On 8 June, El Salvador’s Legislative Assembly voted to pass the Ley Bitcoin(Bitcoin Law), with a majority vote of 62 out of 84. The legislation was presented to the Assembly days after President Nayib Bukele announced his intention to make bitcoin legal tender, speaking via video broadcast to the Bitcoin 2021 Conference in Miami. Effective from 7 September, all businesses in the country will be required to accept bitcoin alongside the United States dollar, El Salvador’s current currency. Since the bill’s passing, legislators in Panama and financiers in Mexico have expressed interest in recognizing bitcoin as legal tender.
Rather than China’s digital renminbi or Venezuela’s petro, El Salvador will not be pursing the creation of its own cryptocurrency. Bukele is adamant that at this stage Bitcoin will not make up any of the nation’s reserves, held in the Central Reserve Bank of El Salvador. Rather, a trust in the country’s development bank (BANDESAL) worth US $150 million will guarantee convertibility to dollars as a safeguard against bitcoin’s volatility. In doing so, the BANDESAL trust would make sure that the price of a commodity does not widely fluctuate between point of purchase and completion of transaction.
In Bukele’s address he made mention of the lack of financial inclusion for Salvadorans being a motivation for the law. In a country where informal employment makes up around 70% of the labor force, anonymous peer-to-peer cash transfers without the formal requirements of a bank account or the high charges of Western Union make sense as an alternative. Bukele has also expressed his hope that the move will make El Salvador “less dependent” on the United States, given that dollarization ceded monetary independence to the Federal Reserve. But given the increasing centralization of Bitcoin and its reliance on big tech money, it is far more likely that bitcoinization will merely make El Salvador dependent on a different section of US capital.
El Salvador’s Dollarization
Following the end of El Salvador’s civil war in 1992, the country embarked on a period of structural reforms to achieve macroeconomic stability. These reforms included privatization of the banks and telecommunications system, a fixed exchange rate between the Salvadoran colón and the United States dollar in 1993 and the passage of numerous laws ensuring bank transparency. Full dollarization of the economy in 2001 was seen as a way of enhancing these previous reforms and a method of both keeping control on inflation and attracting foreign investment.
While inflation was indeed kept low, FDI as a percentage of GDP tended to be lower in El Salvador than in other Central American economies. Critics of dollarization argued that the move was largely done to appease the entrepreneurial, financial and import backers of the ruling right-wing ARENA party, who by the turn of the millennium had largely replaced El Salvador’s landowning oligarchy. In an interview on the subject, Bukele himself claimed that dollarization was a means of “helping the banks rather than the people”.
Many Salvadorans complained that the process of dollarization happened far too quickly and without popular consent. A prominent negative effect of dollarizaiton in the informal economy was the phenomenon of “rounding up” new dollar prices; as the exchange rate was 8.75 colones to one dollar, businesses and vendors outside of the formal economy (where the Law of Monetary Integration specified that prices could only be rounded up to the nearest cent) began rounding up their products to the nearest dollar. As one woman recounted to Central American media organization the Tico Times: “from one day to the next, the bundle of onions went from five colones (equivalent to 57 cents, at the time) to one dollar. We lost 43 cents in rounding.”
After 20 years of dollarization, why is El Salvador now adopting bitcoin as a legal currency? While the legislative press release mentions employment opportunities and true financial inclusion, it is the desire to increase economic dynamism that seems to be the most important factor to Bukele, who is keen to secure new forms of FDI in the context of El Salvador’s deindustrialization, slowdown in economic growth and deteriorating investment prospects. That Bukele chose to announce the introduction of the bill to the Bitcoin 2021 Conference in Miami is evidence of the law’s presentation as an appeal to international finance.
Bitcoinization and Crypto FDI
In a tweet, Bukele set out a few reasons for why crypto investors will flock to El Salvador following the nation’s adoption of bitcoin as a legal currency: the good weather, lack of property tax, absence of capital gains tax on bitcoin and the promise of permanent residence for crypto investors. Such conditions will likely draw interest from some of the world’s crypto-millionaires, as permanent residence will be guaranteed to anyone investing 3 bitcoins (around US$ 100,000 at the time of writing) into the Salvadoran economy. By way of a comparison, effective national property tax in the United States is 1.1% and capital gains tax on property (which bitcoin is currently classed as by the IRS) can be as high as 20% on long-term held assets generating profits above certain rates.
