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The Bitcoin Experiment in El Salvador: a Modest Success or a Fluke?


Alex Paulson
Alex Paulson

Crypto and Forex professional trader, analyst, contributor.

#Bitcoin

On September 7, an event of great significance happened in a small Central American country of El Salvador that lies in the dead center of the Americas. On that day, the 40-years old president of the republic, Nayib Bukele, signed into action the act that made Bitcoin (BTC) the legal tender. This document immediately became known as the "The Bitcoin Law," and the event itself became the main point of discussion - and debate - across all media platforms that in some way related to finance or technology.

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Needless to say, that "The Bitcoin Law" was met in the global crypto community with sheer excitement, with many influencers like Anthony Pompliano, Mike Saylor, and crowds of Bitcoin maximalists been praising Bukele for bravery, congratulating El Salvadorians on receiving the privilege of having BTC as a legal method of payment and profit-making, and even calling it a pivotal point for the modern financial system and the history of mankind. This kind of pathos is understandable if you are a cryptocurrency aficionado who thinks that the worldwide incorporation of encryption-based money and assets would resolve the majority of the world's problems, at least in the financial department.

However, to a cold-minded observer, who is not a part of the "crypto cult" but also doesn't share the critical point of view of Bitcoin and cryptocurrencies in general, this was a perfect opportunity to witness a bold experiment carried out by one of the poorest countries in the LATAM region; an experiment that helped BTC to make a step out of the shadows and prove its worth as a payment system and as a store of value. It has been almost two and a half months since the experiment began, and it would be fair to say that it didn't go without a few bumps in the road.

In the following article, we offer an in-depth look at the fundamental reasons behind the president's decision to adopt Bitcoin to the fullest - Bukele had been pushing hard for the approval of the crypto-related proposition by the Senate. We will also analyze the events that followed this historic date, including the response that such a radical Bitcoin adoption received from certain groups of the population as well as from international financial institutions. In doing so, we will find the answer to the question of whether El Salvador's controversial experiment with the first cryptocurrency has lived up to the expectations or did it turn out to be a total fluke.

These will be the preliminary conclusions, of course, because the transition of such scale in a country where the majority of the population has a subpar financial education can't happen overnight, or even over a year for that matter. It might take years for such innovative things as cryptocurrencies to settle in the financially struggling country, but the precedent has been made, the first confident steps have been taken, and their consequences provided us with much food for contemplation and analysis, the results of which we intend to share with our devoted readers.

The economic environment of El Salvador that facilitated the adoption of Bitcoin

Some crypto enthusiasts might have dreamt that the adoption of any cryptocurrency as legal tender would have been initiated by some developed and innovation-focused country like Singapore, but the reality turned out to be quite different. While "the rich and smart" had been ruminating about all pros and cons of mass acceptance of crypto, one of the most economically struggling countries in Latin America has made a bold move that created waves of hype around the globe and brought El Salvador on the front pages of all financial media outlets. What's also fascinating about this initiative is that El Salvador actually doesn't have a national currency, which puts it in the group of nominally independent states that have their financial systems pegged to the US Dollar; the other ones being Palau, Ecuador, the British Virgin Islands, the Marshall Islands, East Timor, Micronesia, and Turks and Caicos. The adoption of Bitcoin as legal tender has literally made El Salvador the only country that has two officially recognized currencies that aren't minted by the government. This alone makes the start of Bitcoin's journey towards becoming a real global currency as intriguing and challenging as it gets.

And it's challenging indeed, because this country on the South of the Pacific Ocean is rated 107th in the global GDP rank, with a - 5.4% GDP dynamics as of 2021, mostly the consequence of the COVID-19 pandemic, though in pre-pandemic years, its annual GDP growth rate rarely exceeded a mere 3% since the period between 2009 and 2019, when its economy had performed a massive bounce in response to the global financial crisis of 2008.

