El Salvadors Decision to recognize Bitcoin as legal tender is confusing for the majority of people who still see cryptocurrency as a speculative bubble or a Ponzi scheme.
The arguments against such an assumption seem to be quite logical.
Bitcoin’s price is volatile – on May 19th, for example, it plummeted 23% in two hours – and appears to pass the most basic test of all currencies: acting as a “store of value”.
This, in turn, hinders its ability to serve as a “computing unit” – another important test. Retailers cannot price their goods in BTC as these prices would have to be constantly changed throughout the day. And even then, the “real value” of the goods would still be tied to a more stable unit of account such as the US dollar. If the price of an apple went up in BTC values, that wouldn’t say anything about the value of apples; it would just mean Bitcoin is having a bad day.
There is also the problem of the medium of exchange. For a currency to prevail, everyone in the economy must be willing – and practically able – to use it on a daily basis.
Critics see a number of problems here. Sure, El Salvador can pass laws that force its retailers to accept bitcoin. But many governments try to force citizens to do things they don’t want – and citizens always find a way out. In a largely cashless economy like El Salvador, the way out is obvious. And what about the high transaction fees? Why would someone buy a $ 1 newspaper with bitcoin when the cost of interacting with the network is often around $ 10?
If bitcoin enthusiasts make a mistake hearing these concerns, then it is a negative attitude.
It is much better to acknowledge the criticism; admit that Bitcoin is an immature asset with room for improvement; and explain why some of these improvements are closer than many people think. In fact, close enough to bear fruit in 2021.
Let’s start by thinking How a bitcoin standard can improve life in El Salvador. This model can and likely will be replicated in the developing world, causing the largest shift in global wealth creation in centuries.
Do you have corn?
To understand how El Salvadorans handle their economy, we need some basic economic data for the country.
First of all: it is poor. Real GDP per capita is only $ 8,891, according to the International Monetary Fund, which is less than $ 25 per person per day. Every penny counts. Another important point: about a fifth of the money that flows through the economy is sent to El Salvador by citizens who live and work abroad. These remittances are a lifeline for the country. According to data from the Central Bank of El Salvador, they totaled $ 6.8 billion over the past 12 months.
What can Bitcoin bring to the party? Two things. In the short term, it can ensure that more of these transfers go to the intended recipients instead of being skimmed off by intermediaries. In the longer term, it may also give El Salvadorans the option of holding a currency that designed to increase in value over time, rather than devalue.
The short-term argument is irrefutable. Money transfer companies such as Western Union
However, the longer-term perspective is difficult to pin down for many.
Westerners in particular find it difficult to understand how a 12-year-old digital currency dubbed “Internet Magic Money” could be more secure than the US dollar, which has long been recognized as the world’s only reserve currency. The answer is actually quite simple: The Federal Reserve is taking advantage of the confidence placed in it by inflating the money supply to meet its macroeconomic goals. As Fed chief Neel Kashkari said in a now infamous interview with CBS: “There is no end to our ability [flood the system with money] … There is an infinite amount of cash in the Federal Reserve. “
The right or wrong of this approach can be discussed elsewhere. What is out of the question is the simple fact that printing money alone does not create wealth. And if total wealth remains constant, then a higher amount of money means a lower proportional value for each individual currency unit – in this case for each dollar. This is a detour to describe inflation.
The same pizza can feed two or ten people. The act of feeding more people does not magically create more food. On the contrary, everyone gets less.
No wonder the citizens of Latin America – a relatively poor region with a history of hyperinflation – are so eager to embrace this concept. You have bitter personal experiences: In Venezuela, the national currency Bolivar has been devalued so much that Today banknotes are worth more as novelties than as cash. That won’t happen to the dollar. But a steady decline in its purchasing power due to inflation is already underway. And it is the citizens of developing countries with dollarized economies – like El Salvador – who are at the sharp end of the Federal Reserve’s policy.
Why? Because, unlike the richest Westerners, they are completely excluded from the benefits of a larger amount of money.
They cannot allocate their excess capital to nominally increasing assets – real estate, precious metals, art, etc. – because their reserve capital is far too small to be efficiently invested (Remember: $ 25 GDP per person per day). Worse still, the majority of them cannot even earn interest to protect their meager savings: 70% of El Salvadorans do not have a bank account.
From this perspective, “magic internet money” with a permanently fixed offer becomes quite attractive.
There will only ever be 21 million bitcoins. That’s a maximum of 0.00269 BTC (worth $ 108 at the time of writing) for any person living today. As more global citizens adopt the currency, increasing demand will inevitably drive up the value of every coin.
Ask yourself: what would you do if you lived in one of the poorest countries in the world and had the choice of building your savings in dollars; build them in Bitcoin; or split your money between the two? Would you place your trust in a foreign government that you hope will act in your best interests? Would you attribute it to a global community of geeks who claim to be using new technology to democratize finance? Or would you hedge your bets? For many people under 30, the first option is the least attractive.
But what about the concerns I raised earlier? Let’s address each one individually:
- Safekeeping: It is true that Bitcoin is a unpredictable Store of value. Nobody knows what the price will be tomorrow, and 80% crashes have happened several times in its history. Look beyond short-term price action, however, and its long-term performance is remarkably attractive. Over the past decade, Bitcoin’s average annual return has been 891%. It won’t last forever: with greater acceptance, volatility will smooth out. But a firm supply ensures that Bitcoin will always be deflationary. It will always appreciate against inflationary currencies.
- Unit of account: Rejecting Bitcoin today because people cannot reliably value goods in BTC is the logical equivalent of rejecting cars at the beginning of the 20th century because they were unsuitable for paved streets. The naysayers are right: Bitcoin doesn’t work as a unit of account today. It won’t be for a long time either. That’s not a valid reason to reject its long-term prospects.
- Medium of exchange: The willingness and ability of El Salvadorans to trade Bitcoin is determined by a group of people: El Salvadorans. It is not my place to advise them, nor should they turn to foreign institutions or governments for impartial advice. The only point I want to emphasize is this Bitcoin’s transaction fees are not a barrier to acceptance. Like any technology, Bitcoin is evolving. The Lightning Network is a secondary layer built on top of the primary blockchain that enables millions of dollars to be transferred for a few cents. Strike, the digital wallet preferred by the El Salvador government, is a pioneer of Lightning. El Salvadorans will not pay a $ 10 fee to buy a $ 1 newspaper – the truth is, it will likely cost about $ 0.01.
El Salvador’s decision to recognize Bitcoin as legal tender should not in itself convince anyone of the values of cryptocurrencies.
It was supposed to present a case study to the rest of the world on how developing countries can break free from US financial hegemony. It is unfortunate that The richest people in the world got richer during the Covid-19 crisis, almost entirely due to the selfish monetary policy of the central banks in the West. That the same policies are making the world’s poorest citizens even poorer – through the devaluation of USD cash holdings and inflation in global real estate markets – adds even more hurt.
El Salvadorans have the strongest incentive to make their Bitcoin experiment a success.
If this succeeds, other countries in Latin America, Africa and Asia will follow suit. Many seem determined to do so anyway. And with every new country taking the plunge, deflation will reward previous adopters with disproportionate capital growth. Those citizens who choose to save a percentage of their money in Bitcoin will – perhaps for the first time in their lives – own an asset class that significantly affects their quality of life.
The best part? The very last countries to join the Bitcoin standard will be the ones with the most to lose: Western nations whose monetary systems benefit directly from the inability of developing countries to create and maintain wealth.
This is certainly music to the ears of those who care about global inequality.
Financial Disclosure: The author has owned Bitcoin since 2013.