Bitcoin as National Currency in El Salvador Could be High Gain But High Risk

President Nayib Bukele of El Salvador is going to turn the nation into the first in the world to use Bitcoin as a national currency. The decision, announced this week, has been welcomed by cryptocurrency entrepreneurs and advocates as it promises to create a tax haven for them. 

But the move from the young, controversial president promises high risks as well as high gains. 

“#Bitcoin has a market cap of $680 billion dollars,” said Bukele on Twitter over the weekend following a video appearance at a cryptocurrency conference in Miami, Florida.  “If 1 percent of it is invested in El Salvador, that would increase our GDP by 25 percent. On the other side, #Bitcoin will have 10 million potential new users and the fastest growing way to transfer 6 billion dollars a year in remittances.”

He also changed his profile picture on the platform to an image of himself with red, “laser eyes,” a symbol among Bitcoin proponents who are laser focused on the value of the currency reaching a hundred thousand dollars per unit.

Cryptocurrency advocates and entrepreneurs applauded the decision.

“I called my dad and just kind of pissed my pants,” said Jack Mallers, chief executive of Zap, a Bitcoin investment and payments company, recalling his reaction when the Salvadoran government asked him for help in drawing up the proposal.  

But analysts cautioned that making Bitcoin a national currency is not without risk, and that the success of the initiative will depend upon many of the same factors that currently hinder economic development in El Salvador, where a civil war, poverty and gang violence have forced the equivalent of roughly a quarter of the population to flee to the U.S. over a generation. 

“Bitcoin doesn’t get in the way, but it’s not enough to attract investment,” said Leonor Selva, executive director of the national business association ANEP. “If you are thinking about foreign investment, first you must have the business climate and legal security conditions that we can say have not been characteristic of this administration.”

Following a recent midterm election that gave Bukele’s party a majority in the national assembly, lawmakers ousted the attorney general and judges on the constitutional court. The move was widely criticized as an assault on the independence of the judicial branch.

Bitcoin could also attract the wrong kind of investment, such as that from money launderers or criminal groups who prefer the anonymity offered by cryptocurrencies.

“With weak and compromised institutions, with weakened judicial bodies, promoting tools that allow you to make financial transactions anonymously becomes riskier in a Central American region that was already prone to be a logistics hub for organized crime and drug trafficking,” said Selva.

“What they want is to create a tax haven where bitcoins can be sent to El Salvador and exchanged for cash and then with the dollars to be able to transfer it anywhere in the world,” said the economist Luis Membreño.

Corrupt officials in El Salvador could also benefit. Three of the past four presidents have been charged with crimes, including the laundering of funds stolen from public coffers. In May, the U.S. State Department included several high-ranking officials in Bukele’s government on a list of people in the region credibly accused of corruption.

In 2001, El Salvador adopted the U.S. dollar as its national currency in order to stabilize its finances. Cryptocurrencies, however, are known for their volatility.

A public break up in May with the world's-richest person and Tesla chief executive Elon Musk slammed the value of Bitcoin during a difficult month for the cryptocurrency, which ended with a cumulative 36 percent price drop. The announcement from El Salvador hasn’t helped, as the value has since fallen about 16 percent. 

“This high volatility of the cryptocurrency can be harmful to the economies of small businesses and members of the informal sector, as they do not understand well how the tool is used and how that volatility is managed so that it works in favor of a person, not against,” said Selva.

On a micro level, Bitcoin has already been adopted along the nation’s Pacific coast. A little more than an hour’s drive from the capital San Salvador, a number of surfing villages have created small Bitcoin ecosystems over the past couple years that operate through the use of a mobile phone app. The project, led by a group called Bitcoin Beach that is funded by an anonymous donor, “has been a good rehearsal,” said Selva, albeit with mixed results.

Small business owners have reported losses due to the currency’s volatility, underscoring the challenges of implementing its use on a larger scale.

The country also runs the risk that others better suited to adopt Bitcoin and attract investors will steal its momentum. Lawmakers in Panama, long the financial hub of Central America and one of the world’s preferred tax havens, have joined a growing chorus of peers across the region who are calling for their countries to follow the example of El Salvador.

“First they ignore you, then suddenly Paraguay, Argentina, Panama, Brazil, El Salvador, and Nicaragua embrace #Bitcoin,” tweeted investor Tyler Winklevoss, who was made famous for his role in the creation of Facebook by the movie The Social Network.

In the end, El Salvador, with all its underlying problems and where roughly 50 percent of the population has regular access to the internet, may not be able to compete.

“The Bitcoin announcement can generate a lot of excitement, but if you have not met a lot of country conditions, such as internet service access, you are going to fall short on impact,” said Selva.