The overture to high-tech investment makes sense given the current structure of El Salvador’s FDI. The Central Reserve Bank reported that the communications and information sector recorded the highest FDI growth rate in 2020, totaling US $1.36 billion. Foreign capital has already mobilized since the law was passed, with digital wallet company Strike partnering with El Salvador to develop government-backed wallets which will be provided to all Salvadoran adults, pre-loaded with US $30 worth of bitcoin. ATM company Athena Bitcoin has also announced investment of US $1 million to roll out 1,500 bitcoin ATMs across the country. El Salvador is no stranger to bitcoin investment – the small beach town of El Zonte experimented with small-scale bitcoinization through the foundation of Bitcoin Beach, a project funded by an anonymous donor to promote payment for goods and services, wages and bills through bitcoin.
But how much “independence” will El Salvador achieve through bitcoinization? Despite its libertarian origins, the Bitcoin network has become increasingly centralized in recent years as more and more computing power is needed to mine blocks with an ever-decreasing reward. Large amounts of bitcoin are held on exchanges that make profits from purchases of cryptocurrency and request identification and bank documentation from prospective users. Recent efforts to create a Bitcoin Mining Council to “promote energy usage transparency” are also demonstrative of further centralization of Bitcoin. As geographer and political economist Jaya Klara Brekke points out, such a situation of is worlds away from the decentralized vision of cryptocurrency held by the early cypherpunks.
A further barrier is the developing regulatory framework of Bitcoin in the United States, where President Biden is currently eyeing proposals targeting cryptocurrency transfers of more than US$ 10,000. Given that the Salvadoran economy relies heavily on remittances (estimated to make up 23% of the nation’s GDP and benefiting some 360,000 households), further regulation and taxes could well affect remittance flows from the United States to El Salvador. Given the reliance of Bitcoin on concentrations of huge mining capacity and increasing regulatory efforts aimed at curbing its rise, the arguments in favor of bitcoinization on the basis of financial inclusion and independence make little sense.
Another recent development has been the effect of prominent individuals to drastically alter the price of bitcoin through spreading so-called “fear, uncertainty and doubt” (FUD). Following Elon Musk’s surprise announcement that Tesla would no longer allow payments using bitcoin citing environmental concerns, the cryptocurrency market cap crashed from an all-time-high of over US$ 2.5 trillion in May 2021 to its current valuation of US$ 1.3 trillion. Bitcoin has seen its value more than halve from the all-time-high of over US$ 63,000. For retail investors placing savings into digital assets in the hope of long-term gains in future bull runs, such fluctuations are par for the course; but for a Salvadoran vendor in the informal economy relying on bitcoin as a means of exchange, such crashes could have far more profound implications. While dollarization gave control of El Salvador’s monetary policy to the Federal Reserve, bitcoinization will pass control to cryptocurrency speculators and large-scale mining companies.
Bukele is a younger, more forward-looking representative of international capital than his predecessors, one less tied (and perhaps even antagonistic) to the formalities and institutions of the Washington Consensus. Indeed, the World Bank refused to help with the bitcoinization process and IMF Spokesperson Gerry Rice warned of the “macroeconomic, financial and legal issues” that bitcoinization will entail. Bukele also faces opposition from representatives of capital in his own country: Javier Simán, former president of the National Association of Private Enterprises (ANEP), tweeted that bitcoin is a “smokescreen for covering up corruption” and that its adoption as a currency is a “bad idea”. In an era where trust in the US dollar is waning, particularly over concerns of inflation, it is not surprising that developing countries are turning to nominally decentralized alternatives such as Bitcoin. But given the project’s focus on external investment, it is likely that bitcoinization will do little to lessen the dependence of El Salvador on the United States. Bukele will need to be wary that he has not simply swapped dependence on the institutions of Washington DC for the tech entrepreneurs of Silicon Valley.