What’s behind El Salvador’s bitcoin leap of faith?

El Salvador surprised markets by passing a law that makes bitcoin legal tender, just like the US dollar, making the country the world’s first to take such a step.

Analysts and cryptocurrency experts are scrambling to assess the implications, potential market consequences and if the bet to institutionalize the world’s most famous, unregulated and decentralized cryptocurrency will set precedents elsewhere.

“El Salvador now became a big trial balloon. For the next six months, the world will be looking to the country to evaluate this experiment,” Rudá Pellini, CEO of US-based Wise&Trust, which is specialized in digital asset investment funds, told BNamericas.

Under the terms of the bill overwhelmingly approved in congress, bitcoin may be used in any transaction, and any business with the required technological capacity will have to accept it.

Bitcoin will be used alongside the dollar, which has been the country's official currency since 2001.

Pellini said by adopting bitcoin El Salvador is trying to move away from its reliance on the US dollar and the related lack of monetary sovereignty. But trading and using bitcoin is not so simple either, Pellini said. 

“The big question in terms of adoption is: 'will people prefer bitcoins to dollars?' Because if citizens have the dollar option, maybe nothing will happen and it will all have been a marketing stunt by the president [Nabil Bukele] to attract capital and investment to the country.”

This assessment is based on a measure that grants foreign crypto entrepreneurs permanent residency in El Salvador. And the state offers tax exemptions for capital gains in dollar and will also do so in bitcoin. El Salvador is also among the few countries that don’t have property tax.

“[Bukele] seems to be willing to transform El Salvador into a tax haven, more than in a cryptocurrency hub,” said Pellini.

But bitcoin fluctuates significantly, lacks price stability and liquidity unlike traditional currencies. That means bitcoin is not a solution if El Salvador wants to gain monetary control.

Bukele expects bitcoin to become an accessible financial platform for citizens who lack a bank account, which is around 70% of the population of 6.5mn.

But as digital asset bitcoin requires large-scale internet penetration – which El Salvador lacks. And even prolific internet users often don't have the digital literacy to facilitate widespread use of bitcoin.

According to the World Bank, a little over 33% of the population were internet users in 2017, the latest data available.

Institutional assessment

Global banking institutions are equally skeptical.

“We have been clear at the [Bank for International Settlements] BIS that we don’t see bitcoin as having passed the test of being a means of payments. Bitcoin is a speculative asset and should be regulated at such,” Benoît Cœuré, the bank’s innovation head, was quoted by Reuters as saying.

In November 2018, Cœuré said bitcoin was the “evil spawn of the [2008] financial crisis.”

Yet he admitted that El Salvador’s initiative was “historic” and an “interesting experiment.”

Meanwhile, IMF spokesman Gerry Rice said during a press briefing on Thursday that adoption of bitcoin as legal tender “raises a number of macroeconomic, financial and legal issues that require very careful analysis.”

He added, “what we have said in the past in general is that crypto assets can pose significant risks and that effective regulatory measures are very important when dealing with them.”

Rice said the IMF was “following developments closely and will continue consultations with the authorities.”