Is El Salvador the first domino in global bitcoin adoption?

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Learn Crypto Blog Learn Crypto Blog
Learn Crypto Sep 08 · 4 min read
  • What is Legal Tender?
  • The stranglehold of dollarization
  • Second domino more important than first

On September 7th 2021 Bitcoin became legal tender in El Salvador. The crypto community celebrated the news  as the beginning of the next phase of adoption. The mainstream media focused on the FUD and price dumped by 13%. So is El Salvador the first domino to fall in Bitcoin’s global adoption or just a sideshow in a broader struggle to gain recognition?

To understand the significance of El Salvador’s announcement to accept Bitcoin as legal tender you have to unpick what that actually means.

What is Legal Tender anyway?

Legal tender is a formal definition which basically means the money that a country recognises for common use. Prior to El Salvador's President, Nayib Bukele, making the announcement regarding Bitcoin, the US Dollar was the official legal tender in El Salvador alongside the Colon, the official national currency up until 2001.. 

So El Salvador’s decision means that businesses must make reasonable effort to accept payment in Bitcoin, citizens must be able to pay their taxes in Bitcoin and Bitcoin will be exempt from capital gains - a tax on the increased value of assets - because it is now officially considered money, not a commodity.

This makes sense for El Salvador because the country relies so heavily on remittance, the in-flows of money from abroad. This totalled almost $6billion in 2020, almost a quarter of the Salvadoran economy, with 95% coming from the USA.

$6bn

The size of El Salvador's remittance economy, with 95% coming from the USA

The problem with remittance is that traditional methods for sending dollars back home are really expensive and often rely on physical collection which can often involve long queues at banks and the danger of robbery.

Bitcoin fixes that, especially through the use of the Lightning Network, which is part of the back-story of how El Salvador came to its decision. The Bitcoin-based money transfer service, Strike, was central to that.

With Bitcoin circulating in the economy, and gradually becoming part of the country’s currency reserves - through taxation - this sounds like a really progressive step, so long as Bitcoin’s value doesn’t tank.

Of course that is exactly what happened the day Bitcoin officially became legal tender leading many observers to suggest it was more than just a coincidence. Every citizen was granted $30 in a specially created wallet, Chivo, to try and spur adoption, while the country is building Bitcoin reserves, at 100BTC a day. The idea that national and local holding lost more than a tenth of their value in just 24 hours will sow doubt.

Bukele has four years to prove his decision was right, which also happens to be a crucial time span for Bitcoin, taking it past the next halving cycle, but beyond price volatility, what’s the downside to this story? If El Salvador’s Bitcoin experiment succeeds won’t countries in a similar situation follow their lead?

The stranglehold of dollarization

Substituting the US dollar for local currency is called ‘dollarization’. For El Salvador this began in 2001 and was the result of a troubled economic and political history. It isn’t alone in relying on the US Dollar, which is the world’s global reserve currency.

The dollar gained that status after the end of World War II, with America taking a leading role in restructuring Europe after years of destruction. The World Bank and the IMF were two of the three main institutions that emerged from the Bretton Woods Conference in 1944 to help countries in financial trouble.

Those institutions are funded by members in proportion to GDP, so the USA contributes the most and also has the biggest say in how they are run and how funds are distributed.

El Salvador is a poor country reliant on loans from the IMF and World Bank. The US has de facto control over those institutions, so El Salvador’s decision to introduce a new legal tender alongside the dollar has been perceived as a threat, especially if it encourages other countries to do the same. 

The US wants to retain its role as the world’s reserve currency. It gives it tremendous power, so it's gonna make life difficult for El Salvador, and announcements by both organisations after its bold move to Bitcoin illustrate this. But if enough countries follow suit, it could change the power dynamic.

The second domino may be more important than the first?

El Salvador has a tiny economy by world standards, ranking 107th by GDP, smaller than every individual US state. So it’s like a petri dish for this crypto experiment, which many other dollarized countries - with more significant economies - for whom remittance is also crucial, will be watching to see whether it flourishes.

Several have indicated an interest, including Panama, Mexico, Paraguay, Argentina, Tanzania and the Philippines. Showing an interest in following El Salvador in accepting Bitcoin as legal tender might, of course, simply be a strategic move by these nations to use as leverage in their general relations with the USA. 

It seems unlikely that any country with a significant GDP would make the move, though those suffering chronic inflation, financial exclusion or both (think Iran or Venezuela) might have a bigger incentive.

The reaction of the US and its proxies to El Salvador’s Bitcoin move has been a kind of slap on the wrist, an implicit order to get back in line and a warning to others. If another country decides to ignore the instruction and join El Salvador, it could be that the second domino is far more significant than the first in respect of Bitcoin’s global adoption.