Opinion

El Salvador’s great crypto experiment

Can bitcoin surpass the dollar in popularity and make El Salvador the first state to operate entirely with a private currency?

By: Date: September 14, 2021 Topic: Banking and capital markets

This piece was original published in Money Review and El Economista.

In September 2021, the government of El Salvador became the first to make bitcoin legal tender. This means it can now be used to make payments and settle debts, if businesses have the technology to accept it. Importantly, one of the implications of this legal change is that if creditors do not accept settlement of debts in bitcoin, then that debt is cancelled.

It is worth mentioning that El Salvador has been fully dollarised since 2001, in other words, it does not have its own currency but has relied entirely on the US dollar. The recent law means that the bitcoin will now operate alongside it.

But what does this mean in practice? Can bitcoin really surpass the dollar in popularity and make El Salvador the first state to operate entirely with a private currency?

Money has three functions: it is a unit of account, a medium of exchange and a store of value. For an item to be considered money, it must perform all three functions. Bitcoin is traded in international markets, making it a common measure of value, or unit of account, for goods and services. And as legal tender in El Salvador, bitcoin must be accepted domestically for the payment of goods and services, making it a valid medium of exchange.

But it is the third of these functions, the storing of value, that is crucial for achieving “good” and “popular” money. A stable and predictable value is what makes money acceptable and broadly used. To understand bitcoin’s ability to be a good store of value, we must differentiate between bitcoin as an asset and bitcoin as a means of payment.

The blue line in the figure shows that the value of bitcoin in dollar terms has increased since 2014. If you had invested in bitcoin before 2020, you would have today an asset many times more valuable than what you paid. Viewed as an investment therefore, bitcoin would have been a good choice. Since 2020 however, that is not the case and the timing of your investment would have mattered.  As an asset therefore, bitcoin is no different to any other asset class. Assessing the volatility, the timing as well as the horizon in which to invest are all factors that will determine whether any investment is profitable.

The orange line in the graph, which plots the change of the bitcoin price from one month to the next, tells a different story and helps to understand the cryptocurrency’s ability to store value and act as a means of payment.

For example, on the 4 July 2021, the value of bitcoin in relation to the US dollar reduced by 12% compared to its value a month earlier. On the 4 August 2021 it recovered by 8%, not the full value it had lost in the previous month. If one had opted to have their salary denominated in bitcoin, as indeed Salvadorans can do from now on, then the graph would show two things. First, the value of their monthly pay would have fluctuated between 180% and -65% since 2014 and second, that fluctuation would have been very volatile throughout this 6-year period.

All this is relevant if prices in El Salvador continue to be denominated in dollars so that conversion between the two continues on a daily basis. The country has been fully dollarised for the past 20 years and, at least for the moment, two thirds of Salvadorans are not keen on using bitcoin. Also, given the country runs a persistent trade deficit with its main trading partner (the US), it will still need dollars to finance that trade. It is difficult, therefore, to see how the use of the dollar will diminish.

There is, however, one area where bitcoin can make a difference: facilitating remittances. Salvadorans in the diaspora send the equivalent of 20% of GDP back home in remittances every year, typically through services like Western Union. If bitcoin catches on, it could induce a sizeable reduction in remittance costs, which amounts up to $400 million per year according to some estimates.

There are many other issues that are currently being heavily debated, from the motivation behind this experiment, all the way to privacy issues in the design of electronic wallets, to the political intentions of this move. All these factors play into trust, and ultimately, for a currency to become popular there needs to be trust that its value will be managed to ensure it remains stable and predictable. For the moment, the conditions for this to happen are not there.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read about event More on this topic
 

Upcoming Event

Jun
29
14:00

Autonomous, digital and green Europe: a conversation with Margrethe Vestager

At this event Margrethe Vestager will reflect on strategic autonomy, digital regulation and the implications of the Green Deal on competition.

Speakers: Guntram B. Wolff and Margrethe Vestager Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author
 

Blog Post

A practical arrangement for cooperation between digital economy regulators

Overlapping rules in the digital economy require cooperation between national regulatory authorities; a practical arrangement based on case information, case allocation and case resolution would ensure consistency and effective enforcement.

