Bitcoin is now legal tender in El Salvador. Is this the start of something?

El Salvador has become the first country in the world to make bitcoin legal tender. John Stepek explains why, and asks if other countries might do the same.

Yesterday, cryptocurrency bitcoin became legal tender for the first time.

The central American nation of El Salvador became the first country in the world to mandate that bitcoin can be used to pay your taxes, do your groceries, buy a house – all the things your standard “fiat” (government-issued) currency takes for granted.

Is this world-transforming? Or just another crpyto-gimmick from the wacky world of bitcoin?

I’m not sure, but it’s certainly fun to write about.

The key point – El Salvador does not have its own currency

Bitcoin has libertarian roots. The whole idea of the cryptocurrency is tied up in ideals of escaping authority and centralisation, and enabling free exchange across all sorts of borders.

El Salvador, which has just adopted it as legal tender, is not a libertarian utopia.

For example, I was flicking through news about El Salvador while writing this piece (it’s not a country I know much about, strangely), and it turns out that earlier this week, just before bitcoin was made legal tender, a woman was released from jail after serving nine years for being suspected of having an abortion.

She may have counted herself lucky. The original sentence was 30 years.

Anyway, it’s currently run by Nayib Bukele. He’s a young (39 – younger than me, anyway), populist (always being compared to Donald Trump, naturally), pseudo-dictator (he was elected, but last year he got the army to take control of Congress).

And now he has pushed through a law which adopts bitcoin as legal tender. He even changed his avatar on Twitter to give it the “laser eyes” which denote a cryptocurrency fan on the social media website. (If you’re not on Twitter, this will probably mean nothing to you, but I honestly wouldn’t worry about it).

I’m sure a lot of you know a lot more about El Salvador than I do. But the main fact that matters to this story is a simple one: El Salvador does not have its own currency.

Until 2001, El Salvador ran on the “colon”. But then it ditched it, and opted to use the US dollar instead.

So El Salvador is what’s known as a “dollarised” economy. At some levels it makes sense: the US is its most important source of remittances (money sent back by workers overseas) and the economy is heavily tied to the US – so why not use the currency?

However, this also means that El Salvador has ceded a great deal of control over its own affairs.

El Salvador uses dollars but it has no say over US monetary policy (ie, what the Federal Reserve does) and receives no benefit from US fiscal policy (ie, El Salvador doesn’t get any money directly from US taxpayers). The rules around the US dollar are set for the benefit of the US – not for El Salvador.

For some countries – particularly those with a history of instability and poor governance – tying yourself to a more stable currency is worth the sacrifice of this control. But there’s no doubt that it’s a sacrifice.

Might other countries view bitcoin as a viable alternative arrangement?

This goes back to what we’ve been discussing here a lot recently – this question of control. 

A sovereign currency is a valuable thing: if you can print your own money, issue debt in your own money, and still maintain sufficient confidence in it that other people will happily accept it or readily exchange it for other currencies – that’s a good position to be in.

It gives you a lot of room for manoeuvre (or sufficient rope to hang yourself, as every reserve currency issuer across history has learned too late – but that’s a topic we’ll return to another day).

This is why countries with sovereign currencies are particularly edgy about the idea of competition from digital currencies (both independent, decentralised ones like bitcoin, and rival government-backed digital currencies like China’s digital yuan).

However, if you already lack all control over your own currency, then why not adopt another one? Particularly one where at least the monetary policy side is predictable. Bitcoin is a “hard” currency in that there’s a set limit on how much is printed and how quickly it’s printed.

So from that point of view, El Salvador’s adoption isn’t immediately significant in the grand scheme of things.

However, it does make me wonder what might have happened if awareness of bitcoin and crypto generally had been more widespread during the early days of the eurozone sovereign debt crisis.

Would Greece have viewed it as a potential solution to the currency question? Fear of leaving the euro is ultimately what kept Greece in the EU at that point. The option of bitcoin-isation might not have tipped the balance but the topic would certainly have come up.

What does that mean for future discussions over breakaway regions? Currencies are often the biggest sticking point. If populations can be convinced (rightly or wrongly) that digitisation or bitcoin-isation is somehow a less painful alternative to ease yourself out of a currency union, then that’s going to have an impact on politics everywhere.

As for what it means for bitcoin itself – that’s harder to say. I have no real grasp of what drives the value of bitcoin and I don’t mind admitting that. This certainly draws attention to it again, and that’s one thing that bitcoin definitely likes.

I’d be surprised if any Salvadoran citizens who actually own bitcoin are happy to use it instead of dollars, given its wildly fluctuating value.

However, this does create a live experiment and incentives to improve the technology. I still see the main hurdle to widespread acceptance of bitcoin as being its user-unfriendliness. Perhaps this will see a drive to make it more consumer-friendly.

At the end of the day, this is mostly an economic curiosity occurring in the type of country where economic curiosities happen all the time. But it’s worth keeping an eye on. It’s not as though El Salvador is the only dollarised country out there.

For more on cryptocurrencies in general and questions on central-bank backed digital currencies, subscribe to MoneyWeek magazine. I can see it’s going to be another of the big defining issues of this decade, alongside inflation. You can get your first six issues free here.

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