El Salvador: a safe haven for Bitcoin? Economy and ecology

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High waves and a relaxed atmosphere that were the hallmarks of El Zonte, a little surfers paradise on the Pacific in El Salvador. But over the past couple of years a very low-key experience has unfolded and has now taken hold in the spotlight of the world. In this fishing village, you can pay for your coffee with bitcoin or use it for shopping at the corner store.

It competes with the US dollar, which has been the country’s official currency since 2001. In El Zonte, young people and a few entrepreneurs in particular are excited about Bitcoin. Others, however, considered it all to be an exotic craze until President Nayib Bukele legalized bitcoin overnight in early June. But what prompted him to take this step?

The history of Bitcoin in El Salvador

The search for clues leads to Mike Peterson, a Californian surfer, who moved to El Zonte in 2005. The staunch Christian set up a youth project called Hope House and trained lifeguards, among others. Around two years ago when Bukele took office, he told the Los Angeles Times that he was contacted by an anonymous donor who had promised him $ 100,000 in bitcoins on condition that the money was distributed to the population and becomes El Zonte. in a bitcoin lab.

From that point on, Hope House distributed bitcoins to pick up trash, to get good grades, and for residents who fell ill or unemployed during the pandemic. Local businesses accepted the bitcoin after Peterson’s painstaking efforts to convince them. Hope House even installed a bitcoin machine where you can use an app to exchange dollars for bitcoin or to get credit for transferred bitcoins or have them paid in dollars.

The experiment solved practical problems. Many Salvadorans who live in El Zonte receive dollars from relatives in the United States. But there is no bank branch in the village. Half of Salvadorans don’t have a bank account anyway, so they withdraw money for high fees from intermediaries like Western Union. To do this, they had to drive from El Zonte to the neighboring village.

Many Salvadorans who live in El Zonte receive dollars from relatives in the United States. But there is no bank branch in the village.

For young people, bitcoin was the entry into the financial world, into concepts like saving and investing. The $ 100,000 converted into bitcoins flooded the village with cash. The experiment worked in a similar way to how solidarity currencies work all over the world, as it set in motion a local circular economy.

Bitcoin insiders suspect the figure behind it could be cryptocurrency guru Jack Mallers. Mallers has developed, among other things, Strike, an app that allows people to pay and receive bitcoin and then immediately exchange it for a virtual dollar-linked stablecoin called Tether, thus guarding against fluctuations. The Los Angeles Times learned that Yusuf Bukele, the president’s brother and advisor, contacted Mallers in February. They met and discussed a bitcoin law. Four months later, the country the size of Israel became the first in the world to legalize bitcoin.

Bukele, the trendy president

Many initially thought it was a publicity stunt by the impulsive head of state. Bukele has been ruling since 2019 and has a reputation for being fashion conscious and cultivating his millennial nonchalant image. His Bitcoin announcement at the Bitcoin Congress in Miami on June 5 was surprising. After China previously banned cryptocurrencies and closed bitcoin farms, legalization in El Salvador was good news to cushion the fall in prices.

Three days later, the bill was presented to Congress and passed the next morning. From September, Salvadorans will be able to pay their taxes in bitcoin and use it to shop at the supermarket. A state trust fund worth $ 150 million is meant to absorb currency risk and, if traders wish, immediately hedge bitcoins back into dollars. In addition, Bukele wants to grant bitcoin investors a golden visa and exempt them from capital gains tax.

Bukele makes two arguments in favor of bitcoin. First, the cryptocurrency has a market cap of $ 680 billion. If one percent of that amount is invested in El Salvador, our GDP would increase by 25 percent, he said, referring to mining farms now looking for other locations after the ban in China. But that’s only the case if bitcoin generates new added value, say experts like John Hawkins. For many investors, however, bitcoin is just a way to store value.

Some 1.5 million Salvadorans live in the United States alone, and last year they sent nearly $ 6 billion to their families back home. It is 20 percent of the country’s GDP.

