The announcement by El Salvador’s president, Nayib Bukele, last week at a Fintech conference in Miami that the country would make Bitcoin its new official currency provoked an immediate reaction as the digital currency market rallied on the news. But what is the impact of El Salvador’s new law in the wider cryptocurrency sphere?
Paul Domjan, senior contributing analyst at Tellimer Research, in a research note contends El Salvador’s embrace may very well ring in a few major changes. These developments include a fundamental shift in crypto’s global role and the International Monetary Fund (IMF) may be forced to finally engage with crypto.
As the first country to adopt Bitcoin as legal tender, Bukele is heading counter to quite a few governments such as Canada and China, which have all warned in recent months against the perils of digital currencies.
However, Bukele, a populist president with consistent high favourability ratings, expects to make more gains not only from foreign-made transfers from the Salvadoran diaspora in the US but also with the goal for greater financial inclusion which he called “a moral imperative”.
In El Salvador, the law allows for everyday use of Bitcoin. This means you can buy goods and makes the cryptocurrency a fiat currency, which according to Domjan adds another level of how to interpret Bitcoin’s value, resulting in a fundamental change. Domjan posits that fiat currency has value because the state asserts it, with taxes paid in fiat and the state compelling economic actors to accept payment.
Quoted on Reuters, Bukele said: “In the short term, this will generate jobs and help provide financial inclusion to thousands outside the formal economy.” Bukele made the argument on Twitter that if just 1% of Bitcoin’s market cap of $680bn was invested into El Salvador, it would increase GDP by 25%.
Stay tuned! #Bitcoin♻️
Where El Salvador goes, will others follow?
So far, there are no indications of other emerging countries following suit. As the pioneer, El Salvador is the use case on providing access to the unbanked through the digital coin. But Rahul Shah, head of financial equity research at Tellimer Ltd, thinks that countries with high deprivation levels and a dependence on money sent home from abroad, such as Haiti, South Sudan and Liberia, may be likely to adopt Bitcoin.
However, market commentators have questioned how well Bitcoin can address the structural inequalities of banking. In addition, what it means in practice, allowing Bitcoin to be used for everyday transactions, is also unclear.
Domjan doesn’t think Bitcoin will be the long-term winner as a digital currency for emerging markets and argues that central bank digital currencies (CBDC) are better alternatives but only “if they are widely circulating genuine cryptocurrencies”. An option that works for credible central banks, perhaps, but credibility which El Salvador lacks.
“Adopting Bitcoin, like adopting the dollar, allows El Salvador to access a potentially more attractive form of money without a credible central bank, but it also means ceding monetary policy and control of the currency,” writes Domjan. He posits that in fact, adopting Bitcoin doesn’t reduce the country’s dependence on the US Federal Reserve and it is now likely to be in thrall “to both US interest-rate policy and the global Bitcoin dynamics”. This could include the US legal system through its US-based Bitcoin wallet provider, Strike.
Flashy PR tactic
The quick adoption of Bitcoin could have an impact on El Salvador’s $1bn programme with the IMF. Analysts see this situation as having a complicating effect which may appear as “less a cohesive economic plan” and more a “flashy PR tactic”, according to Siobhan Morden, head of Latin America fixed income strategy at Amherst Pierpont Securities.
However, it could also lead to engagement with the official sector, says Domjan: “The IMF, which has so far only indicated that a staff team will be meeting Salvodorean president Bukele to discuss the issue, will need to decide whether to treat this as an obstacle to a new programme and, if El Salvador does eventually enter a programme, whether to allow El Salvador to use Bitcoin to meet its obligations to the IMF.”
For now, it’s not likely that cryptocurrency is going to replace other currencies, which are more stable than the inherently volatile Bitcoin. Marc Chandler, chief market strategist at Bannockburn Global Forex, said in Bloomberg: “Why do countries peg their currency to another currency or have a currency board or have a dollarized economy? It’s because their currency has become too volatile or lost credence in the market and become out of control, very inflationary.”