Nayib Bukele, president of El Salvador, has got himself a pair of laser eyes — on his Twitter profile at least.
Laser eyes are something social media users give themselves to show they love cryptocurrency — and Bukele proved his crypto-enthusiasm last week by having El Salvador become the world’s first nation to make Bitcoin legal tender.
El Salvador’s parliament passed Bukele’s proposed legislation on June 9, after he announced his plan just a few days earlier. The law will take effect in September.
Some Bitcoin fans have leapt on this as a step towards much broader acceptance. But the changes in Bitcoin’s market value since Bukele announced his plan gives crypto-skeptics reason for doubt.
Over the past week, Bitcoin’s value was as high as $38,200 and as low as $31,428. Over the past month, it has fallen from more than $58,000. This isn’t the type of price volatility any government generally wants to see in a currency.
Such fluctuations show Bitcoin’s weakness as a viable alternative to central bank currencies — good only for transactions you don’t want to be traced and as a speculative investment.
So what is Bukele thinking in wanting to make Bitcoin legal tender for the small Central American nation (population about 6.5 million) whose economy accounts for less than 0.05 percent of global GDP?
What does “legal tender” mean?
Before we get to that, let’s clarify what making Bitcoin legal tender means.
Using Bitcoin is already legal in El Salvador, as it is in most countries. If you want to pay for something in bitcoins, and the recipient is willing to accept them, it’s all good.
Making bitcoins legal tender means a payee will have to accept them. As the new legislation states, “every economic agent must accept Bitcoin as payment when offered to him by whoever acquires a good or service.”
El Salvador making this move isn’t as significant as it would be for most nations, because it is one of about a dozen countries — most of them micro-states such as Andorra and Nauru — without its own currency or a common currency such as the Euro.
El Salvador abandoned its own currency (the “colon”, named after Christopher Columbus) in 2001 and adopted the U.S. dollar as its legal tender. This process of “official dollarization” was seen as a reform that would curb inflation and increase trade with the U.S., by far its major trading partner.
So El Salvador has less to lose than other nations in adopting a second currency as legal tender. There is no controversy about losing sovereignty and monetary policy autonomy. There will be no loss of “seignorage” — the profit made on issuing currency that’s worth a lot more than the cost of making it.
But having two legal tenders will complicate matters, particularly when one of those currencies is subject to wild swings in its value.
Consider the provision in the new law that “all obligations in money expressed in USD, existing before the effective date of this law, may be paid in bitcoin”.
Even that is complicated. How, and by whom, will the number of bitcoins necessary to pay a debt be determined? Will it be based on the Bitcoin price at the time the debt was incurred, or when the debt falls due?
The difference of even a few days could be significant.
If the expectation is the price of Bitcoin is going to rise, why would you want to buy things with it? Why not wait? If the expectation is the price is going to fall, why would you want to accept it? For most transactions, using U.S. dollars will still make the most sense.
So making Bitcoin legal tender could help destabilize El Salvador’s economy.
Increasing El Salvador’s GDP
Things would have been simpler if El Salvador had adopted a “stablecoin”…