Will El Salvador’s crypto gamble pay off?

El Salvador's President Nayib Bukele addresses the 76th session of the UN General Assembly remotely, on 23 September 2021. (Credit: Keystone/EPA/Mary Altaffer)

On Thursday, the young, hip and controversial president of El Salvador Nayib Bukele told the world his country is going “towards a new path towards our development and, [God willing], an example for all other countries in the world.”

The President went on to say: “Economic development will be a happy consequence and extra economic development will be a means and not an end, this is what we'll do in El Salvador. We're trying to live by little, build opportunities and cultivate the judgment to use them with the tools that we've been lent and hand in hand with people that are increasingly alert and wishing to build their future.”

While Bukele did not mention it explicitly, he was likely referring to his recent decision to adopt Bitcoin as an official currency, making El Salvador the first country in the world to do so. Bukele argued that it would boost the economy. While most experts agree that the move was bold, there is a consensus that it was also risky.

Two different worlds

Peter McCormack hosts WhatBitcoindid, a podcast featuring interviews with world leaders on the currency. He’s the only international reporter to have interviewed President Bukele on the topic and has done so twice. After his first interview, he posted a picture inside the presidential palace, wearing a Metallica shirt. While it may fit with the president's hat-wearing style, it stood out a bit in the golden palace.

“I think he understands [Bitcoin] better than me [and better] than most of us,” he said, referring to Bukele.

In the world of Bitcoiners, 40-year-old Bukele is perceived as somewhat of a god, somebody who’s finally seen the light.

“We behave like this because we know we’re right,” McCormack said.

Peter McCormack with Salvadorian President Nayib Bukele. (Photo courtesy of Peter McCormack)

But the Bitcoiner world for some is a bit of a parallel universe, and in the rest of the world, Bukele is far from being viewed as god-like. Despite being widely popular with Salvadorians, he’s been criticised for his authoritarian tendencies and populist rhetoric. McCormack is well aware of the criticism, but he believes one has to separate the politician from the Bitcoiner, and he is convinced that what Bukele is doing on the economic front is ultimately the best for Salvadoran people.

Arguments supporting Bukele’s decision to introduce Bitcoin, in general, are along the lines of sovereignty, inclusivity, cheaper remittances and development, but while it  was perceived as revolutionary by many, the more conservative economists were rather worried about the potential repercussions.. The Central American country has a population of six million and a third lives below the poverty line. Despite progress, economic growth has been constantly low in the last two decades and the economy has taken a hit from the pandemic. Economists fear that it could destabilise the already fragile economy.

Mainly, skeptics took the day the currency was introduced as a bad omen: the application developed by the government was not working properly, and the currency’s value dramatically dropped in one day. President Bukele’s answer was “we just bought the dip” and added 150 new coins to the country’s reserve.

Inside El Salvador, the move has also sparked resistance. Last week, thousands of Salvadorans took to the streets to demonstrate against the introduction of Bitcoin and calling Bukele a dictator.

“Bitcoin makes sense in a country that has a lot of electricity, a lot of good communications and a relatively sophisticated population, and what I mean by sophisticated is people who understand things like cryptocurrencies,” Jay Zagorsky, a professor at Questrom School of Business in Boston, told Geneva Solutions.

The potential of crypto

Bitcoin – not to be confused with other cryptocurrencies – is a decentralised digital currency started in 2009 by an anonymous developer called Satoshi Nakamoto. It’s capped to a maximum amount, so its proponents argue that it can’t be manipulated like other governmental currencies. But there are also concerns about the future of the currency, the increased risk of cyber thefts and its high volatility.

The main argument for Bitcoin in Salvador is that it lowers the cost of remittances, as transaction fees  associated with the cryptocurrency tend to be cheaper than going through a traditional bank – and El Salvador’s economy depends heavily on expatriates sending money back home to their families.

Clovis Freire Junior, an economist at the United Nations Conference on Trade and Development (UNCTAD), also points out that since it can be easier to have a digital wallet than a bank account, the adoption of bitcoin as a currency has had the effect of democratising banking.

“You have people in El Salvador that didn't have any access to a bank account and now are using applications to send Bitcoin to one another,” he told Geneva Solutions. “So, they have been brought into this financial realm where they have access to some finances and financial services.”

One thing Freire Junior is going to watch in Salvador is the long-term effect it’s going to have on people’s behaviour with money. Since Bitcoin fluctuates more than the US dollar, he believes that people may start holding on more to their Bitcoin and thus save more money.

“In the long term, most analysts would say that they see Bitcoin become even more valued than today,” he says. “In the longer term, they say  that Bitcoin may reach $100,000, or even more. In that sense, if people were able to survive this volatility, in the long term, they may be able to save more money using Bitcoin than if they were using dollars.”

But the main problem remains volatility. The fluctuation of Bitcoin in a single week, sometimes in a single day, is nothing compared to the US dollar. On Monday, the currency fell by 10 per cent, while many other cryptocurrencies found themselves in the red as well.

“The problem is that most people want to divorce their gambling from their money,” Zagorsky says. “What I live on, I don't want to gamble with that. When I want to gamble, I say let me go to the casino, let me go to the lottery. What Bitcoin does is it puts the two of them together.”

Who will follow?

The adoption of Bitcoin in El Salvador partly made sense because the country does not have its own currency and instead relies on the US dollar, Freire Junior noted.  Despite the risk factors, a number of countries could be tempted to follow suit.

“We have a first country [to adopt cryptocurrency as legal tender] and that will not be the only one, there'll be other countries in the future that will be using it as a template,” Freire Junior said. “I would say that countries like El Salvador, that have a dollarized economy and don't manage their own currency, I think, would be more open to this kind of possibility.”

Other countries from the Latin American region that use the US dollar as their official currency like Panama and Cuba could be potential candidates.

The day after the introduction of Bitcoin in El Salvador, a parliamentarian in Panama introduced a bill to open up the country to Bitcoin and Ether, another cryptocurrency. Ukraine also passed a law to legalise and regulate Bitcoin in the country.

“A lot of countries are not happy to be sort of tied to the US dollar,” Zagorsky said, “They're tied to US government policies, they're tied to US government interest rates and they want to go their own way. They do not believe the US government always has their own best interests at heart. It makes perfect sense.”

Now, Bitcoin is only one of many cryptocurrencies that have emerged in recent years. Countries don’t have to make a cryptocurrency a legal tender to facilitate its use in the country. Kenya, for example, has created an application facilitating the digital transfer of its own currency, making banking more accessible to its population.

Alternatively, many countries with a strong economy, and even the European Union, are exploring the idea of creating their own cryptocurrency in order to have more control over it.

In a way, there is also a benefit in being the first country to adopt Bitcoin, Zagorsky concluded: “El Salvador doesn't get very much coverage in the world news, right? By doing this, El Salvador is bringing a lot of coverage. In many places, especially if you read it in cryptocurrency, newspapers, magazines, and news services, El Salvador is being treated like God.”