El Salvador GDP chart

El Salvador GDP chart. Source: International Monetary Fund

Since that period, as seen on the chart, El Salvador's economy has been in a permanent state of stagnation and needed a shake-up of a grand scale, like the adoption of Bitcoin as legal tender. The situation around GDP per capita is also far from being great as its nominal estimate is only $4.031, with worse figures among neighboring nations showcased only by Venezuela (for obvious reasons), Nicaragua, and the Dominican Republic. Moreover, the 2021 Index of Economic Freedom rates El Salvador as the 94th in the world with a tendency towards decrease due to the lack of institutional reforms, the absence of integrity within all echelons of power, and even an inclination towards authoritarianism. It certainly doesn't look like a profile of the country that is fundamentally prepared for the incorporation of a fledgling fintech technology that is blockchain and its offspring, Bitcoin.

Such an economic environment was created over nearly three decades of the ruling of opposed-minded political powers: the right-wing Nationalist Republican Alliance, which provided five presidents (Alfredo Cristiani, Armando Calderon Sol, Francisco Flores, and Antonio Saca) who had held the office in the period between 1989 - 2004, which was marked by the demise of country's former national currency, colon, and the adoption of until recently the only legal tender - US Dollar. The official transition to USD was made in 2001; back in that day, the head of El Salvador's national bank, Rafael Barraza, called this move "the bullet-proofing mechanism for joining the globalized market."

In fact, it was nothing but the result of an immense impact that the United States had on the weak economies of most countries in that region, most notably Argentina and Panama. Barraza had also assured that the transition to USD was to instigate the economy and attract foreign investment, almost exactly the same wording that we had heard from Nayib Bukele when he had been pushing the Bitcoin agenda. But unlike the recent voting on the Bitcoin Law, the decision to give up colon in favor of the US Dollar was met with fierce opposition from the members of the ruling party who believed it to be the betrayal of national sovereignty.

Interestingly enough, the situation around BTC is diametrically opposite; the dominant cryptocurrency with the market capitalization of $1.2 trillion has no central governing power, and isn't associated with a foreign state that would influence the policies of El Salvador in this area. It's most likely the reason why the proposition regarding Bitcoin acceptance, which was voiced by Bukele in the middle of the spring, was met with some caution but without loudly outspoken criticism.

In our opinion, there would be a lot of similarities in the way El Salvadoreans adapted to the introduction of a currency towards which they didn't have any mental or historical attachment, the US Dollar, and how they would learn to live with Bitcoin as an alternative means of payment and transaction of value. As already mentioned, the shift to the USD-based economy wasn't met enthusiastically by members of political circles and the general population.

The citizens saw the prices climb higher and higher while their wages stayed practically at the same level. But over time, the disgruntled ones had grown to understand and accept the fact that despite the partial loss of sovereignty and the ability to form independent fiscal and monetary policies, the economy might have benefited from low interest rates set up by the US Federal Reserve since cheap loans became available for the banked population.

However, 'banked"' is a crucial word here because according to the latest data, only 30.4% of people in El Salvador actually have a bank account, thus have access to the most basic banking services, while the rest prefer to make business dealings or miscellaneous purchases with cash. In fact, a strive to help the unbanked population to obtain the ability to make savings, along with having access to financial services, was one of the main points in Bukele's promotional campaign prior to the Bitcoin acceptance as legal tender.

The inseparable ties with the US Dollar have also helped shape the current economic landscape in El Salvador. Obviously, it has grown to be very US-oriented, with the main focus on services, the energy industry, and agriculture. When it comes to services, El Salvador is known primarily for having tons of call centers that serve US corporations. The United States constitutes El Salvador's main export destination - over 40% of its export is going to the North American neighbor. This is not mentioning the workforce that migrated to the US en masse over the past few decades in search of better opportunities. The active migration created an entire industry of personal remittances (when a person who works abroad sends money to the family members that live in the home country) that has gradually transformed into a key component of El Salvador's economy.

