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Why has El Salvador officially adopted bitcoin as its currency?

Why has El Salvador officially adopted bitcoin as its currency?

A Starbucks that accepts bitcoin in San Salvador, El Salvador

Camilo Freedman/Bloomberg via Getty Images

El Salvador has officially adopted bitcoin as legal tender. Draft legislation may soon lead Panama down the same path, while China, the US and the UK are investigating launching their own cryptocurrencies. Here’s what you need to know.

Why are countries adopting bitcoin?

President Nayib Bukele hopes bitcoin will alleviate El Salvador’s prickliest economic problems: citizens sending money home from abroad account for up to a fifth of the country’s GDP, but they have to pay high transaction costs, and 70 per cent of people have no bank account. Bitcoin enables quick, cheap payments across borders, and doesn’t require banks.

Every Salvadoran has been gifted $30 in bitcoin (the US dollar is the nation’s other official currency) and can now shop or pay their taxes with it. Companies must accept it by law, but are permitted to instantly swap all bitcoin to dollars once received. A Panamanian congressman has now proposed legislation that would see the country follow in El Salvador’s footsteps.

Will it work?

There will be hurdles, as bitcoin isn’t simple to use. While many in El Salvador were posting their successful bitcoin purchases on social media, others were marching in the street in protest.

And the markets are spooked. The Financial Times reports that the yield on long-term Salvadoran bonds rose from 8.5 per cent in June prior to the bitcoin announcement to 11 per cent, meaning confidence in the state’s finances has dropped,

Bitcoin itself is also volatile (the currency’s value has veered as low as £21,700 and as high as £46,500 this year), which isn’t a desirable property for legal tender. A company accepting bitcoin payments may find that the value of that currency has dropped when it is time to buy new stock.

Will many other countries follow suit?

In a word, no. It’s extremely unlikely that any major economy would back a cryptocurrency like bitcoin, which cannot be controlled by a central bank and was created by a secretive cryptographer.

But we are likely to see central banks around the world launching their own digital currencies, combining benefits of cryptocurrencies and traditional money. Financial consulting firm PwC published a report earlier this year on these so-called Central Bank Digital Currencies (CBDCs). The report claimed that 60 governments are currently working on one, and that 88 per cent are basing them on blockchains, the technology behind bitcoin, though not all CBDCs will be cryptocurrencies.

Have any countries started using CBDCs yet?

The Bahamas was one of the first nations to issue a CBDC, launching a cryptocurrency version of the Bahamian dollar last year in an effort to avoid moving physical cash across its 700 small islands. Cambodia, too, launched a CBDC version of its own currency called Bakong in 2020.

China has been trialing its e-CNY currency for some time and plans a large-scale test during the Winter Olympics next year. The US has two programmes running to investigate a digital dollar, and the Bank of England is talking to banks, retailers and members of the public to decide what its own digital currency should look like.

How does a CDBC work?

Unlike a decentralised cryptocurrency, which is controlled by no single organisation, a central bank would manage a CBDC. But it could retain some of the perceived benefits of a cryptocurrency, such as simple transfers of large sums, the ability to do away with physical cash, and an audit trail to crack down on corruption and tax evasion. But while cryptocurrencies like bitcoin have hard-coded limits on the number of coins that will ever exist, a CBDC could be created from thin air by central banks with quantitative easing just as with traditional currencies – something bitcoin advocates say is a major downside.

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