El Salvador’s adoption of Bitcoin as legal tender, a year ago, was considered a watershed moment by crypto advocates hankering for more recognition for the world’s biggest cryptocurrency. The tiny Central American country is the region’s fourth biggest economy and has been a dollarized nation since 2001.
Proponents of the move argued that Bitcoin adoption would unshackle its economy from American monetary policy and bring the country’s unbanked population – which, according to some estimates, is as much as 70% – into its financial infrastructure. Bitcoin could also help make remittances, which constitute more than 20% of its GDP, cheaper.
While the El Salvadorean government has launched ambitious initiatives – Bitcoin Beach, Bitcoin City, a bond backed by its Bitcoin holdings, and a government-issued Bitcoin wallet – bitcoin adoption as a payment mechanism and as a tool for remittances is yet to take off.
Less than 2% of the country’s remittances are routed using crypto. Very few businesses on Bitcoin beach use the cryptocurrency for payments. Development work on Bitcoin City has stalled. Meanwhile, its President’s profligate post-pandemic spending and bitcoin-buying sprees using taxpayer money even caused the International Monetary Fund (IMF) to reconsider a $1.3 billion bailout loan.
Is El Salvador’s move to Bitcoin a failure?
A Botched Bitcoin Debut
The issue of currency not backed by fiat authority is a fraught exercise. One of the main concerns about Facebook’s Libra was that the digital currency could become unofficial money of sorts by taking over the function of a government-issued medium of exchange in countries with weak economies. For example, bitcoin could have potentially replaced the El Salvadorean peso if it was a viable cryptocurrency with low transaction times and fees.
As things stand now, however, Bitcoin is riddled with problems. Its interface is clunky and not suited for those who are technologically illiterate. Transaction fees and confirmation times are long. Even conversion to fiat currency from Bitcoin ATMs can take as much as six hours.
These problems have become stumbling blocks its use as a payment system in El Salvador. A $30 credit with the government issued Chivo wallet convinced 46 percent of the country’s population to download it. By April of this year, however, less than 20 percent of those who had downloaded it, were using it. In fact, according to some estimates, there have been no downloads of the app this year. The app is slow and glitchy, based on reports.
An Expensive Option
In one of his interviews about Bitcoin, President Nayib Bukelele said he wanted to eliminate his country’s dependency on American monetary policy. Paradoxically enough, Bitcoin’s prices lately have moved in tandem with the Federal Reserve’s moves to tamp down inflation in the economy. Thus, by adopting Bitcoin as legal tender, Bukelele has wedded the country even more to America’s economic policy.
There’s also the other problem, related to remittance, that he said would be solved by Bitcoin in his country’s economy. Available research indicates that it might be cheaper to send money via regular wire transfer mechanisms rather than through crypto channels.
A team at the John Hopkins University found that the average cost for sending dollars home using bitcoin was 5% of the overall amount plus network fees (for bitcoin) plus other assorted fees related to crypto, such as security fees and travel fees.
The average transaction cost as a percentage of sending remittances using traditional channels like Western Union was 2.85%. “As things currently stand, the cost of using bitcoin to send remittances to El Salvador is not, in fact, cheaper than traditional money transfer services. Indeed, at present, traditional transfer methods are the cheapest way to make remittance payments,” researchers wrote.
Is El Salvador’s Bitcoin Experiment a Blunder?
Many critics point to the state of El Salvador’s economy as evidence that its move to Bitcoin failed.
But the country’s economic circumstances are a function of other, more immediate factors like the Covid pandemic and a global inflation crisis and bad policy decisions. In fact, the country emerged from the pandemic in relatively good shape. Its economy grew by 10.7% in 2021 and foreign direct investment rose by 12% in 2021.
Bukelele, who enjoys high ratings owing to his crackdown on gang warfare, has chosen to keep on spending even during a contraction in the global economy. El Salvador’s external debt has surged by 35% between the last two quarters. Meanwhile, remittances have increased only by 0.6%.
Despite these problems, it might be a tad early to label El Salvador’s experiment a ‘blunder’, as some researchers have called it.
Bitcoin’s network is a work in progress currently. The number of lightning nodes, which are necessary to expedite payments on its blockchain because they create a second layer for faster transaction confirmation times, has multiplied since last year. That is good news for bitcoin’s evolution as a payment and remittance system.
For all its promised benefits, the problem with using Bitcoin may not related to economic policy at all. Rather it may lead to centralization and control of the country’s payment infrastructure in the hands of select American companies. The most popular non-custodial wallet for remittances is Strike, which is developed by a Chicago-based company, which has been granted an exclusive license for the job. Other American consultancies also have a hand in developing its new payments infrastructure. These moves could centralize payments and remittance infrastructure, when there are other options available currently, in the country.