Why is El Salvador embracing Bitcoin and why doesn’t IMF approve?

In today's Finshots we discuss El Salvador's experiment with Bitcoin and understand why IMF believes this might be a risky endeavour.

The Story

El Salvador became the world’s first country to adopt bitcoin as legal tender back in June. Ordinary people could formally use bitcoin to pay for goods and services throughout the Central American nation, alongside its existing currency. And it was a momentous occasion for El Salvador and scores of crypto believers worldwide… An actual country recognizing cryptocurrency as legal tender.

Amazing!

But as expected, the move also invited a fair bit of criticism. And chief amongst those critics was The International Monetary Fund (IMF), who lambasted the notion of a sovereign country adopting Bitcoin as legal tender in a blog post titled “Cryptoassets as National Currency? A Step Too Far”. Here’s an excerpt from the post…

“New digital forms of money have the potential to provide cheaper and faster payments, enhance financial inclusion, improve resilience and competition among payment providers, and facilitate cross-border transfers. But doing so is not straightforward… Some countries may be tempted by a shortcut: adopting crypto assets as national currencies… We believe, however, that in most cases risks and costs outweigh potential benefits.”

And while the blog does go on to acknowledge some potential benefits of cryptocurrencies as they mentioned, it remains largely critical of bitcoin.

But before we get to the criticism, perhaps we should look at El Salvador’s point of view here.

El Salvador has a population of 6.5 million. But almost 2 million of its citizens live and work abroad. These people work hard overseas to send money back home so that their families can get by. And whilst at it, they also end up making an important contribution to the country’s GDP — estimated to be around $4 billion each year. In fact, around 20% of the country’s GDP could be attributed to remittances alone. But sending money this way can be a very expensive and tedious affair.

According to the World Bank, remittance of $200 can incur average fees between 5% and 9%, depending on the countries involved and the mode of service used. You indirectly have to pay for complying with “Know-Your-Customer” (KYC) requirement, Anti-Money Laundering regulations, capital controls, and a whole bunch of other things. With Bitcoin, you don’t have to pay this prohibitive fee (at least in theory).

Also, a significant portion of El Salvador’s migrant workforce is undocumented. These are marginalized people who don’t even have a bank account. So in theory, sending home Bitcoins could turn out to be a cheap and hassle-free way of transacting across borders.

But the IMF blog post has its own contentions.

They believe that this could pose several real risks for the economy. For instance, if people can transact with both Bitcoin and the local currency, they’ll keep weighing their options trying to see what would work best. This IMF believes is a wholly unproductive enterprise. Also, as the blog post notes — “even if all prices were quoted in, say, Bitcoin, the prices of imported goods and services would still fluctuate massively, following the whims of market valuations.”

Then there is money laundering. How would you prevent “crypto assets from being used to launder ill-gotten money, fund terrorism, and evade taxes?”

Well, it’s hard. Which is probably why IMF feels this is a step too far. However, that hasn't deterred El Salvador one bit.

The country now harbors ambitions of becoming a Bitcoin mining hub.

For the uninitiated, bitcoin mining is energy-intensive in nature. Global bitcoin mining operations use more electricity annually than the entire nation of Argentina and Bitcoin's environmental impact has been under scrutiny of late. But El Salvador contests that they have a solution. They are offering the Bitcoin mining community a chance to harness and develop geothermal energy from El Salvador's volcanic sites — a clean source of energy to maintain the bitcoin network. And if all goes well, the country believes it could bring an influx of foreign currency and crypto-technology helping boost El Salvador’s status among its peers.

So yeah, we’ll have to wait and see how this story pans out. Will IMF be proven right as time goes by or will El Salvador be the first of many nations to truly adopt Bitcoin?

Until then...

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