El Salvador bitcoin plan “bulletproof”, president says

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Men buy snacks at a store where bitcoins are accepted at El Zonte Beach in Chiltiupan, El Salvador June 16, 2021. REUTERS/Jose Cabezas/File Photo

LONDON, June 23 (Reuters) - El Salvador is determined to push ahead with making bitcoin legal tender, a process that will bring only small risks and prove a “leap forward for humanity”, the country’s President Nayib Bukele said in an interview with a bitcoin journalist.

El Salvador this month became the first country to adopt bitcoin as legal tender in a move taking effect in September. read more

Speaking in the interview released on Wednesday, Bukele said the move would boost jobs and economic development to the Central America country.

He said he was confident the project would be a success - despite the World Bank declining to offer technical support and concerns expressed by the International Monetary Fund.

“It looks bulletproof,” he said in an hour-long interview with bitcoin podcaster Peter McCormack. “I’m pretty sure this is going to work, not only for us but for humanity, because it is a leap forward for humanity.

Bukele said the move would lessen El Salvador’s reliance on the U.S. dollar, the existing legal tender.

“(We will be) at least becoming a little less dependent on the output of new dollars, and the new inflation that’s coming with those all those new dollars,” he said.

There was no plan to hold bitcoin in national reserves, though that might happen “probably in the future”, he said.

The World Bank declined to give assistance to El Salvador’s bitcoin implementation given the environmental and transparency drawbacks. read more

“Having the World Bank, advisers or technical support would have been nice, but we really don’t need it,” Bukele said, adding local talent was more than enough.

He acknowledged there might be some risks to the push.

“But I really do not see them as big risk, only probably getting some people angry at us but they haven’t been so nice to us anyway, so you know, why not try something new?”

Analyst have voiced concerns that the bitcoin push could endanger the country’s request for an $1 billion programme to the IMF. The fund has voiced economic and legal concerns regarding the move, though Bukele said his government had spelled out its plan and would offer more explanation if needed. read more

“We adopted the U.S. dollar in the year 2001, what’s the difference?” he asked.

“The only difference, probably, is the reasons why we’re doing this. In 2001 it was probably done for the benefit of the banks and this decision is done for the benefit of the people.”

Bukele also said he had received a lot of interest from parties over exploiting renewable energy from the country’s volcanoes to build a bitcoin mining hub.

“We have discovered new (geothermal) wells that will give us 95 megawatts, which is not huge but still quite considerable,” he said.

A bitcoin mining plant would be built at a cost of $480 million, he said, while bitcoin would pay for infrastructure from schools to bridges.

Editing by Alison Williams

Our Standards: The Thomson Reuters Trust Principles.

Why Bitcoin Could Be Good for El Salvador

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The news that the president of El Salvador plans to adopt BTC as an alternative to the U.S. dollar for transactions in his country has caused quite a stir. Bitcoin has captured its first country. Reactions have varied from “wow, this is BIG for bitcoin” to “this is not going to end well.” As ever, the truth is probably somewhere in the middle. It’s not a major coup for bitcoin, but it could work quite well for El Salvador. And, importantly, it might establish a real-world use case for bitcoin that doesn’t involve crashing the entire global monetary system. I don’t think bitcoin will replace the dollar as the premier global settlement and reserve currency, but that doesn’t mean it couldn’t be good for some countries.

Frances Coppola, a CoinDesk columnist, is a freelance writer and speaker on banking, finance and economics. Her book, “The Case for People’s Quantitative Easing,” explains how modern money creation and quantitative easing work, and advocates “helicopter money” to help economies out of recession.

El Salvador (population 6.5 million) is a “dollarized” economy. It doesn’t have a currency of its own. Instead, it uses the U.S. dollar as its domestic currency. El Salvador’s relationship with the U.S. is not like that of a U.S. state, or even a territory such as Puerto Rico. It is an independent sovereign country that chooses to use the dollar instead of issuing its own currency. El Salvador is not subject to U.S. law and the U.S. government has no jurisdiction there.

Because it doesn’t produce its own currency, El Salvador’s government can’t print money. And it doesn’t benefit from the Federal Reserve’s money creation. The Fed is not in any way responsible for ensuring that El Salvador has enough dollars for domestic use. So, El Salvador must either borrow or earn the dollars it needs.

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It can earn dollars by exporting more than it imports and by receiving dollar remittances from its citizens working overseas. If those two sources don’t provide enough dollars to meet domestic needs, both the private sector and the government can borrow dollars on international markets.

