Don’t Read Too Much into Bitcoin’s Status in El Salvador

By Vectorios2016

Whether they like it or not, consumers in El Salvador can now use bitcoin to buy everything from Big Macs and Starbucks coffee to big-ticket items like automobiles. But don’t be overly impressed by the cryptocurrency’s newfound status as legal tender in the Central American nation. While newsworthy, it isn’t the watershed moment in monetary history that true believers claim. In fact, risk-averse investors, along with business managers in other nations thinking about accepting bitcoin, should pay more attention to what is happening in more influential economies.

Earlier this year, China—where central bankers are developing a national digital currency—outlawed activities in the unregulated cryptocurrency realm. As the world’s second-largest economy and a formidable challenger to the United States’ geopolitical clout, the Asian nation’s economic policies can have a huge global impact. In this case, the crypto crackdown briefly eliminated about US$1 trillion in total crypto market capitalization, with bitcoin tumbling nearly 50 per cent. By contrast, when El Salvador initially announced its plan to adopt bitcoin as a local currency alongside the U.S. dollar in July, the market reaction was largely muted despite the media headlines.

El Salvador’s much-hyped rollout of bitcoin in early September, on the other hand, did move markets, since it was hampered by technical glitches that helped drive down the cryptocurrency’s value by more than 15 per cent. The drop moved El Salvador—which had made a big deal about acquiring 400 bitcoins the previous day—to support demand for the cryptocurrency by spending millions of dollars more on the cryptocurrency. But despite this political act of faith, local merchants didn’t voluntarily come to the conclusion that accepting bitcoin was good for business. It can be perceived that they have been forced to accept the unstable cryptocurrency in exchange for their goods and services by a politically motivated law (unless technologically unable to conduct bitcoin transactions).

“Protesters are now taking to the streets to express fears related to crypto-market instability and the risk of inflation. And they have reason to worry. After all, while governments can influence financial and economic landscapes, they can hardly add credibility or utility to any commodity.”

Being the first nation to adopt bitcoin is a great way to make headlines, especially for El Salvador, since its stature in the global economy is minuscule. It is neither a member of powerful groupings such as the Group of Seven (G7) and the Group of Twenty (G20) nor a major trading partner. Moreover, a sizeable portion of the country’s gross domestic product comes from remittances. But a policy decision as big as this for any nation should be backed by an indisputable rationale. And El Salvador’s decision to embrace bitcoin is a significant gamble by President Nayib Bukele, who insists Salvadorans living abroad will save millions of dollars in commissions on money they send home. He also argues that if just one per cent of the cryptocurrency’s market cap is invested in El Salvador, the nation’s economy can surge by 25 per cent. A reasonable roadmap for this to happen isn’t clear, but you don’t have to be an economist to see the risks. After all, digital or not, currencies are meant to be a reliable store of value, which requires price stability, not volatility.

More than a few citizens in El Salvador—where government funds will be used to help ensure people can easily convert bitcoins to U.S. dollars—considered the logic for making a dated cryptocurrency legal tender to be shaky even before the nation’s rocky adoption of bitcoin. Protesters are now taking to the streets to express fears related to crypto-market instability and the risk of inflation. And they have reason to worry. After all, while governments can influence financial and economic landscapes, they can hardly add credibility or utility to any commodity. Enabling green energy policies, for example, can promote the adoption of electric vehicles, but they cannot add to the commercial viability or practicality of battery-driven cars, which is for the industry participants to achieve. In the case of bitcoin—which ironically wasn’t designed to work in tandem with a fiat currency or need government support—viability as a currency will take much more than enabling legislation from an arguably impulsive Central American president whose policy decisions and legislative actions have evoked international censure.

The world is likely to eventually warm up to digital currencies. But while the distributed ledger tech that underpins the unregulated digital currency space might have proven its potential application by being transparent and secure, it has yet to demonstrate practicality in terms of utility. And how things shake out in the crypto space could be poles apart from the contemporary scene.

Originally developed for people who distrust central banks, bitcoin was indeed conceptualized as a replacement for fiat money. But for numerous reasons, it is now widely seen as nothing much more than a volatile investment instrument—and policymaking in El Salvador isn’t likely to change that. Meanwhile, China’s pilot project on introducing a digital yuan is forcing central banks in other influential parts of the world to expedite their own digital currency projects. If you are interested in government policies that will influence the future of crypto, this is where you should be looking.

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