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El Salvador may have just become the world’s largest currency testing ground. The country officially adopted bitcoin as a legal tender, as its bitcoin law, which was passed in June, becomes effective Tuesday.
Bitcoin
BTCUSD,
can now be used to settle transactions and pay taxes in the Central American country.
Since the plan was first announced, the country’s landmark, full-throttle shift into the world of crypto has drawn equal parts of curiosity, excitement and doubt, as the world now turns to a country, with a population of 6.5 million and a gross domestic product of about $25 billion, as of 2020, for clues on how digital currencies might move from niche asset to official monetary unit.
Salvadorans are referring to it as “Bitcoin Day,” and so far the start has been as turbulent as skeptics might expect, as the government disconnected its Chivo wallet, a digital wallet for bitcoin transactions, due to technical glitches. The administration earlier promised $30 incentive worth of bitcoin for anyone who signs up for the app.
President Nayib Bukele also has posted several tweets seeking user feedback.
To smooth out the adoption, El Salvador bought 200 bitcoins on Monday, and another 150 on Tuesday, pushing its total reserves to 550 bitcoins, President Bukele tweeted.
The country, about the size of New Jersey, passed a law in late August to establish a $150 million fund to facilitate transactions from bitcoin to U.S. dollars. It also has been installing 200 ATMs and 50 consulting centers across the country for Salvadorans to withdraw cash in U.S. dollars.
What it means for bitcoin prices
Bitcoin dropped almost 19% on Tuesday after it rose to nearly $53,000, the first time since May. The cryptocurrency was trading at $46,967 recently, down 9.4% during the past 24 hours, CoinDesk data show.
“The news may be priced in already,” David D. Tawil, president and co-founder of crypto asset fund ProChain Capital, told MarketWatch in a phone interview recently. “There are certainly going to be both positive and negative stories that come out of El Salvador over the next period of time,” Tawil said.
Some analysts are bullish on the news in the longer term. “The impact of El Salvador adopting BTC is broadly priced into the Bitcoin story, but other developing countries following in their wake are not,” Kay Khemani, managing director of Spectre.ai, wrote in an email. “This creates a series of potential and positive catalysts for long term adoption.”
Politicians in countries such as Paraguay, Panama and Mexico have expressed some support of embarking on their own bitcoin experiments.
Financial freedom?
Supporters of El Salvador’s bitcoin move have been focusing on the cryptocurrency’s potential to help the country’s unbanked community, which accounts for about 70% of the population, according to the World Bank’s data.
“Crypto can lower geographical barriers to entry, and can enable people within the least developed countries to access financial services,” Alexander Filatov, co-founder and chief executive officer at TON Labs wrote to MarketWatch via email.
However, only 33.8% of individuals used the Internet in El Salvador as of 2019, according to data from the World Bank.
President Bukele said bitcoin would also help the country save Salvadorans $400 million annually in remittance fees. The country received $6 billion from abroad in 2020, which accounted for 24% of its gross domestic product.
Adopting bitcoin as a legal tender may also help a country reach currency stability, especially for those without political stability, according to Tawil, who believed that El Salvador’s adoption of bitcoin is “revolutionary.” Despite bitcoin’s current volatility, broader adoption will help stabilize the cryptocurrency’s price in the long term, Tawil said.
Obstacles and risks
Some economists are concerned about the challenges that Salvadorans face in transacting in bitcoin.
“It’s natural that merchants and sellers of goods would not want to accept bitcoin, because it’s so volatile,” said Ariel Zetlin-Jones, an economics professor at Carnegie Mellon University.
“So what I can envision happening is, some people have bitcoins, they spend them at the store, the store converts with the El Salvadoran government into dollars,” Zetlin-Jones said. “So all that risk is now borne by the El Salvadoran government.”
The country’s move has thus drawn doubts from analysts at International Monetary Fund, or IMF, from which El Salvador has been seeking more than $1 billion financing.
Tobias Adrian and Rhoda Weeks-Brown, analysts at IMF, wrote in a July blog post that choosing cryptocurrencies as legal tender could post “substantial risks” to a country’s macro-financial stability, financial integrity and the environment, among others. The views may not necessarily represent the views of the IMF and its executive board, the blog post noted.
“Attempting to make cryptoassets a national currency is an inadvisable shortcut,” Adrian and Weeks-Brown wrote.
In July, credit rating agency Moody’s downgraded El Salvador’s rating to Caa1 from B3, citing various reasons including the bitcoin law. A Caa1 rating, equivalent to CCC+ at S&P Global Ratings and CCC at Fitch Ratings, is a noninvestment grade rating that signifies substantial risk of default by the debt issuer.
The bitcoin law will likely be a credit negative for local insurance companies “with exposure to the newly established currency due to higher [currency] and earnings volatility risk as well as additional regulatory and operating risk considerations”, Fitch wrote in an August report.
“There’ll definitely be hiccups and bumps along the way, I have no doubt. Even with a country as small as El Salvador,” ProChain Capital’s Tawil said. “Thankfully, this is not being tested in a gigantic country, where I think those problems get amplified.”
