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Implications of El Salvador’s tryst with Bitcoin

Two important races in digital money were won by unlikely winners: El Salvador and the Bahamas. El Salvador was the first to allow Bitcoin to be legal tender, while The Bahamas became the first nation to issue a digital currency central bank (CBDC).

Legal tender is the ability to make Bitcoin payments freely and that the receiver cannot reject payments in Bitcoin. Although the race to the CBDC has been ongoing for some time, there is no similar race for Bitcoin. Although the race to legalize Bitcoin was a huge opportunity in many ways, it remained a barren field. How should we view this policy after El Salvador became the first to race the track?

A little background information is necessary before we get into the details.

Satoshi Nakamoto, in 2008 after the Lehman Brothers crisis, created Bitcoin as a peer to peer payment system. It was created to be a currency and payment system that used cryptography, without the need of a central bank or banking system. This idea led to private cryptocurrencies that became more like crypto assets, and no longer served the currency function. These trends were mostly ignored by the central banks.

With the introduction of Libra, a Facebook-backed stable currency, the game was changed in 2018. Central banks began to look at creating their own CBDC. The Bahamas won the race and dubbed its digital currency “Sand Dollar” — a digital representation for the Bahamian Dollar.

El Salvador’s experiment in this area is very interesting. While others have been experimenting with CBDCs and private-issued Bitcoin, El Salvador allows them to circulate alongside the US Dollar (USD), its currency. El Salvador adopted USD in 2001 as its official currency. Salvadoran Colon was named after Christopher Columbus, and Salvadoran Colon was named after Cristobal Colon. One option to reduce high inflation in economies is to adopt stable currencies like USD. This will allow for inflation that is similar to the US. This is evident in the following figures. The average inflation rate in El Salvador between 1980 and 2000 was 14%, while it was 4 percent in the US. The average inflation in El Salvador for 2001-20 was 2.27 percent. This is almost the same as the US average of 2.06 percent.

It is quite interesting that El Salvador decided to legalize Bitcoin due to the low inflation rates. In hyperinflation areas like Zimbabwe and Venezuela, we have seen individuals adopt Bitcoin on their own.

It is also remarkable how fast this decision was made. El Salvador President Nayib Bukele tweeted on June 5 about the benefits of Bitcoin for financial inclusion. The draft Bill was sent to Congress by Nayib Bukele, who proposed that Bitcoin be legalized as a currency. The Bill was approved on June 8th, which opened the way for Bitcoin to be legalized in the country within three months. It was fast! This is in contrast to India, where policy regarding cryptocurrency has been ambiguous.

What do you think this decision will look like in the real world of money?

First, Bitcoin was initially created by libertarians who hated the State and its role with money. Ironically, one State approved Bitcoin. It was also done by Bukele, who is considered an autocrat!

Bukele was found guilty of sending soldiers into Parliament in an attempt to intimidate lawmakers who opposed him on a matter of policy. He is young and has promoted himself as an innovator. After the Bitcoin announcement, he changed his profile picture on Twitter. Blue light was seen emanating from his eyes. Experts from El Salvador called this a publicity stunt. El Salvador’s International Monetary Fund (IMF), which has been financially supporting El Salvador, reacted to the announcement by declaring that adopting Bitcoin legal tender will have macroeconomic consequences. The IMF will be closely watching developments.

It is one thing to declare a currency legal tender, but quite another to make it accepted across the country. Because of Bitcoin’s volatility people are more inclined to keep it as an investment than to spend it for general purpose. However, Bitcoin was not accepted by many shops before the law. It will be closely monitored to see how the exchange rate between Bitcoin and USD in the country.

This is third, even if we take into account the first and second points. It’s a small victory in favor of Bitcoin supporters. This day was not expected by many, even ardent crypto supporters. With high volatility and concerns about their use mainly for money laundering or trafficking, cryptocurrencies like Bitcoin have come under increasing pressure. It is amazing to see Bitcoin being declared legal tender in a country under these circumstances.

It is clear that El Salvador and Bukele are causing a stir in money-making circles. It was not something that anyone could have imagined that a small country like New Zealand would be the first to target inflation. Similar developments have also occurred in El Salvador. Many of us will be wondering if other countries will join the Bitcoin market after El Salvador enters the field. Will this be a publicity stunt that is destined to fail like many other stunts by policymakers? These developments will be closely watched by economists.