Bitcoin Republic

El Salvador is in the cryptocurrency news. I can see why it makes sense to use renewable geothermal energy from a volcano to mine bitcoin and then sell it to support El Salvador’s economy in the absence of fresh IMF support. But I don’t see why El Salvadorans should be forced to accept bitcoin as payment for goods and services.

The economist Hyman Minsky famously observed that making money is easy, but difficult to get it accepted. Indeed, innovators throughout history have faced the same problem and solved it in different ways.

For example, in 1260, the Chinese Emperor Kublai Khan decided to replace metal, raw materials, precious stones and specie with paper currency. Imagine how crazy that must have sounded! Replace real stuff with seemingly worthless paper! So what was the Khan’s marketing plan for his new fiat currency and how did he convince traders to adopt it? It was easy. If you didn’t accept paper money, he would kill you. Admirable clarity of politics.

A similar acceptance problem arose after the French Revolution, when the revolutionary government took over church property and, on the basis of this security, issued interest-bearing bonds, so-called “assignates”. In 1793 the National Convention decreed that refusing to accept these bonds as payment would mean “twenty years in iron” in the case of repeat offenders, but even that was not enough to persuade the populace to accept the new currency that soon introduced to exchange cents on the dollar for hard currency.

Given the history of forcing people to accept new forms of money, I was a little surprised to hear from the Bitcoin 2021 conference in Miami that El Salvador was planning to introduce legislation to make Bitcoin legal tender alongside the US dollar partly because “legal tender” is an outdated and essentially meaningless concept, and partly because everything bitcoin is isn’t money.

Legal what?

The following means legal tender in the United States. Section 31 USC 5103 states that “Federal Reserve Notes and Circulation Notes of Federal Reserve Banks and National Banks are legal tender for all debt, government dues, taxes and levies”. But that doesn’t mean anyone has to accept dollar bills. It simply means that you can’t refuse a cash payment if you’re in debt. Businesses in the US are completely free to say they only accept bitcoin if they want to (aside from areas like San Francisco, where local lawmakers passed “Party like its 1699” laws that impose a stealth tax on retailers by force them to accept cash).

Legal tender is not required in a modern economy. Look at Scotland. Scotland has no legal tender law. Having said that, I have been to Scotland on a number of occasions and have often seen Scots shop in shops using banknotes, cards and mobile phones. The lack of legal tender laws does not appear to be a major impediment to trade between willing participants.

El Salvador is a cash economy where approximately 70% of the people are unbanked and remittances account for one fifth of the economy. In 2001, El Salvador officially adopted the US dollar as legal tender. As a result, all wages and prices, all accounts and transactions were converted into dollars, and over time the national currency disappeared. The outcome, as this IMF paper examines, was fairly positive. The elimination of devaluation risk and currency savings have reduced interest rates by 4-5%, giving the private sector a net saving of around 0.5% of GDP per year. Not bad.

Bitcoin Republic

When El Salvador’s President Nayib Bukele announced at a Bitcoin conference in Miami that he would submit “a bill to Congress that would make Bitcoin legal tender,” I was very excited. Additionally, like many others, I listened live on Twitter Spaces as he did just that, and it was ratified by delegates, which whatever you think of Bitcoin was undeniably interesting.

But why a legal tender law? I am sure that the President is sincere in his concern for the financially excluded Salvadorans and in his desire to enable them to participate in the modern economy. But I don’t recall Safaricom having to lobby the Central Bank of Kenya to change legal tender laws to force merchants to accept private currencies in Kenya when M-PESA Mobile Shilling was introduced. As far as I can tell, a mobile money service can deliver the inclusion needed. All such a service needs is transparency in reserves (a lesson learned in Ecuador) so that Salvadorans can be assured that the electronic dollars on their phones are backed by dollar deposits.

If it’s not really about inclusion, is it about commerce? Nothing prevented traders in El Salvador from accepting bitcoin if they wanted to. JP Koning was quick to point out the perverse implications of requiring Salvadoran businesses and markets (referred to as “economic operators” in the bill) to price in Bitcoin and accept Bitcoin as payment. No Salvadoran will choose to use this feature: the bitcoin folks for fear of missing out on a price spike, and no-coiners for fear of bitcoin volatility. Because of this, the President announced the creation of a $150 million fund to convert coins received from merchants into dollars “instantly” (although what that means in this context is not clear to me).

Maybe transfers? Jack Mallers, the CEO of Zap (which runs the Strike wallet used in El Salvador), explains that anyone in America can use Strike to convert $1,000 into bitcoins, which can then be sent to El in less than a second and for free Salvador will be sent where they are converted to USDT (Tether). The Salvadorian recipient can then easily convert the tether into bitcoin and withdraw it at a bitcoin ATM. But as far as I can tell, and I look forward to getting updated numbers from El Salvador, the average bitcoin ATM commission is around 8%, which is only double the average dollar transfer commission of around 4%, so I am not sure if that will catch on.

It seems to many observers that the bill was not about legal tender at all. As economist George Selgin put it on Twitter, it was about “mandatory tendering”. This is certainly at odds with the libertarian views of Bitcoin proponents and isn’t necessary to advance the ancestral cryptocurrency’s causes, so I’m not surprised that some El Salvadorans are “concerned that it’s just a tool for the corrupt.” officials could act”.

Like many others, I will be watching the dynamics of the cryptocurrency sector in El Salvador with keen interest, and as a student of new forms of money, I will be fascinated to see and understand the implications of the bill. However, I have to say that I am not convinced that the adoption of any particular cryptocurrency into some form of mandatory bidding will result in financial inclusion that improves the fortunes of the average El Salvadorian.