Caribbean & Central America - July 2021

President Nayib Bukele is moving ahead with plans to make the cryptocurrency, bitcoin, legal tender in El Salvador despite concerns at home and abroad.

At the beginning of June, El Salvador passed legislation adopting bitcoin as legal tender alongside the US dollar, the country’s official currency. President Bukele said using bitcoin would give the country access to a secure, efficient, and globally integrated electronic payments system, which would also allow the roughly 2m expatriate Salvadorean workers to send home remittances without paying bank charges. Bukele also said the move would improve financial inclusion in a country where around 70% of the population doesn’t have a bank account and works in the informal economy.

However, the expedited approval of the bitcoin legislation sparked concerns over the lack of debate in the national assembly of its consequences; the volatility of bitcoin; its possible use for criminal activity; and the practicalities of using the cryptocurrency in everyday life (see sidebar).

The move has also thrown into doubt a US$1.3bn financial assistance programme that El Salvador is negotiating with the International Monetary Fund (IMF). Government officials had previously spoken of securing new IMF financing as an essential part of the government’s response to the coronavirus (Covid-19) pandemic, that would help to put the country’s high foreign debt onto a more sustainable path.

In terms of the nuts and bolts of the new bitcoin legislation, Bukele said that the bitcoin-US dollar exchange rate will be freely set by the market; that Salvadorans will be able to pay taxes in bitcoin; and that his government will make sure that systems are in place for when the law takes effect on 7 September, including setting up a US$150m trust fund at the Salvadorean development bank (Bandesal) to support automatic and instantaneous conversions of bitcoin into dollars.

Bukele also said that businesses in El Salvador will have to accept bitcoin, with exceptions for those that do not have access to the right technology. But he later contradicted himself by saying that the use of bitcoin “will be optional”. In addition, any debt, including bank loans, can be converted into bitcoin, and employers will also be able to pay their workers in bitcoin.

A group of Salvadorean economists spoke out against the new legislation in a joint statement published 9 June on Twitter, bemoaning the fact that it was approved without thinking through all its consequences. “It is equally irresponsible for deputies and government officials, in the full exercise of their functions and in the face of the lack of information on the measure, to declare themselves unconditionally in favour, without analysis nor signs of opening the debate to different sectors of the country”, the statement reads.

The Central American institute of fiscal studies (Icefi), a regional think-tank, weighed in on the plans in a statement published 11 June. Although Icefi recognises the potential benefits of adopting bitcoin, it believes they are outweighed by risks including the danger of a financial bubble driven by the volatility in the value of the cryptocurrency.

Icefi also points out that the US$150m Bandesal trust will be financed by public debt, which means that the risk and the cost of bitcoin volatility will in fact fall on taxpayers. Icefi was also careful to underline that failed negotiations with the IMF “could generate a crisis of confidence with respect to El Salvador’s sovereign debt”; and recommends delaying the implementation of the bitcoin law to allow more time for technical analysis. IMF spokesperson Gerry Rice highlighted issues with El Salvador’s adoption of bitcoin as legal tender on 10 June, warning that it “raises a number of macroeconomic, financial, and legal issues that require very careful analysis”. On 24 June Rice announced that discussions with El Salvador over a financial assistance programme “are continuing,” but reiterated concerns over the adoption of bitcoin.

This scepticism was echoed by the World Bank, when on 16 June it declined to provide technical assistance to help El Salvador with the move citing “environmental and transparency drawbacks”, news agency, Reuters, reported. Salvadorean debt premiums also started to rise, and analysts warned the damage may be long-term. “The recognition of a 'Bukele' risk premium has probably done some permanent damage to investor sentiment”, Siobhan Morden, head of Latin America fixed-income strategy at Amherst Pierpont Securities in New York commented. International credit ratings agency, Fitch Ratings, added its voice to the chorus of concerns on 25 June, writing that the bitcoin law “would increase financial institutions’ regulatory, financial and operational risks, including the potential of violating international anti-money laundering (AML) and terrorist financing standards”. Fitch also cited worries over the “rushed implementation” as well as a lack of clarity over the extent of the government’s involvement and how the system will work in practice.

Despite the misgivings Bukele remains convinced by the plan. On 26 June he defended the initiative in an official statement in which he railed against “businesses and public figures who have devoted themselves to misinforming the population”. Bukele said that adopting bitcoin will benefit people and will “open us up to the world and put us in the spotlight for something good and innovative”. Two days later in another statement Bukele said that each person that downloads the government’s electronic wallet dubbed ‘Chivo’ would be given US$30 worth of bitcoin. The idea is not to give money away but to promote the use of bitcoin and Chivo. There will also be 200 Chivo terminals around the country where users can convert bitcoin into dollars, Bukele added, while the government is planning a series of training days to teach people to use Chivo.

Many questions remain about the practicalities of making bitcoin legal tender. Some say Bukele is improvising and is more concerned with projecting a modern image than with any potential negative effects. However, El Salvador’s embrace of bitcoin has sparked debates in other Latin American countries such as Paraguay and Panama on regulating the use of cryptocurrencies if not following El Salvador’s lead in adopting them as legal tender. Notably, in a 11 June client note investment bank JP Morgan raised the possibility that this could be “the beginning of a broader trend among similarly situated, smaller nations”.

•  Warnings and resistance

International financial analysts have criticised the plans warning that bitcoin has been used for highly speculative purposes and suffered bouts of volatility that could derive in big losses to its users. Unlike a central bank digital currency (CBDC), bitcoin is a decentralised and anonymous system that can used to conceal tax avoidance, money laundering and corrupt payments. Meanwhile a survey by El Salvador’s chamber of commerce & industry found that 45.3% of those that own business are worried about being made to accept bitcoin payments, while 51.6% said they would immediately convert bitcoin into dollars. Among consumers, 93.2% of respondents said they didn’t want get paid their salaries in bitcoin, while 82.5% said they wouldn’t want to receive bitcoin remittances.