El Salvador’s crypto foray has a cautionary tale

[ad_1]

It will be fascinating to see how this experiment plays out in practice and central bankers around the world will be able to assess the difficulties that arise in practice if bitcoin is used for a high volume of micro-transactions.

The small Central American nation of El Salvador has embarked on an interesting experiment by recognizing bitcoin as legal tender.

This is proving painful for many of its citizens, but it is a useful “pilot” project for large economies considering the peculiarities of this new asset class.

El Salvador has a population of 6.5 million and a GDP of approximately $ 27 billion.

With a nominal per capita of less than $ 4,200, it is not a rich country.

In 2001 he “dollarized” which is a traditional Latin remedy for high inflation.

He replaced his currency, then the colonist, with the USD.

This month, at the behest of its president, Nayib Bukele, who is a crypto enthusiast, he also adopted bitcoin as legal tender.

This means that it now has two parallel legal currencies, USD and Bitcoin.

He created a government wallet for Bitcoin, called Chivo.

Each citizen received a $ 30 bitcoin grant, which they could download from Chivo to their wallet to encourage adoption.

Some 200 new ATMs are being installed to convert dollars into bitcoins.

The new law means that every business must accept bitcoin as legal tender for goods or services, unless they are unable to provide the technology needed to process the transaction.

The adoption has caused turbulence in the cryptocurrency market and does not appear to have been well received in El Salvador itself.

The value of bitcoin fell 19% on September 7, the first day of adoption.

Chivo has been overwhelmed with users trying to register.

There have been riots and demonstrations against the new currency.

Most citizens do not want to accept crypto in normal transactions.

They are naturally reluctant to own an asset, the value of which often fluctuates 10% during an average day and 25-30% during “swing sessions”.

The spread of interest paid by El Salvador on its national debt over US Treasury rates has widened.

Credit rating agencies downgraded El Salvador after the bitcoin plan was announced in July.

The rationale for adopting bitcoin, according to Bukele, is that it could help give unbanked residents better access to financial services.

Importantly, it can also reduce transaction costs for small cross-border remittances, which constitute 20 percent of El Salvador’s GDP.

Some 2 million citizens live abroad (mostly in North America) and send more than $ 4 billion annually.

The government estimates that bitcoin remittances could save the country $ 400 million a year in transaction fees.

Independent estimates suggest it would be closer to somewhere between $ 150 million and $ 200 million.

All of these estimates have large error factors given the volatility levels of bitcoin.

Bitcoins are created by solving complex mathematical puzzles (“mining” in crypto lingo) and verifying transactions made in the currency on an open electronic ledger called the blockchain.

While this is, in theory, something anyone can do, it requires enormous amounts of energy to run the specialized servers used in practice for this task.

Bitcoin mining consumes more electricity on a daily basis than Belgium.

It is therefore not ecological.

This is one of the reasons why China has proposed cracking down on cryptocurrency.

However, various bitcoin mining consortia are trying to set up operations using renewables or geothermal energy, which could make mining greener.

Another problem is that the money supply grows at a fixed rate, and every transaction recorded on the blockchain involves a single bitcoin.

This makes it difficult to carry out normal loan transactions.

Fractional reserve banking is difficult except by converting every transaction into fiat currency before lending, and converting it back when servicing the loan.

This means accepting massive risks on the exchange rate.

This process will be doubly delicate in El Salvador, which relies on the US Federal Reserve for variations in the money supply in its “other” currency.

The Fed is highly unlikely to change its monetary policy for the good of the tiny republic in Central America.

On the other hand, we will get an idea of ​​how crypto works as it is used in normal daily transactions.

McDonald’s, local grocery stores, taxi services, etc. have started accepting bitcoin in El Salvador, and it is estimated that around 10% of daily transactions in value are now done in bitcoin.

It’s not a problem to make small transactions because each bitcoin can be broken down into one hundred million unique and equal pieces of code (each called Satoshi, after the mysterious creator of the algorithm).

But it can take a long time for a transaction to be recorded and verified on the blockchain as it needs to be confirmed by multiple blockchain-watchers.

One of the barriers to adoption is the lack of understanding and another is the lack of technology.

In a local survey, less than 5% of Salvadorans said they understood how bitcoin works and 68% were against adoption.

Transactions are difficult without a smartphone, and smartphone penetration is less than 40%.

Local businesses cite this as a reason to avoid bitcoin adoption.

It will be fascinating to see how this experiment plays out in practice and central bankers around the world will be able to assess the difficulties that arise in practice if bitcoin is used for a high volume of micro-transactions.

[ad_2]