Crypto, a Boom or Bust for El Salvador’s Economy

Written by Gaurika Anand

On September 7, 2021 President Nayib Bukele adopted Bitcoin as legal tender as a “path to financial freedom” in El Salvador. This major change has come with a polarized reaction and it seems as though there are strong arguments from each side. 

Adopting cryptocurrency may be a strategic move considering the circumstances which shape El Salvador’s economy. The country has been under the burden of the US dollar since 2001. Although reliance on the dollar has helped to stabilize the Salvadoran economy, the dollar does not permit financial freedom. The economy has to follow monetary policy decisions dictated by the United States, which might necessarily not always coincide with Salvadoran economic interests. With international remittances accounting for ⅕ of El Salvador’s national GDP, transaction costs incurred sending money home are unprecedentedly high. Part of the reason to adopt bitcoin was to avoid these costs. 

In order to back the crypto-based economy, an app called “Chivo” has been developed with strong approval ratings from the government of 85%. The app, along with certain ATMs and financial centers, can exchange the dollar for bitcoin and this app works so each download remits a $30 bitcoin bonus. 

Currently, over 3 million people actively use Chivo, which is more than half of the population of the country, reflecting a positive public response. The Salvadoran Foundation for Economic and Social Development reported that 12 percent of consumers are using cryptocurrency for their daily transactions. Despite technical hiccups with the administration and technicalities of the application “Chivo,” Salvadorans seem to respond optimistically to cryptocurrency. Although, it is important to note that many analysts question the reliability and sustainability of a financial system based on digital currency. 

Although cryptocurrencies have proven volatile to-date, the reform might, in effect, stabilize the Salvadoran economy in the long-run. Accounting for a fifth of El Salvador’s GDP, remittances have proven costly with transaction fees amounting to 7-8 percent. The free cryptocurrency market will help reduce these costs, and hence, leave households with more disposable income. In line with this, the Chivo network had around 24,000 remittances in one day by mid October. Moreover, in an economy where 70 percent of the population do not have bank accounts, adoption of bitcoin coerces a large sum of the population to digitise their everyday transactions. Digitisation of blockchain technology, which will be a by-product of bitcoin, will help keep track of the money trail and deter financial fraud. The developing economy already uses the US Dollar as a currency, which can mean less freedom in terms of monetary policy. Hence, adding bitcoin as a legal tender can lighten the burden of the US Dollar under which El Salvador has operated for decades. 

That being said, the move to using Bitcoin is not without its flaws. A cup of coffee that costs you a bitcoin today might cost you $1/6000 bitcoin after a week. Demand and supply dictate the value of cryptocurrency, which makes it a poor store of value. The absence of a floor or ceiling, or any government regulation permits wild fluctuation on a daily basis for digital currency.  While conversions can be made automatically in a digitised economy, accounting for fractions is the hard part for most businesses especially those that have just started out. Volatility of bitcoin also questions the four functions of money: medium of exchange, unit of account, store of value and standard of deferred payments, which many economists live by. The non-regulated market for cryptocurrency can prove to be a siphon for black money. While blockchain technology can keep track of every bitcoin, developing a robust and trustworthy system would take time and resources and fraud could happen in the meantime.

How do you regulate a currency whose exchange rate goes from $6 to $60000 in under a week? How will the Salvadoran economy account for volatility? How do you regulate a market that is characterized by a lack of regulation? How will the government fund the maintenance and inception of Chivo? The long term benefits and costs are still unknown but these unanswered questions expose the immense amount of grey area in El Salvador’s decision to unilaterally accept cryptocurrencies.