Currently, El Salvador exports less than it imports, but remittances are large enough to ensure that its “current account” – the net value of all its transactions with the rest of the world – remains slightly positive. On balance, therefore, El Salvador is receiving net dollar inflows. But the government is borrowing heavily: In the last couple of years, government debt has risen to over 90% of gross domestic product, and borrowing costs are rising. It’s unclear how much more the government will be able to borrow.

Furthermore, dollar flows are volatile. It’s only a few years since a commodities price crash caused dollar inflows for countries such as Nigeria and Angola to reverse abruptly, forcing them to sell down their dollar reserves to maintain their currency pegs to USD. A dollarized economy such as El Salvador doesn’t need reserves to maintain a currency peg, but it does need dollar reserves to maintain liquidity for domestic banks, businesses and households. Running short of dollars can force it to close its banks and sharply curtail government spending.

In its 2019 Article IV report, the International Monetary Fund said that El Salvador’s dollar reserves are too low for its economy. El Salvador needs more dollar income, and that means developing export industries and encouraging overseas workers to send more dollars home. Earning some income from its existing reserves would also help. Today’s near-zero interest rates on safe dollar investments aren’t good for countries like El Salvador.

Considering all of that, adopting BTC as a second currency doesn’t look like a bad idea. There are several potential benefits.

First, using bitcoin to send remittances could be easier, cheaper and faster for overseas workers than using money transmission services or bank wire transfers, so remittances might increase. Of course, remittances would need to be exchanged for dollars inside El Salvador, but that could be achieved with a phone app linked to a cryptocurrency exchange.

Alternatively, citizens could use their BTC directly to pay for goods and services, and merchants could be provided with the means to exchange BTC for dollars. There’s obviously a risk that BTC exchanges would fail because of a lack of dollar liquidity within El Salvador. So, the El Salvadoran government proposed to establish a trust fund initially worth $150 million in the state development bank Bandesal, which would guarantee liquidity for the exchanges. And a version of the Strike app is being prepared for use by Salvadorans, though it’s not clear yet exactly how that would work.

Second, diversifying the country’s dollar reserves into bitcoin could create opportunities to earn yield, thus increasing the size of the reserves.

Third, a partially “bitcoinized” economy could be attractive as a home for bitcoin investors and headquarters for bitcoin businesses, which could raise the country’s GDP. And it would also create an opportunity to develop new bitcoin-based businesses. The government has already proposed a scheme to use geothermal energy to power bitcoin mining.

If this partial “bitcoinization” scheme works, then El Salvador could increase both its reserves and its GDP, reducing the pressure on government borrowing costs and potentially freeing up money for social programs.

Downside risks

There are serious risks, however.

By far the biggest is the possibility that the country will run out of U.S. dollars. Diversifying into bitcoin may improve the earning potential of the reserves, but BTC’s price is notoriously volatile. A crash such as that in 2018 would wipe out 80% of the country’s dollar reserves, potentially forcing the banks to close and making it impossible for the government to meet its USD obligations. El Salvador defaulted in 2017. Diversifying into BTC could force it into another default.

A BTC crash would also seriously hurt Salvadorans who had wholly or partly adopted BTC for remittance income and savings. And it would cause a run on BTC by businesses that have a guaranteed exchange route into the U.S. dollar, because it would be in their interests to exchange their devaluing BTC for USD. That $150 million trust fund would very quickly run dry.

Even without a major BTC crash, the country could still run short of U.S. dollars. Converting remittance income to BTC unfortunately reduces dollar inflows and hence increases the risk of dollar shortages. It’s easy to buy bitcoin with U.S. dollars, but not so easy to sell it for U.S. dollars, especially when lots of other people are all trying to sell at the same time. Stablecoins such as USDT (tether) can be a temporary hedge against BTC volatility, but they aren’t much use for businesses and governments that have dollar debts that must be serviced.

Also, the rest of the world might not be too enthusiastic about lending dollars to a country that had diversified its reserves into BTC and run short of dollars as a result. The IMF, which is currently in negotiations with El Salvador about a potential loan, has already expressed some concern.

There’s a different kind of risk too – and one that unfortunately has all too often come to pass in Latin America. That is the risk that the monetary tightness caused by dollar shortages and BTC illiquidity proves unbearable, and the government starts issuing its own currency, perhaps in the form of a stablecoin. Initially, that might be fully backed by its dollar and BTC reserves in a currency board type of arrangement similar to that in Hong Kong. But BTC’s volatility makes this hugely problematic. Even a small BTC crash would leave the currency partially unbacked.

Furthermore, if the desire of the government to give away money outstripped the ability of the productive economy to earn dollars and BTC, the currency board might quickly turn into a permanent fractional reserve type of arrangement. That would leave the new currency wide open to a speculative attack designed to drain the reserves and force it off its peg.