The share of remittances in El Salvador's GDP

The share of remittances in El Salvador's GDP. Source: World Bank

As you can see on the chart above, the percentage of personal remittances in the country's GDP has been growing exponentially since the 1970s, reaching 23% as of last year, which says a lot about the state of its economy. Therefore, in 2019, when Nayib Bukele replaced Salvador Sanchez Cerez in the presidential office, El Salvador was in a paradoxical situation where a considerable portion of its GDP came from transactions sent from abroad while the overwhelming majority of the population remained unbanked. It meant that they couldn't receive money via bank transfers and had to rely on wire transfer providers like Western Union that traditionally charge exorbitant fees for their services.

This was, obviously, a burning issue for all citizens who received money from abroad and especially for those that belonged to over 30% of the population that live in poverty and nearly 10% of people that live on less than $4 a day.

Before the emergence of blockchain technology and Bitcoin, there was practically no way to avoid paying these fees, but even when its features became known, not a single government of a developing country that relies on remittances to sustain its economy didn't consider letting Bitcoin remedy the situation. That was until the former mayor of San Salvador, the country's capital city, decided to run for president as the leader of the newly created political party "Nuevas Ideas" (New Ideas) after the controversial expulsion from the National Liberation Front (FMLN). The tech-savvy 39-years old candidate was surely aware of the remittance issue and incorporated it in his campaign, the successful realization of which had put him in the presidential office on June 1, 2019. This man is a central figure in this whole Bitcoin saga, though his interior motives remain unclear to observers like us - we will speculate about them in the next paragraph - though the exterior ones are evident and stem from social and economic struggles. To summarize, the main reasons for El Salvador's acceptance of Bitcoin as legal tender were as follows:

Nayib Bukele: a great visionary or a posturer with autocratic ambitions

In order to understand the prospects of the Bitcoin experiment in El Salvador, it’s important to try and comprehend the reasons that drove Nayib Bukele towards making such a controversial decision. Because if that is just another case of political showboating, this experiment is doomed for failure to the disappointment of crypto enthusiasts and the joy of Bitcoin skeptics. And given the fact that we are talking about Latin America, where not a single state boasts efficient and corruption-proof institutions, we can’t help but have suspicions regarding Bukele’s real intentions with regard to BTC and its future in his homeland.

The first arrow of skepticism arrives from the official ideology of “Nuevas Ideas,” which appears to be populistic as its statutes declare that this “decentralized” party’s main objective is to create a free El Salvador that is built on principles of social economy and free market. In other words, they fight “for everything that’s good against everything that’s evil,” the rhetoric of populists, and as political history shows, this ideology is usually disastrous for the well-being of the country. Even this entire story about Bukele’s fascination with Bitcoin that has grown strong after he had learned about the El Zonte case looks a bit too scenic.

For your information, El Zonte is a small fishing village in El Salvador that became a tiny hub for Bitcoin enthusiasts after an anonymous donor gave around 100 BTC to the local NGO in exchange for their help in promoting crypto as means of payment in that area. These people must have done a great job because, in a relatively short period of time, most local businesses were considering Bitcoin, while the holders were able to benefit financially from the bull market. History has it that Bukele got inspired by this initiative and went on to introduce the entire country to the major digital currency. In all candor, it sounds too Hollywood-ish to be true, though that’s also the type of story that populists are thriving on.

In addition to being a populist, Bukele is also accused of having dictatorial traits like the ones he displayed when ordering the heavily-armed police and troops to enter the parliament in an attempt to pressure the legislative assembly into granting $109 million from the state budget to law enforcement agencies. Like many autocrats, the president doesn’t spare any effort to create a likable image among the population, which in the case of Bukele, is a portrait of a hip young president who gets things done, keeps his mind open towards tech innovations, and isn’t afraid of bold moves even if they irritate global financial players, especially the International Monetary Fund (IMF). He isn’t even afraid of mocking the international human rights community by naming himself “the coolest dictator in the world” in the Twitter bio. Bitcoin could easily be a plaything for yet another Latin American dictator who cares little for its adoption but rather for his own approval ratings.

