Curious Case of El Salvador and Bitcoin

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In June 2021, El Salvador made Bitcoin one of its legal tender. Now Bitcoin can be used for making payments in the country. In 2001, El Salvador had accepted US Dollars as its national currency. Now they have 2 official currencies for payment. The crypto community is very excited by the nation’s move.

Like other Central American nations, El Salvador is plagued by slow economic growth, immense violence, poverty, and political instability. It has been more than 25 years since the civil war ended in the country. Despite its stunning beaches, rich culture, and abundant natural reserves, the nation has been given the title of “ The Most Violent Country in the World”. More than half of the population living in the country wants to leave for a better life.

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It has been reported that it costs El Salvador more than 4 Billion USD every year due to violence. Kidnapping, theft, and extortion are very common in the country. This is the major reason why El Salvador has the lowest foreign investment in all of Central America.

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This was not always the case. In the 80s and 90s, the country was relatively peaceful. But with the rise of drugs and Maras, hell unfolded on the nation. El Salvador comes in between the major drug route to the USA. This gave rise to MARAS the local gangs.

Nayib Bukele and Bitcoin

The young leader of El Salvador, Nayib Bukele announced that El Salvador will accept Bitcoin as its official currency apart from the Dollar. But why did he do so? How can Bitcoin lift the economy of the nation from its current state? Will Bitcoin be able to achieve what the Dollar couldn’t?

El Salvador accepted the Dollar in 2001. Although immense benefits of Dollarization could not be seen in the economy, one has to understand that El Salvador did not accept the Dollar due to hyperinflation. Rather, it accepted the Dollar to prevent hyperinflation. But El Salvador’s economy has been struggling for ages. Nayib Bukele sees Bitcoin as the path towards economic growth and upliftment of the native people of the country. He expects the country’s GDP to rise as much by a whopping 25%. Also, a lot of migrants in the USA send money back to their homeland El Salvador, with Bitcoin they can easily do so without the need of a middleman. These remittances account for more than 20% of the country’s GDP. Further, almost 70% of El Salvadorians do not have a bank account, giving room to Bitcoin as a currency.

With all the high ambitions and hopes, does El Salvador have the proper infrastructure in place to accept Bitcoin as a legal tender? No doubt Bitcoin overcomes many of the flaws of the modern banking system but can it be used as a currency?

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First of all, Bitcoin is deflationary. Since it is limited in number and cannot be produced as per wish like the Dollar, people are going to store it rather than spend it. This will lead to deflation, which is not good for any economy. With deflation, prices of goods fall and there is a low circulation of money. People stop spending with the hope that the prices of commodities will fall more in the future hence, it will be a better time to buy in the future. This leads to less growth and innovation in the economy.

Further, Bitcoin is less cost-effective for smaller transactions. Also, with slower network speeds and high network costs, it is not suitable for everyday usage.

Moreover, we humans are prone to errors. Bitcoin is stored on the blockchain and we have to interact with the blockchain to transact in Bitcoin. Silly errors like forgetting the private key or sending the currency to the wrong address can result in a permanent loss of value.

Last but not the least, Everyday prices of bitcoin see huge volatility. One day they are something, the other day it can be as low as more than 50%. You would not want your currency to fluctuate so much.

It will be important to observe the challenges that El Salvador will face in implementing Bitcoin as a legal currency. It is the first nation to do so and is expected to face some major bottlenecks. The others can learn from the El Salvador model and assess for themselves whether Bitcoin or a stable coin is a better currency? Also, if Bitcoin is a better asset class than a currency?

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