It’s essential that El Salvador’s government resists the temptation to buy short-term improvement to economic growth and welfare by issuing large amounts of a new fiat currency or stablecoin only partly backed by hard currency reserves. That’s a recipe for a foreign exchange crisis, debt default and hyperinflation. Too many countries in Latin America have played this scene before. It’s a risk El Salvador really shouldn’t take.

So I’m giving a qualified welcome to El Salvador’s scheme. It could work, but there are enormous risks and temptations. And it must be connected with serious efforts to attract inward investment and develop export industries. Changing the monetary regime is all very well, but in the end, it is production of real goods and services that matters. That’s where the wealth of nations comes from.

If this scheme works, it’s obviously good for bitcoin, as it would establish it as a national currency and minor reserve asset. And, believe it or not, I hope it does work. I’d like to see El Salvador achieve prosperity, and if bitcoin can help it do that, then that’s a great use of bitcoin.

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Lawmakers in El Salvador made history on Tuesday when they voted to make Bitcoin legal tender, the first country in the world to recognise a cryptocurrency on such terms.

Momentum behind the move built up at breakneck speed.

Just three days passed from Salvadoran president Nayib Bukele announcing his plans for the crypto at the Bitcoin 2021 conference in Miami on Saturday, to legislation being voted on and approved in the country’s Legislative Assembly.

What’s more, the new law, passed by the president’s populist New Ideas party with a supermajority of 62 votes to 22, will be fully enacted within 90 days.

Such a move is indeed historic and unprecedented, but it’s perhaps not entirely surprising given the deepening relationship many countries in Latin America are developing with cryptocurrencies and what they are being used for.

Pushing aside the well-aired concerns about decentralised and unregulated currencies like Bitcoin, in Latin America at least, it’s being seized upon not by the ultrarich but by many facing grinding poverty.

From the Rio Grande in Mexico to the tip of Patagonia, crypto has become a lifeline for millions.

While it’s the only country to have taken the plunge so far, El Salvador has set in motion change that is likely to sweep up many more with it.

Is El Salvador the first domino to fall?

Following the vote in the Salvadoran assembly, politicians in Argentina, Paraguay, Brazil and Panama took to social media to endorse the decision.

Of these countries, it looks increasingly likely Paraguay will soon follow El Salvador’s example or at the very least, introduce favourable laws towards cryptocurrencies.

One man in particular is leading the charge; a 36 year-old Paraguayan congressman called Carlos Rejala.

Having vociferously expressed his support for Bukele on social media, Rejala alluded on Monday to an “important project” which would “innovate Paraguay in front of the world”.

“As I have been saying for a long time, our country must move forward hand in hand with the new generation. The moment has come, our moment,” he tweeted.

While specific details of the project are yet to emerge, speculation is rife that it will involve both Bitcoin and Paypal. Rejala is also widely expected to present a bill before the country’s parliament which would facilitate crypto mining and attract crypto businesses looking to set up in the country.

According to Coindesk, Rejala first began following the Bitcoin trend in 2017 before eventually becoming a crypto trader himself in 2019. Following the vote in El Salvador, he shared a photo of himself embellished with the red “laser eyes” now synonymous with proponents of Bitcoin.

He is not alone in his admiration for Bukele - or Bitcoin.

In Panama, too, lawmakers are mobilising to put forward plans for new crypto-friendly laws.

On Monday, Gabriel Silva, a deputy in the country’s National Assembly, reposted one of Bukele’s tweets and announced that he was looking to draft a proposal to put to his parliamentary colleagues.

“Panama cannot be left behind. If we want to be a true technology and entrepreneurship hub, we have to support cryptocurrencies,” he posted.

But what is it in particular that makes Central and South American countries such fertile grounds for this crypto boom?

Inflation, hyperinflation and deflation

As in many countries in the developing world, nations in Latin America are intermittently beset by political and economic crises and the crippling hardships caused by them.

In the face of soaring inflation, and in the absence of traditional banking services for large swathes of the population, Bitcoin and other cryptos have become part of the way of life.

“The Latin American countries where you have this combination of inflation or hyperinflation cycles - deflation as well - and then you have very high friction for financial transactions, a high percentage of people who are unbanked, cryptocurrencies make total sense,” Fred Thiel, CEO of US-based Bitcoin miner Marathon Digital Holdings, told Euronews.

“You only need to have a phone really to use it. And in these countries, most people do have phones”.

In El Salvador, around 70 per cent of the population do not use or have access to banking services. It’s not just Latin America, either, where phone ownership outstrips bank account holders.