Bukeles’ second argument targets a sector that has been in the crosshairs of alternative financial service providers for several years: migrant remittances from abroad. These represent a billion dollar business around the world. Some 1.5 million Salvadorans live in the United States alone, and last year they sent nearly $ 6 billion to their families back home. It is 20 percent of the country’s GDP.

However, not even half of Salvadorans have a bank account, as account management and transfer fees are high. The rest use money transfer services. But even these collect between $ 4 and $ 50, depending on the amount transferred. It is a lucrative business especially for international and local elites. Bukeles’ narrative is that, for the benefit of the poor, he wants to cut off the flow of money to these elites.

The Salvadors Remittance Problem

The problem is real and has preoccupied institutions such as the World Bank in the past, but has also fueled windy business ideas such as Wirecard. At first glance, bitcoin as a transfer looks appealing: transferring money through an app in just a few seconds. But on closer inspection, it’s a pipe dream. Hawkins writes that only 33 percent of Salvadorans have access to the Internet. How many street vendors or farmers are technically equipped for Bitcoins? He asked.

The argument that bitcoin transfers are free is also wrong, according to financial expert Steve Hanke. Fees would be charged for virtual Bitcoin transactions over the internet or for exchanging them for dollar cash that would end up with app developers like Mallers instead of banks. Additionally, there are some familiar issues with cryptocurrencies, such as high volatility. Bitcoin fluctuated between $ 58,000 and $ 31,000 last month. In a country where 35% of the population lives below the poverty line, such fluctuations can trigger social disasters. The $ 150 million in public funds seems small compared to the total amount of remittances.

Bitcoins are a form of payment, but there is no credit market for them. Economic development will therefore be difficult, said financial expert Carlos de Sousa. But right now, the heavily indebted state needs new capital to deal with the pandemic. However, this is now under threat. The IMF, with which El Salvador is negotiating a $ 1 billion loan, has called the bitcoin law an incalculable risk. The World Bank refused to help El Salvador implement it.

Bitcoin fluctuated between $ 58,000 and $ 31,000 last month. In a country where 35% of the population lives below the poverty line, such fluctuations can trigger social disasters.

International investigators are concerned about the law as a possible gateway for money laundering, especially as El Salvador has just pulled out of a regional anti-corruption deal and is a hub for cocaine smuggling. Attracting international tech entrepreneurs is one thing; attracting money launderers or international tax evaders is another, warned Julia Yansura of the Global Financial Integrity Institute in Washington.

Experts fear that the public fund has no way of determining the origin of bitcoins. Presumably, it will be exploited at very short notice and not by Salvadoran street vendors. Against this background, the evidence of covert negotiations between the government and the country’s criminal gangs inspires very little confidence. And there is also the fact that one of Bukeles’ advisers, Jos Lus Merino, is himself under investigation for drug and arms trafficking.

That being said, there are two reasons why Bukele embarked on this adventure. He is under increasing pressure from Washington because of his authoritarian behavior and the corruption of his administration. Although there is currently no threat of sanctions, they cannot be ruled out in the future. And therefore, the US dollar is tantamount to a straitjacket. Bitcoin would make it easier for Bukele to circumvent possible US sanctions.

The second reason is economic. Bukeles’ high popularity of 90 percent is based on a policy of generous government spending without tax increases. However, due to the peg to the dollar, the growing deficit cannot be offset by the printing press. And government debt securities are also subject to a higher and higher risk premium, which becomes more and more expensive for the government.

The IMF loan would be a lifeline. But if that fails due to resistance from the United States, for example, bitcoin could be a Plan B. Bitcoin critic David Gerard considers all of this to be the pipe dream of libertarian tech maniacs who are out of touch with it. reality and who play politically with fire. . I’m pretty sure Bukele and the bitcoiners who sold him this scheme are each convinced they are going to be wrong. It is possible that both will lose, of course.

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