El Salvador’s Bitcoin Act: A Thin Line Between a Miracle and  Doom

By Gustavo A. Maranges on January 11, 2022

photo: presidential twitter

Latin America’s economic landscape in 2021 was marked by the heavy impact of COVID-19 in the main economies of the region. Countries like Argentina, Mexico, Venezuela, Colombia, and Panama were unable to overcome the Gross Domestic Product (GDP) fall of 2020. It determined that the regional growth of 5.9% was not enough to restore the pre-pandemic levels, which will only happen after 2023, according to the Economic Commission for Latin America and the Caribbean’s (CEPAL) last report.

Given the current situation of the pandemic, and the many challenges it poses to the main regional economic activities, many countries, especially the small ones, looked for new ways to recover the pace. Venezuela introduced new monetary measures; Perú focused on rising  public expenditure, and some other countries relaxed their tax policies. However, the most resounding case came from Central America, where El Salvador became the first country in the world to entitle Bitcoin (BTC) as a legal course currency. The Salvadoran Bitcoin Act sounded the alarms not only in Latin American countries but in monetary and financial institutions like the International Monetary Fund (IMF).

The possible result of the measure is as uncertain as the cryptocurrency’s value because there is not a single precedent. Therefore, voices are rising for and against the two-sheet law, which was passed in a brief congressional session of only 5 hours. Something that only happened because the government coalitions (New Ideas and Gana parties) in the Salvadoran parliament hold the majority of seats.

Just four months have passed since the law was enforced on September 7, 2021. So many argue that it is not enough time to evaluate the success or fail of this strategy. However, by analyzing the current conditions of the Central American country’s economy, we can get closer to the answer to this dilemma. But, before getting into it, it is necessary to know what BTC and cryptocurrencies are all about.

BTC is the main cryptocurrency in the market and is backed by almost 1 trillion dollars in investments. Cryptos are decentralized and digital or virtual currencies secured by cryptography. So, anyone who has the capacity to mine it, which is not common at all, can generate it. Crypto’s exchange rates are very volatile, turning them into one of the most speculative businesses these days.

According to El Salvador’s President Nayib Bukele, the law will help informal workers, who account for 70% of the country’s labor force. These people do not have a bank account, which places them in unfavorable conditions to obtain to credit cards and other services. Moreover, adopting the BTC as an official currency will also benefit those who send remittances to the country, who have to pay up to 30% of commission fees for an activity accounting for 20% of the GDP.

From a macroeconomic view, the law aims to attract foreign investment from bitcoiners (people who own large amounts of BTC). If only 1% of BTC capitalization were invested in the country, the GDP would grow a 25%. Bukele said these perks will be evident in a 10 year timeframe, but this is not convincing enough for a county with 26.2% of the population below the poverty line, who need urgent actions to face the harshness of their economic environment.

According to a survey by the Centro American University (UCA), less than 5% of the people in El Salvador understand what is BTC is and they can use it, meanwhile 68% have said they disagree with the government’s decision. Even when this poll only used a small sample of 1.000 people, its results match with the country’s reality, since many protests are taking place across the country to demand the abolition of the Act, and commerce and market sellers do not want to accept BTC.

Understanding cryptos is even hard for financial experts, so it is easy to imagine how it would be for a country where 48% of the working population has only reached a basic level of education. In order to narrow the knowledge gap, the government created a team of 4000 people to offer technical support to the whole country, but this has not cleared the worries on this issue.

The most defying obstacle for this strategy to benefit people is internet access. El Salvador is the third country with the lowest internet penetration on the continent. Only 57% of the population uses the internet, and most of it through mobile access. In the countryside, where the economic situation is most concerning, the number reduces to a critical 10%, meaning that the people in the most need will have few benefits from this measure.

Another technical condition undermining the Bitcoin Act’s success is the lack of Crypto ATMs, which are the easiest way to exchange cryptos for cash, and the only one for those who do not own a bank account. The government announced the installation of 200 ATMs of that kind in the country and another 50 in the US, but four months after the decision, the deployment remains incomplete.

Moreover, people also needed to have the official crypto-wallet named “Chivo-Wallet”, which has presented several errors, entangling the assimilation process of cryptos in the daily economy even more. Official sources wanted to cover this situation by celebrating the incredible number of 3 million downloads in the first month, but they curiously forgot to mention that this may be biased by a 30 dollars gift (in BTC) to each user.

Bukele has marketed his proposal by stating that BTC transactions will not be charged with income taxes. He also announced the creation of Bitcoin City, where everything will be paid in BTC, while the only existing tax will be the Value Added Tax (VAT). This kind of announcement found opposition from some international regulatory entities. The Bank of Spain issued a report criticizing Bukele’s move, and the IMF has not come out favorably either.

Among the strongest arguments quoted by these institutions is the volatile nature of BTC value, which fell 17% (1-million-dollar losses) the same day that the Act was passed, proving the threats it poses for a small economy. Another concerning fact is the enormous risk of turning El Salvador into  tax haven or the perfect place for terrorists and the mafia’s money laundering. At this point, it is also worthy to note that, regardless of the accuracy of the comments, those organizations are among the biggest enemies of cryptos, since they represent an alternative to the current and heavily centralized international financial order. Thus, the success of this policy is the worst news they could ever receive, which means they will not spare efforts to make it fail.

All this has ended up deteriorating El Salvador’s financial risk rating qualification from “stable” to “negative,” according to the US financial services risk rating agency Standard and Poor. Now, the country will have to pay higher fees and interest rates because, whether we like it or not, this kind of institution is still in control of the world’s finances. Meanwhile, Bukele remains firm in his intentions and recently announced the purchase of another 150 BTC, raising the national reserves to 750 BTC.

Maybe the strategy is not that crazy after all, but it is also true that the conditions are not the best ones to succeed. The haste to implement the changes may put a cost on a lot of people who have been heavily affected by the pandemic. Despite the official discourse line and efforts, only 10% of people use BTC to pay for goods or services BTC, showing that the solutions carried out so far are not effective enough. Then, in the short run, the Bitcoin Act will only benefit a small group of people while exposing most of the population to huge risks without getting the alleged benefits back.

Source: Resumen Latinoamericano – English