No, Bitcoin Won’t Crash El Salvador’s Economy: But The IMF Might

El Salvador’s Bitcoin experiment has made it some powerful enemies.

Bitcoin is now officially legal tender in El Salvador, but Nayib Bukele’s plans don’t stop there. The eccentric president announced using the country’s volcanoes for “green” Bitcoin mining and a “golden visa program” for Bitcoin investors.

The policies were welcomed in the crypto community. However, not everyone is as excited. Global financial institutions the least of the bunch.

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The International Monetary Fund (IMF) was the first to raise concerns over El Salvador’s ambitious crypto plans. IMF officials warned of significant risks that come with crypto assets.

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Institutional investors took notice and proceeded to dump El Salvador’s bonds. Since Bukele has announced its Bitcoin plans, yields on bonds maturing in 2025 have jumped from 6.3% to 8.4%.

This means that the country will have a harder time accessing international credit. What is more, IMF is still considering El Salvador’s request for a $1.3 billion loan. In light of the recent developments, that loan may come into question.

What is more, World Bank rejected El Salvador’s request for help in implementing Bitcoin as legal tender.

The request was rejected over the supposed “environmental and transparency” shortcomings of Bitcoin. As Bitcoin is probably one of the most transparent financial instruments, it’s difficult to accept that justification.

Add all of these facts together, and a clear picture is emerging. El Salvador’s Bitcoin experiment has put it at odds with some of the most powerful global financial institutions.

Bitcoin

But why is Bitcoin a problem for them? Will the Bitcoin experiment destroy the country’s economy, as Steve Hanke, professor of Applied Economics at Johns Hopkins University suggests?

According to Hanke, the “criminal element” that supposedly deals with crypto wants the move, so they can exchange crypto for dollars. El Salvador uses the U.S. dollar as legal tender.

“They will suck up all the dollars from El Salvador like a vacuum, and the economy will collapse. That’s why it’s so stupid,” Hanke said in an interview with Kitco News.

Historical Precedents: Gresham’s Law

This reasoning is in line with the old economic dictum of “bad money driving out good money.”

El Salvador now has two official currencies, the U.S. dollar and Bitcoin. This is similar to how some countries in the past used both gold and silver as legal tender.

When these countries tried to set official exchange rates between gold and silver, they ran into serious issues.

If the market price of gold in terms of silver is higher than the official rate, the public will flock to spend their silver and to buy gold. No one would want to sell gold at the official rate.

That’s why, as Gresham’s law has it, “bad money drives out good money.”  

If El Salvador was to introduce an official exchange rate between Bitcoin and U.S. dollars, it would very quickly run into similar problems.

But that’s not what El Salvador ever considered doing.

As article 2. of the “Bitcoin law” states, “the exchange rate between bitcoin and the United States dollar, subsequently USD, will be freely established by the market.”

What This Law Really Is

El Salvador won’t fix exchange rates between USD and Bitcoin. Sellers won’t have to put out prices for their goods in Bitcoin. All Bitcoin transactions will be denominated in U.S. dollars.

What this law does is mandate that all sellers accept Bitcoin as a payment method, if they have access to the required technology.

As the country’s secretary of Commerce Miguel Kattán stated:

“The dollar will continue to be the legal tender in El Salvador. Operations can be done with bitcoin – obviously related to its value in dollars.”

However, most economists will have you believe that no one will be using Bitcoin in El Salvador. High costs of transactions on the blockchain is one reason.

The country is poor, and remittances constitute 20% of its GDP. It’s unlikely that Slavadoreans will be willing to pay high transaction costs.

 

The big problem with crypto, in general, is that you can’t convert them into actual real legal tender that’s usable – cheaply and quickly,” Hanke said.

‘Lightning’ Solution For Emerging Markets 

The fact is that this is entirely possible with new technology, and El Salvador is leading the way in adoption.

One of the most exciting places for cryptocurrency today is El Salvador’s Bitcoin Beach.

Bitcoin Beach, also known as El Zonte, is actually a small surfing town of 3000 residents. What makes it special is the town’s adoption of a new Bitcoin payment infrastructure; the Lightning Network.

The Lightning Network is a second layer payment protocol, that settles transactions off-blockchain. That allows it to have low fees as well as low energy costs.

The Lightning Network is exceptionally useful for instant micropayments. This is a growing trend in emerging economies, where many people don’t have access to credit cards.

In Kenya, a mobile payment system M-Pesa is dominating the payment industry, making a good case for similar services in emerging economies.

The Lightning Network offers instant payment at low fees, with the added benefit of the security provided by the blockchain.

As the developers put it: “This is similar to how one makes many legal contracts with others, but one does not go to court every time a contract is made.

Only in the event of non-cooperation is the court involved – but with the blockchain, the result is deterministic.”

But if El Salvador’s adoption of Bitcoin could actually help its economy, why are all the international institutions attacking it?

Could it be that they are concerned with what crypto can do to their ability to control the markets?

Rather than presenting a danger for the economy, the adoption of Bitcoin should signal that the country is open for business.

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Freelance journalist, student of the Austrian school.

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