By the way, Bukele enjoys an approval rating of over 75%, typical for dictatorial regimes in backwater countries. His Venezuelan counterpart, Nicolas Maduro, has also been active in the field of crypto: he ordered the issuance of state-backed crypto dubbed “PetroCoin,” but it did nothing to benefit poor Venezuelans. We aren’t drawing comparisons between Bukele and Maduro but pointing out the possibility of it being just a big publicity stunt.    

Another thing that raises concern is the fact that whether we like it or not, crypto still remains a popular instrument for money-laundering and other illicit financial operations by criminal organizations across the world, including those that are associated with El Salvador. Many experts point out the possibility that resounding success in fighting organized crime in the country was the result of behind-the-scenes deals concluded with bosses of the most notorious gangs like Mara Salvatrucha, also known as MS-13. It could make sense given that during Bukele’s presidency, the crime rate has dropped by an astounding 20% to 30%, which would have been hard to attain given the “underfunding” of law enforcement.

In theory, it might be a lucrative deal: a significant boost of electoral sympathies in exchange for the introduction of an unregulated digital currency on a national scale, the transactions in which could remain virtually untraceable yet legal. And while it might sound like a conspiracy theory for Bitcoin maximalists who believe that any initiative related to the first cryptocurrency carries a noble purpose, the realities of the political game in that part of the world dictate that the Bitcoin adoption could have been a bargaining chip.

Even the logic behind the adoption of Bitcoin as a way to facilitate cheaper remittances for the representatives of the general population appears a bit flawed because this and other cryptocurrencies have already been serving this exact purpose without the political recognition - the government just had to remove any obstructions that people might have encountered in the process.

But regardless of Bukele’s motives and Bitcoin’s fate in El Salvador, this initiative created a historic precedent that could be used by another country that is more politically and economically prepared to use the benefits provided by cryptocurrency adoption to its fullest extent.   

El Salvador in the BTC era: what followed the enactment of the Bitcoin Law

On September 7, Nayib Bukele tweeted:" In 3 minutes, we make history," referring to the adoption of the Bitcoin Law that made El Salvador the most popular nation in the global crypto community. However, the festive mood was quickly overshadowed by yet another sell-off on the Bitcoin market that had shed 10% off its value during the day the law had been enacted - certainly not the move that the enthusiasts have been expecting, but definitely, the one that showcases the risks associated with excessive volatility that is inherent to crypto.

This rocky start was exacerbated by the rapidly growing number of user reports about server capacity errors that they encountered while trying to set up the government-backed digital wallet called Chivo. The wallet was developed in collaboration with BitGo, the US-based digital asset trust company that created the multi-signature digital wallet solution that allows for both hot and cold wallet configurations. This firm is known for being a part of the first $1 billion acquisition deal in the crypto industry after it had been purchased by the Galaxy Digital fund in May. The problem had grown so large that BitGo had to take the wallet app down for a few hours to perform the necessary maintenance, though, after that, there have been no reports of any other major malfunctions. Apart from BitGo, El Salvador's major bank, Bancoagricola, partnered with the crypto payments facilitator Flexa to serve the needs of the banked citizens who want to use cryptocurrencies. 

Another bit of controversy had arisen after the government announced that all merchants in El Salvador are obliged to accept payments in Bitcoin should a customer express the desire to pay in cryptocurrency. This caused a backlash from local businesses at first, but then Javier Argueta, the chief legal counsel to the president, explained that merchants are only obliged to have the corresponding electronic wallet that accepts BTC payments - it's not mandatory to keep the profits from sales of goods or services in crypto as the payments can be instantly converted into USD upon the transaction settlement. The fees associated with such transactions are to be covered from a special $150 million fund called the Bitcoin Trust that had been set up by the government, though many experts are concerned that eventually, this financial burden would be put on the taxpayers' shoulders. 

