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Bitcoin becomes legal tender in El Salvador: hype or breakthrough?

Investment Insights

4 min read

Bitcoin becomes legal tender in El Salvador: hype or breakthrough?

On 7 September, 2021, bitcoin became legal tender in El Salvador alongside the US dollar. According to the new law, all economic agents will have to accept payment in the popular cryptocurrency. Here Joaquin Thul looks at the reasons behind the adoption of bitcoin and why, in the short term, it is unlikely to be successful.

Joaquin Thul
Joaquin Thul

Financial inclusion

El Salvador, with a population of almost seven million people, currently has one of the lowest levels of financial inclusion within Latin America and the Caribbean. According to World Bank data, in 2017 less than 30% of Salvadoreans aged 15 or over had an account with a bank or a financial institution. Only 23% of people in El Salvador have Internet access at home, one of the lowest rates in the region, although over 85% of people use a mobile phone.

Although the low levels of financial inclusion and high mobile phone penetration in the country could favour the adoption of a digital currency as a means of payment, the use of bitcoin seems to go against some of the country’s long-term plans. For example, the unregulated nature of cryptocurrencies and their links with illegal activities contradict the transparency goals set by the digitalization agenda. In short, people who are currently outside the financial system are unlikely to be included by the adoption of bitcoin.

Remittance costs

Remittances represent almost a quarter of the country’s GDP, the largest proportion of countries in Latin America and the Caribbean and the fifth largest in the world. Proponents of bitcoin believe its use could reduce the cost of sending and receiving money from abroad, possibly saving Salvadoreans around USD 400 million annually in remittance fees. However, data suggests the cost of sending remittances from the US to El Salvador is already among the lowest in the region and has continued to decline over the last year.

In 2021, the cost of a bitcoin transaction ranged from $2 to $60, depending on the number of payments processed on the day, with an average cost of $13 per transaction. Data from El Salvador’s central bank shows the average size of remittances received increased from $280 per month in 2020 to $300 per month in 2021, with fees averaging less than $10 per transaction. Although the difference between fees is, on average, only slightly cheaper for regular money transfers, it nonetheless represents a disincentive to switch to bitcoin. Moreover, the unpredictable nature of fees could be a headwind to widescale adoption by the public.

Will El Salvador eventually replace the US dollar with bitcoin?

A survey conducted in early September by LPG Datos, a Salvadoran polling firm, found that over 65% of the population rejected the introduction of bitcoin as legal tender in the country, and over 70% would refuse to receive payments in bitcoin. It also seems unlikely the country will replace dollars with bitcoin given the country’s close commercial links with the US and the dollarized nature of the Salvadoran economy.

Additionally, the possibility of citizens paying taxes with bitcoin could hinder tax collection for the government given the fees associated with converting bitcoin to US dollars and the high intra-day volatility of its price. On 7 September, the day bitcoin became legal tender, the price of the cryptocurrency fell by 11%, registering one of the largest intraday price variations of the last five years.

Conclusion

Overall, President Bukele’s decision to make bitcoin legal tender in El Salvador resembles more a marketing campaign for his government than a genuine attempt at improving financial inclusion or reducing transaction costs. Bukele’s government has recently been criticized by international organizations for its authoritarian rule, forcing lawmakers to pass a budget law and controlling the judicial system to favour his policies. The approval of a cryptocurrency as legal tender seems questionable at best.

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