El Salvador’s adoption of bitcoin as legal tender is a wake-up call

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Many see the bitcoin market, the world’s leading cryptocurrency, as a game of winners and losers between hedge funds, amateur investors, geeks and criminals. It’s best to leave the enormous risk inherent in a highly volatile anonymous digital currency to those who understand the game well, or really don’t care because they can mitigate the risk or absorb the losses. But bitcoin has recently become more attractive to countries and individuals with limited access to conventional payment systems, i.e. those less equipped to manage the underlying risk.

In June 2021, El Salvador became the first country in the world to adopt bitcoin as legal tender, enacting legislation that will take effect in September. This means that bitcoin can be used to pay for goods and services across the country, and recipients are legally required to accept it.

Salvadorians are not new to this type of monetary experiment. The US dollar became legal tender in El Salvador in 2001 and is the currency used in domestic transactions. At that time, the government of President Francisco Flores allowed the dollar to circulate freely alongside the national currency, the coln, at a fixed exchange rate.

Dollar advocates argued that the expected benefits of macroeconomic stability would outweigh El Salvador’s loss of economic sovereignty, monetary independence, and even seigniorage, the difference between the cost of producing coins and banknotes. and their face value. However, purchasing power suddenly plummeted and made the economy even more dependent on remittances, which have averaged around 20% of gross domestic product per year over the past two decades.

The use of bitcoin as legal tender will exacerbate the monetary constraints that dollarization has exposed, including the lack of an independent macroeconomic institutional framework around which to shape national policies. Additionally, bitcoin is much more volatile than the dollar. Between June 8 and June 15, its value hovered between $ 32,462 and $ 40,993, and in the period from May 15 to June 15, it ranged from $ 34,259 to $ 49,304. Such large fluctuations and the fact that they are entirely market determined, with no possibility for policy makers to deal with fluctuations, make bitcoin an unsuitable instrument for macroeconomic stabilization.

President of El Salvador Nayib Bukele tweeted that bitcoin will make money transfers easier and significantly reduce transaction costs. The fees migrants have to pay to send their money home are shockingly high, despite numerous calls from the United Nations and the G20 to reduce them. According to the World Bank, the average global cost of an international shipment of $ 200 is about $ 13, or 6.5%, well above the sustainable development goal of 3%.

Nonetheless, in 2020, low- and middle-income countries received $ 540 billion in remittances, barely less than the total of $ 548 billion in 2019, and significantly more than these countries in direct investment flows. foreigners ($ 259 billion in 2020) and foreign development aid ($ 179 billion in 2020). Reducing fees to 2% could increase remittances by up to $ 16 billion per year.

The large but globally fragmented remittance industry relies on electronic transfers through commercial bank payment systems, and banks charge high fees for using this infrastructure and benefiting from a secure and reliable international network. But high fees aren’t the only problem. Many migrants do not have a bank account in the country where they work, and their families back home may also be among the 1.7 billion unbanked people in the world. In addition, some international migrants may need to transfer money to countries that are not integrated into the international payment system or that are limited in their ability to receive cross-border transfers, for example Syria or Cuba.

Bukele is right about the need to question this system, in particular by offering low-cost and low-risk alternatives. But bitcoin is not the right tool. Yes, it allows people to transfer value directly and globally without the costly intermediation of a third party. But its volatility makes it at best an asset and an extremely risky store of value rather than a medium of exchange. The risk of a sharp drop in its price means that migrants and their families back home can never be sure how much money is being transferred.

Rather than dismiss the adoption of bitcoin in El Salvador as another example of the crypto craze, we should reflect on the reasons why many people around the world are willing to adopt cryptocurrencies for non-speculative purposes. The answer may lie in whether the current international financial system serves them poorly or not at all.

Innovations in digital money, such as the M-Pesa mobile money service in Africa, have made significant inroads into many payment systems in developing countries. But there is still a long way to go to provide the infrastructure and regulatory frameworks to support digital currency. For now, however, the terrain remains uneven.

Coordinated cross-border policies are urgently needed to ensure that bitcoin and its variants do not do more harm than good in developing countries. Unless the public and private sectors adopt critical reforms and make basic banking services available to all at low cost, citizens and governments will increasingly be drawn to bitcoin and other low-cost alternatives. expensive, high-risk and obscure to traditional banking services. 2021 / Project union

Paola Subacchi is Professor of International Economics at the Queen Mary Global Policy Institute at the University of London and author of The Cost of Free Money

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