El Salvador’s Bitcoin experiment

As the first country to adopt Bitcoin as a legal tender, it is of no surprise that El Salvador has made headlines in recent weeks. Partnering with a digital wallet company, Strike, the adoption of bitcoin technology is with the aim of building financial infrastructure in an otherwise poverty-stricken nation. President Bukele of El Salvador hailed this as a ‘historic step towards financial inclusion,’ with the country’s legislature passing this historic bill with just under 75% of the possible votes at the start of June 2018, having come into effect in mid-July. Whilst an orthodox move, to say the least, the adoption of the cryptocurrency as a legal tender will likely bring much needed financial development to a country where over 70% of Salvadorians lack access to basic financial services.

Share of Salvadorians with a Bank / Mobile Money account

Background

El Salvador remains a largely cash economy, even in the digital age, with 70% of the population without bank accounts. The Salvadoran colon was introduced in the late-1800s as the currency of El Salvador. It was initially pegged to the US dollar, at an exchange rate of 2 colones to 1 dollar. However, El Salvador let its currency value be determined by market forces, following the withdrawal from the Gold Standard in 1931. This move was largely due to the ripple effects of the Wall Street Crash in 1929, which were felt globally. El Salvador too experienced their own ‘Great Crash’ which was a disaster for their financial system at the time. Following a military coup in 1931, the military held control of the nation’s economic institutions until 1979.

The Salvadoran colon was abandoned in 2001, with the nation instead adopting the US dollar. According to Mr Barraza, the director of El Salvador’s Central Bank at the time, this move was primarily initiated to attract foreign investment in the country. Additionally, reducing El Salvador’s real interest rates was also a big factor in this move towards dollarisation, with excessive levels of inflation felt by neighbouring countries such as Ecuador, totalling nearly 30% during the early 2000s. A conversion rate of 8.75 colones to 1 US dollar was aptly announced, with the adoption of the dollar relieving the Central Bank of El Salvador of all responsibilities.

A move towards Bitcoin

El Salvador’s economy is heavily reliant on remittances – money sent home from abroad; they totalled 20% of GDP in 2019. However, this is a highly regulated process, rendering sending funds home as complicated and unnecessarily cumbersome. Thus, the adoption of Bitcoin as a legal tender is a move to try to rectify this, as anyone with an electronic device can easily send money home digitally.

In addition, Bitcoin wallets safely protect funds digitally. Whilst the safety of money may not appear to be an issue in many Western economies, given the poverty that exists in the South American continent in nations such as El Salvador, the threat of theft and mugging is much more apparent. For example, the murder rate in El Salvador lies 10x higher than that of the US, per 100,000 people. Given the use of a pin or password on these digital wallets, they remain a much safer option in terms of storing money, than in physical cash.

With this said, the volatility of Bitcoin will undoubtedly be of concern for many Salvadorians. Bitcoin has dropped just under 50% from its peak value of $64,000 US dollars in April 2021, at the time of writing. This volatility affects the confidence of consumers and thus fluctuations in the price of Bitcoin could heavily affect economic growth in El Salvador, due to the volatility’s impact on spending.

El Salvador’s future

Overall, the adoption of Bitcoin as a legal tender is a net positive for the South American nation. Whilst there are undoubtedly drawbacks – volatility a notable one, given the economic situation of El Salvador with a vast majority without bank accounts, a move towards Bitcoin will allow for more Salvadorians to participate in the financial market, thus progressing the economy of El Salvador in the process.