Even before the crypto bill was passed into law, there have been two groups of active protesters named the Popular Resistance and the Rebellion Block who organized rallied against the implementation of the Bitcoin Law, claiming that it hadn't been put up for discussion with society and that the law would only serve for the benefit of large business groups and criminal organization who might use the article in the law that exempts any foreign business entity or an individual that invests in El Salvador through cryptocurrencies from both capital gains and income taxes. While this initiative was presented as an attempt to draw in foreign investors, the locals have understandably deemed these conditions as unfair and preferential. In addition, the protesters pointed to the lack of education among common citizens regarding Bitcoin and blockchain and the intricacies of its usage.

Indeed, the latest study conducted by the Sherlock Communications agency revealed that 54% of citizens know virtually nothing about BTC, while 41% said that they wouldn't turn to unregulated digital currencies even at times of economic crisis. Lastly, 42% of the respondents expressed their total neutrality towards the overall idea of Bitcoin being a legal tender in their country, with only 29% having a positive outlook with regard to this initiative. This shows that the global crypto community has been much more enthusiastic about the Bitcoin adoption in El Salvador than the majority of its citizens, for whom it still remains a super volatile gimmick that pales in comparison with the "stable" US Dollar. The whole narrative about Bitcoin being the gateway to financial security for people who live beyond the poverty line, or very close to it, seems flawed because virtually any disclaimer on crypto-related platforms warns that BTC and most other coins are insanely volatile and that it's highly inadvisable to invest more than one can afford to lose. But average El Salvadoreans can't afford to lose even a dime, given how narrow the income stream is for most of them. Therefore, encouraging such people to store their minuscule savings in a highly volatile asset comes out a bit cynical.

Nevertheless, Bukele recently reported via his Twitter that over 2.1 million citizens are actively using the Chivo wallet for Bitcoin transactions, having added 1.6 million users in the first two weeks after the launch. Moreover, the president regularly reports about any buying activity on the part of the government during the so-called "market dips." The last of such reports said that the authorized financial body bought 420 BTC, bringing up the nation's total crypto reserves to 1,120 BTC. And after the initial skepticism, people began converting more USD to BTC and making remittances via the Chivo app. The former probably relates to the reinvigoration of bulls on the BTC market, whose collective effort elevated the price to the new all-time high at $68,000. To further incentivize the use of cryptocurrency, the government introduced a $0.2 subsidy per gallon of petrol if paid in BTC via the Chivo wallet.

At some point, the president even teased about the possibility of clean Bitcoin mining using the volcanic thermal energy, which is in abundance - 22 volcanoes in total across the country that takes up only 21,041 square kilometers. The same small country now accommodates over 70% of all Bitcoin ATMs in the LATAM region (205 ATMs in total, though one was burnt during the protests). Before Bukele initiated his pro-crypto campaign, the country had only four such machines.

According to the latest announcements, the government plans to invest a portion of profit obtained from speculations on the Bitcoin market into building a modern veterinary hospital (an initiative that was met with mild criticism) and 20 new schools within the framework of the "My New School Program."

In conclusion, let's have a brief review of the reaction of global financial powerhouses to the Bitcoin Law. Contrary to the expectation of many, the International Monetary Fund and the US government displayed a somewhat tepid reaction to Bukele's initiative, having issued the recommendation regarding the need for more oversight over crypto-related operations. At the same time, Douglas Rodrigues, the head of the Central Reserve Bank of El Salvador, assured that the Bitcoin experiment didn't disrupt the talks about a $1.3 billion loan from the IMF.

Bottom line

Regardless of El Salvador's future and Bukele's future as its president, this country will always be remembered as the real pioneer of mass Bitcoin adoption. There are several factors like corruption and the lack of financial education that might lead to Bitcoin's failure to exert tangible impact on the financial wellbeing of El Salvadoreans, but so far, we would rate this fascinating experiment as a mild success that has had more of a symbolic influence on the price of Bitcoin itself but has certainly changed the perception of crypto around the world. To paraphrase the famous quote, one small step for the country could turn into a giant leap for mankind.

Author: Alex Paulson for Crypto-Rating.com

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