By: Christophe Carugati Topic: Digital economy and innovation Date: June 13, 2022
Read about event More on this topic
 

Past Event

Past Event

Future of Work and Inclusive Growth Annual Conference

Annual Conference of the Future of Work and Inclusive Growth project

Speakers: Erik Brynjolfsson, Arturo Franco, Carl Frey, Andrea Glorioso, Francis Green, Francis Hintermann, Ivailo Kalfin, Vladimir Kvetan, J. Scott Marcus, Anna Kwiatkiewicz-Mory, Anoush Margaryan, Julia Nania, Laura Nurski, Poon King Wang, Monika Queisser, Fabian Stephany, Niels van Weeren and Guntram B. Wolff Topic: Digital economy and innovation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 7, 2022
Read about event More on this topic
 

Past Event

Past Event

MICROPROD Final Event

Improving understanding of productivity, its drivers and the way we measure it.

Speakers: Carlo Altomonte, Eric Bartelsman, Marta Bisztray, Peter Bøegh Nielsen, Italo Colantone, Maria Demertzis, Wolfhard Kaus, Javier Miranda, Steffen Müller, Hannu Piekkola, Verena Plümpe, Niclas Poitiers, Andrea Roventini, Gianluca Santoni, Valerie Smeets, Nicola Viegi and Markus Zimmermann Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 31, 2022
Read about event
 

Past Event

Past Event

Three data realms: Managing the divergence between the EU, the US and China in the digital sphere

Major economies are addressing the challenges brought by digital trade in different ways, resulting in diverging regulatory regimes. How should we view these divergences and best deal with them?

Speakers: Susan Ariel Aaronson, Henry Gao, Esa Kaunistola and Niclas Poitiers Topic: Digital economy and innovation, Global economy and trade Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 19, 2022
Read about event More on this topic
 

Past Event

Past Event

Adapting to European technology regulation: A conversation with Brad Smith, President of Microsoft

Invitation-only event featuring Brad Smith, President and Vice Chair of Microsoft who will discuss regulating big tech in the context of Europe's digital transformation

Speakers: Maria Demertzis and Brad Smith Topic: Digital economy and innovation Location: Bibliothéque Solvay, Rue Belliard 137A, 1000 Bruxelles Date: May 18, 2022
Read article More on this topic More by this author
 

Opinion

Buy now, pay later: the age of digital credit

A relatively new fintech market, BNPL is currently not regulated in the EU, meaning that consumers do not have the same protection level as they do for other credit products.

By: Maria Demertzis Topic: Digital economy and innovation Date: May 17, 2022
Read article More on this topic
 

Blog Post

Insights for successful enforcement of Europe’s Digital Markets Act

The European Commission will enforce digital competition rules against big tech; internally, it should ensure a dedicated process and teams; externally, it should ensure cooperation with other jurisdictions and coherence with other digital policies.

By: Christophe Carugati and Catarina Martins Topic: Digital economy and innovation Date: May 11, 2022
Read about event More on this topic
 

Past Event

Past Event

COVID-19 and the shift to working from home: differences between the US and the EU

What changes has working from home brought on for workers and societies, and how can policy catch up?

Speakers: Jose Maria Barrero, Mamta Kapur, J. Scott Marcus and Laura Nurski Topic: Inclusive growth Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 28, 2022
Read article More on this topic
 

Blog Post

The decoupling of Russia: high-tech goods and components

Sanctions on high-tech goods supplies, combined with financial sanctions and other restrictions, will deprive Russia of a future as a modern economy.

By: Monika Grzegorczyk, J. Scott Marcus, Niclas Poitiers and Pauline Weil Topic: Global economy and trade Date: March 28, 2022
Read article
 

Blog Post

The decoupling of Russia: software, media and online services

Restrictions so far on software, media and online services in Russia have been imposed either voluntarily by firms, or else by Russia itself in order to restrict the flow of information.

By: J. Scott Marcus, Niclas Poitiers and Pauline Weil Topic: Digital economy and innovation, Global economy and trade Date: March 22, 2022
Read about event More on this topic
 

Past Event

Past Event

Who will enforce the Digital Markets Act?

While the Digital Markets Act entered its first trilogue, what will be the enforcement role of the Commission and the Member States?

Speakers: Christophe Carugati, Cani Fernández, Assimakis Komninos and Georgios Petropoulos Topic: Digital economy and innovation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 22, 2022
Load more posts