El Salvador in Crisis, Bitcoin — and Volcanoes?

El Salvador, the smallest country in Central America, along with the roughly 6.5 million residents (and another 1.5 million abroad) have been in prolonged turmoil: Economic tumult, extreme violence, high poverty rates, political instability, corruption and natural disasters plague the small nation. Bitcoin has recently been instated as legal tender and as a potential solution to some of the aforementioned issues. Furthermore, President Bukele also intends to harvest geothermal energy from Volcanoes to support the mining of bitcoin. — Author: JP Patheja Hellmich

El Salvador’s turmoil

El Salvador has been suffering from low levels of GDP growth with a current average of 2.3% annually — and a near 9% contraction in 2020 due to Covid¹. As a result of the slow economy, 1.5 million Salvadorans emigrated to the US to work and send remittances back home to support their families. These remittances make up 20% of El Salvador’s GDP²!

In 2001, in an attempt to stimulate economic growth, El Salvador adopted the USD as their national currency. The rationale being a more accessible entry in the local economy for foreign investors and to stabilize inflation rates. This, however, came at the expense of losing control over monetary policy which was essentially handed over to the US Federal Reserve. Without control over money supply and interest rates, El Salvador now relies on taxes, local spending and foreign investments³.

The extreme violence in El Salvador, amongst other things, hindered foreign investments and growth; as 60,000 gang members are responsible for approximately 51 deaths per 100,000 inhabitants in 2019 (down over 50% from 108 deaths in 2015)⁴ — to boil it down, it is the world’s most dangerous nation by homicide rate. This comes at a significant expense; of the USD 27 billion GDP (2019), violence is costing El Salvador 16% of its GDP⁵.

Part of this high crime rate can be attributed to the poverty rate. Although the poverty rate has declined from roughly 40% in 2007 to 30% in 2017⁶, it still is extremely high. Another factor is the low level of education; the participation rate in secondary education is a mere 62%. Simultaneously, there is a growing rate of youths who neither study nor work (currently 25%)⁷ — Given these facts and figures, the aforementioned high crime rate should not come as a surprise.

Political instability and corruption further hinder progress. For instance, in the 1981 El Mozote massacre, nearly 1000 people (553 children) were raped, abused and killed; in 2020, when the courts tried to bring the responsible to justice, the military still concealed their identity and denied access to the documents detailing the event⁸. Additionally, it is known that the Police themselves are partially responsible for the high rate of disappearances, but only seldomly are these disappearances investigated.

Finally, to top it off, the country is ridden by natural disasters; it is prone to increased volcanic activity; a five-month rainy season that leads to floods and landslides; hurricanes and earthquakes⁹.

Bitcoin as legal tender

It is abundantly clear that El Salvador is in an extraordinary predicament — and extraordinary problems require extraordinary solutions. That is where President Nayib Bukele enters the picture.

On the 7th of June 2021, Bukele’s administration successfully passed the world’s first law recognizing bitcoin as legal tender¹⁰. This means, every business will be required to accept bitcoin as payment. This includes the government, which will even be accepting tax payments in the form of bitcoin. Furthermore, any bitcoin transactions will be exempt from capital gains tax.

Figure 2: President Bukele tweets about bitcoin¹¹

The idea is revolutionary and in theory, magnificent: the implementation of a decentralized currency, such as bitcoin, will aid El Salvador to be less reliant on the USD and hence independent of the monetary policy dictated by the US Federal Reserve. Given, that the FED has printed close to 30% of the current money supply since the pandemic onset alone¹², it may be a good idea to create some distance. The decentralized nature also implies a reduction of corruption and interference by local authorities and individuals.

Furthermore, the transition to bitcoin would save a very significant amount of money from the annually transferred remittances (USD 6 billion), lost through the fees incurred by traditional banks and agencies¹³. Bitcoin would be simpler to use without all kinds of forms and restrictions; significantly faster as transfers are almost instantaneous; and as previously stated, vastly cheaper than the 10% (and higher) incurred through traditional monetary agencies.

Lastly, the shift to bitcoin is very likely to attract foreign investors and ultimately stimulate economic growth within the nation.

Concerns

As promising as the move appears, some questions are left unanswered: Firstly, how will El Salvador (utilizing both USD and bitcoin), cope or deal with the immense fluctuations of bitcoin? Proponents of bitcoin don’t see this as an issue. They claim this volatility is not regarding bitcoin’s monetary policy but rather when measuring BTC in terms of USD and hence, inapplicable¹⁴.

A perhaps more significant question is how El Salvador expects to implement a digital currency when 70% of its nation does not yet even have a bank account. Although not a valid answer, proponents claim this is an excellent foundation for promoting financial inclusion¹⁵ in El Salvador.

Volcanic geothermal energy

Recently, bitcoin has come under much criticism for its adverse environmental impact. But even for that, President Bukele has seemingly found a solution — and to call it unconventional would be an understatement: Volcanoes will power bitcoin mining.

LaGeo, a local utility company, has been contracted to build a geothermal plant using the heat from one of the many active volcanoes in El Salvador. Supposedly, the energy is 100% renewable, completely clean and extremely cheap¹⁶.

This not only seems promising, but also plausible as a solution to cleanly and ethically mine bitcoin.

Summary

As we have seen, El Salvador faces many adversities. In response to the economic situation, President Bukele has become a first-mover in instating a cryptocurrency, specifically bitcoin, as legal tender in a nation. While there are open questions and concerns in regard to the implementation, the opportunities and solutions are manifold. Furthermore, it is truly disruptive and will render an interesting case study to observe, and perhaps even lay the foundation for more nations to adopt cryptocurrencies as legal tender.

References

  1. https://www.worldbank.org/en/country/elsalvador/overview#1
  2. https://data.worldbank.org/indicator/BX.TRF.PWKR.DT.GD.ZS?locations=SV
  3. https://voiceselsalvador.wordpress.com/2011/06/08/ten-years-later-the-impact-of-dollarization-in-el-salvador/
  4. https://oecd-development-matters.org/2018/01/17/reducing-violence-in-el-salvador-what-it-will-take/
  5. https://www.economist.com/the-americas/2016/05/21/the-gangs-that-cost-16-of-gdp
  6. https://www.worldbank.org/en/country/elsalvador/overview#1
  7. https://www.oecd.org/dev/inclusivesocietiesanddevelopment/youth-issues-in-el-salvador.htm
  8. https://www.hrw.org/world-report/2021/country-chapters/el-salvador
  9. https://www.gov.uk/foreign-travel-advice/el-salvador/natural-disasters
  10. https://www.cnbc.com/2021/06/09/el-salvador-proposes-law-to-make-bitcoin-legal-tender.html
  11. https://www.valuewalk.com/wp-content/uploads/2021/06/Image-1-Tweet.png
  12. https://fred.stlouisfed.org/series/M2SL
  13. https://www.reuters.com/business/finance/exclusive-el-salvador-bitcoin-transfers-soar-still-fraction-dollar-remittances-2021-06-14/
  14. https://www.coindesk.com/bitcoin-el-salvadors-legal-tender
  15. https://www.cnbc.com/2021/06/09/el-salvador-proposes-law-to-make-bitcoin-legal-tender.html
  16. https://www.tagesschau.de/wirtschaft/technologie/bitcoin-schuerfen-el-salvador-vulkan-geothermie-ernergieverbrauch-101.html

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