In the summer of 2010, Laszlo Hanyecz, a programmer from Florida, completed a transaction that can only be categorised as one of the most noteworthy transactions in modern history in hindsight.
Spoiler Alert! It was to buy 2 pizzas!
What made this transaction unique was how he paid for them.
Laszlo was short on cash, but he had mined this new fancy cryptocurrency called Bitcoin. So he went on a public forum to ask if anyone would trade his Bitcoins for actual cash. A 19-year-old student took him up on his offer and sent him $41 in exchange for 10,000 Bitcoins.
This ended up being the first transaction where Bitcoin was used as a medium of transaction. Fast forward 11 years and the Latin American state of El Salvador declared Bitcoin as a legal tender on September 7, 2021.
Read this blog to know how this happened and the repercussions that El Salvador is facing after making this decision.
A Brief Insight into El Salvador’s Financial History
El Salvador’s financial history has been rather tumultuous.
It started with the Spanish colonisation and the adoption of the currency ‘colón’. This was followed by a military coup in the 1930s, and finally suspending the colón and turning to the US dollar in 2001 in order to integrate it with the American trade and commerce system.
It is essential to contextualise the early adoption of Bitcoin to understand how domestic politics and economic policies have led it to make a rather bold decision despite the backlash from global financial systems.
Why did El Salvador choose Bitcoin?
Quite shocking as it may be, approximately 70% of the Salvadorian population does not have access to the banking system.
In fact, the self-styled “CEO of El Salvador” and the president Nayib Bukele believe that the adoption of bitcoin as a legal tender will lead to greater financial inclusion. El Salvador’s remittances make up 20% of its GDP, implying that expats working abroad transfer a huge sum to their home country. But, this comes with a huge transaction cost, which could be as much as 30–50% of the transferred monetary value. This makes it even more apparent that this could also be a measure to reduce their dependence on the US dollar.
Response to Bitcoin as Legal Tender: Repercussions and Reproach
Immediately after the launch of the Bitcoin law, the virtual currency plunged by 17% as BANDESAL (the financial promoter of the Salvadoran economy) bought $21 million worth of Bitcoin to set up a trust fund for Bitcoin.
The government introduced ‘Chivo’ a new digital currency wallet app, with a base amount of $30 in Bitcoin for every user. This app had zero transaction costs and allowed seamless cross-border transactions. But, there were several technical glitches in downloading and using the application. Moreover, the application was not available on the app store, etc.
In fact, the domestic population in a survey by Francisco Gavidia University revealed that 24% of the public felt it was a “bad decision” and 53.5% considered it a “very bad decision”. On the contrary, only 12.9% suggested that it was a “good decision’ and a meagre 6.5% considered it a “very good decision”.
On the global front, the International Monetary Fund (IMF) has raised an alarm against the adoption of digital currency as a legal tender for the nation. They have asserted that it would impact several macroeconomic, financial, and legal variables. A recent IMF report from January 2022 suggested the removal of Bitcoin as a legal tender. Failing to do so, El Salvador will find it difficult to procure loans from the institution. The institution insisted that Bitcoin’s volatility was increasing El Salvador’s exposure.
Taking a cue, credit rating agencies like Moody’s had downgraded their sovereign ratings, meaning the long- and short-term bond prices had adjusted downward due to the deterioration in governance and escalating tensions with the U.S. and IMF.
Conclusion
There’s a saying. Innovation, for the sake of innovation, is an empty shell. The case of El Salvador clearly leans towards this end of the spectrum. While the move to make Bitcoin legal tender sounded bold and ambitious during the bull run of the cryptocurrency, it is now being considered a hasty decision that disregarded the possible ramifications of a bear market.
There is a clear consensus amongst citizens, economists, and technologists that BTC as legal tender is a novel idea, but the ecosystem is too young and volatile to be trusted as a replacement for a stable asset like the US Dollar. It does not help that Bukele’s government is down 35% (approximately $40 Million) on the Bitcoin they bought with public funds in May 2022. However, the case study of El Salvador doesn’t provide a definitive blueprint for every nation because of its own tumultuous financial history. So would Bitcoin’s adoption in any other sovereign state be more successful? That’s a question for another day.