Santos Hilario Galvez, a Salvadoran builder, makes a purchase at a small store that accepts Bitcoin, in Tamanique, El Salvador. Salvador Melendez/Associated Press

“You see the same thing in Africa. You see the same thing in India. Indonesia, a huge country of 250 million plus inhabitants and up to 70 per cent don’t have bank accounts but they all have phones,” Thiel added.

“So, those are areas where you are going to see a lot of options for digital currencies”.

Of course, each country is different and faces its own set of circumstances. In El Salvador, the official acceptance of Bitcoin as a legal tender alongside the US dollar was a common sense approach to removing boundaries to one of its main economic drivers: remittances from abroad.

Remittances - transfers of cash or goods made in this case by migrant workers - make up almost 20 per cent of El Salvador’s GDP with some $6 billion (€4.9 billion) sent back to the country each year by Salvadorans living abroad.

We’re going to see a lot of policymakers in countries outside the G7 and G8 adopt fairly positive stances towards the use of Bitcoin Fred Thiel CEO, Marathon Digital Holdings

“I think partially in the case of El Salvador, this is a way to deal with inflation,” Thiel explained.

“It’s a way to bolster the economy by removing fees being paid for money that is already being sent to the country and most of those fees are being collected outside of El Salvador”.

While economic growth has slowed in recent years, inflation in El Salvador remains comparatively low compared to other countries in the Americas.

In Argentina, for example, levels of inflation rose to 54 per cent in 2019 before declining slightly to 42 per cent in 2020.

Worse still is Venezuela where inflation peaked at 1.8 million per cent in 2018. While nowhere near that high at present, forecasts by economists predict that inflation will stand at 1,400 per cent at the close of 2021.

In March, the country’s central bank printed a 1 million bolivar note for the first time, worth around just €0.40.

Through necessity, Venezuelans began to dabble in crypto and digital currencies much sooner than many of their regional neighbours in a bid to outpace the rampant hyperinflation wreaking havoc on their lives.

With its economy in freefall and its political system splintering, the country launched the world’s first state-backed digital coin, the Petro, in 2018. Pegged to Venezuela’s oil reserves, it had minimal success. As civil unrest continued to grow and the country’s fiat currency further deteriorated, cryptocurrency transactions soared in a bid to prevent the value of incomes being eroded.

“As soon as people get their pay or earn money doing something, they convert it right away into Bitcoin,” Thiel explained. “Because also the currency system is very controlled in these countries and it’s very hard to buy dollars so you have to buy them on the black market”.

Is the world warming to Bitcoin?

While the merits of decentralised cryptocurrencies continue to be debated, the genie is already out of the bottle with Bitcoin.

El Salvador’s move to make it legal tender is another step towards making cryptocurrencies a mainstream feature of the global financial ecosystem, but as yet it’s unclear whether countries outside the developing world are ready to warm to Bitcoin and its ilk in the same way.

There’s no question that, at the very least, a thawing is now well underway, according to Thiel.

“I think we’re going to see a lot of policymakers in countries outside the G7 and G8 adopt fairly positive stances towards the use of Bitcoin other than certain regimes which view it as a threat, such as China,” he told Euronews.

In some cases Bitcoin is the ideal currency because it’s just pervasive and easily used. Fred Thiel CEO, Marathon Digital Holdings

Home to 75 per cent of the world’s Bitcoin mines, China has intensified a crackdown on mining operations and cryptocurrency trading in recent months.

In the last week alone, authorities disabled traders’ accounts on Chinese social media platform Weibo and announced a ban on mining farms.

“It’s typically nations where they really want to control more of the economy where they try to limit this,” Thiel said.

“You’re going to see a lot of pronouncements from the G7/G8 here regarding central bank digital currencies”.

Many of the leading industrial nations are beginning to delve into the prospect of launching their own digital currencies, including China, the US and the UK. Plans for an e-currency are already well advanced in Sweden, for instance, which is one of the countries where digital payments are increasing the fastest.

Cryptocurrencies are not without their risks, particularly given the extreme volatility in the price of Bitcoin. Despite the encouraging news from El Salvador, the value of Bitcoin has continued to slide.

But for some countries though, including those in Latin America, the risks surrounding Bitcoin will continue to be a more attractive prospect during times of economic turbulence than digital currencies that are tied to equally volatile fiat currencies or wholesale reliance on the US dollar.

“I think we’re going to see a broad adoption of digital currencies across the board, it’s just in some cases Bitcoin is the ideal currency because it’s just pervasive and easily used,” posited Thiel. “And it allows a country to align itself with a currency like Bitcoin which is not tied to a particular nation”.