated that increasing the use of cryptocurrencies to such extents was extremely harmful because of its volatility and the effect of large emissions caused by Bitcoin mining on the environment. Though President Bukele announced that the country would be making efforts to undertake Bitcoin mining using geothermal energy, this would not be implemented until much later, which would still result in considerable amounts of fossil fuel emissions till then.
The more troubling aspect of the law, however, was the volatility of Bitcoin, which many financial professionals deemed to be extremely harmful to El Salvador’s still developing economy. Experts stated that the economy was still not yet strong enough to withstand certain challenges and risks associated with sudden changes in the value of cryptocurrencies. Other factors like cryptocurrency manipulation and phenomena like crypto winter may also prove to be detrimental to the economy. Unlike fiat currency, the factors behind these changes cannot be controlled by the country but are rather in the hands of the investors, making them unpredictable and dangerous.
Many experts also warned that becoming too reliant on cryptocurrency would make it easier for money launderers and criminals to move funds without detection. Cryptocurrencies, including Bitcoin, pride themselves on their privacy and anonymity features and are also extremely difficult to track due to information being stored on blockchains.
Impact of the ‘Bitcoin Law’
After adopting Bitcoin as a legal tender, the government of El Salvador declared that all businesses make provisions to accept Bitcoin as a form of payment. However, it seems that the population of the country itself remained wary of the currency, as it was reported that months after the launch at least 91% of citizens still preferred to use the US dollar to make transactions.
The value of Bitcoin also infamously decreased by almost 45% around November 2021, which cost El Salvador at least $22 million in its National Reserves, as well as caused heavy damage to the businesses and individuals who were using it as their primary means for making transactions by that point. Many users began to give up on Bitcoin and revert to using cash- which had the complete opposite effect that the government was hoping for by passing the Bitcoin Law.
Though almost the entire population of El Salvador was reported to have signed up for its digital wallet- Chivo- after being encouraged to do so by a $30 sign-on bonus, only 14% of its users admitted to having actually used it for making transactions, with the rest ceasing to use it after cashing out on the bonus. The lack of transparency regarding the Act as well as fear due to volatility, prevented the majority of the population from going all in and adopting its use. Many people were dissuaded from using it after the Bitcoin recession in late 2021, which caused many to lose their hard-earned savings.
The plans of constructing a Bitcoin City at the base of the Conchagua volcano, which would encourage Bitcoin mining using geothermal energy, were also postponed after complications brought on by the Ukraine-Russia war. The value of Bitcoin also decreased by around 50% following the 2021 Bitcoin crash, which caused the country to put many of its public funding projects on hold until the value increases again.
Conclusion
El Salvador recently became the first country in the world to adopt Bitcoin and legal tender in the hope of becoming a Bitcoin Hub. It encouraged local businesses and individuals to begin trading using Bitcoin instead of its official currency, the US Dollar, in the hopes that it would help increase the ease of making cross-border transactions and encourage citizens to educate themselves on digital transactions. However, the Bitcoin Law was widely criticized due to the impact of Bitcoin mining on the environment as well as other detrimental factors, including the volatility of the virtual currency.
However, despite the backlash, El Salvador decided to adopt Bitcoin as a form of legal tender. The infamous Bitcoin crash of 2021-2022 quickly proved why it was an extremely risky idea, with the price of Bitcoin falling by almost half and causing mass panic among those who had adopted Bitcoin as their primary method of transacting. Many people were still also wary of the change and did not respond well to the government’s efforts to promote Bitcoin usage. Hence, El Salvador’s efforts to become a cryptocurrency-friendly country did not go as well as planned, with its economy showing signs of being in dire straits merely a year after implementing the Bitcoin Law.
