The small Republic of El Salvador in Central America made headlines in crypto and mainstream news recently by being the first country globally to adopt Bitcoin as legal tender, effective as of 7 September 2021.
PROFILE – EL SALVADOR
- Population: 6.48 million, thereof 4.51 million (70%) unbanked
- GDP: USD 24.75 billion, thereof USD 5.94 billion (24%) through remittance inflows
- Internet penetration: 59%, Mobile phone penetration: 145% (sic)
- Number of Bitcoin ATMs in the country: 200
- Price of permanent residency: in-country investment of 3 bitcoin
Source: International Monetary Fund, acuant, World Bank
Two things are important to understand the starting situation of El Salvador. First, though a sovereign nation state, it does not have its own national currency but belongs to the group of ‘dollarized’ countries. Such countries use a foreign currency, often the US Dollar, in parallel to or instead of their domestic currency. The debate about the implications of using a foreign currency as legal tender is complex. Briefly said, dollarization implies a key trade-off. Political independence – in the form of receiving revenue from seigniorage as well as autonomy over domestic monetary and exchange rate policy – is traded for economic stability – in the form of fewer speculative attacks, lower inflation, and closer economic integration with the US and internationally.
The second important aspect is that El Salvador receives a very significant part of its GDP from abroad – through remittances from ex-pat Salvadorans. The term remittance is commonly used to describe earnings sent home by migrants working abroad. A typical remittance transaction runs through an intermediary, a money transfer operator (eg Western Union, MoneyGram, etc.) or a bank. It consists of three steps: (1) The sender pays the amount plus fees (currency conversion and transfer) to a local agent. (2) The agency instructs their agent in the target country to deliver the remittance. (3) The agent pays out the sum to the recipient. While Westerners may say, “that’s similar to an international bank transfer”, this option does not exist for the 70% majority of unbanked Salvadorans.
El Salvador is the top 4 country in Latin America receiving nearly USD 6 billion, or roughly 24% of its GDP, in remittances from abroad (cf. Illustration 1). The total remittance inflow for all 20 countries of Central and South America amounted to USD 88.5 billion in 2020.
Illustration 1: Absolute remittance inflows into top 5 Central and South American countries (million USD, 2020e, capped at 5’000 million)
What is the cost for sending remittances? The World Bank maintains a database collecting the cost for a typical remittance transfer of USD 200 from one country to another using different ‘corridors.’ A corridor is a specific route combining agents, bank accounts, credit cards, cash, or mobile wallets. Depending on the route, transfers take from 1 hour up to 3-5 days. The global average cost in Q1 2021 for sending USD 200 is 6.38 percent. One of the targets among the Sustainable Development Goals is to reduce this number to under 3 percent by 2030.
The average cost for sending USD 200 to El Salvador is USD 5.81 (2.9%). For all remittances during a year, this adds up to approx. USD 379 million. With average income per capita at USD 4000 (as of 2019), this sum is equivalent to the wages of nearly 95’000 full-time workers.
Will other countries follow? Not from the Western world anytime soon when judging from the reactions of the IMF and WB. Also, President Nayib Bukele is a controversial figure, criticized for his authoritarian leadership, for eroding the constitutional division of powers and for neglecting human rights.
However, El Salvador is not the only country in Central and South America carrying the burden of remittances as Illustration 2 (and Illustration 1 above) show.
Illustration 2: Relative remittance inflows into top 4 Central and South American countries (% of GDP, 2020e, capped at 10%)
Using Bitcoin for remittance could not only reduce these costs significantly, but also make them faster and more secure. A bitcoin payment (inside of a larger transaction block) over the last 21 months had an average fee of USD 6.79, which for a USD 200 payment is 3.4% and thus roughly half the fee of the traditional money transfer operators. Using an average fee, the transaction would likely be processed within 6 confirmations, so within one hour. As El Salvador encourages use of the Lightning network on top of Bitcoin by offering a USD 30 welcome to each citizen using the official Chivo wallet, it is much more likely that such a payment would cost approx. half a US cent and be transacted instantly, in seconds.
In any case, citizens would not need to travel to an agency, a bank, ATM or other physical location that is prone to mugging as gangs know why people go there. They could transact in a safe place using their mobile phones, without anyone knowing.
The criticism that citizens are forced into Bitcoin is not entirely fair. Yes, “legal tender” implies that merchants need to accept payments in the currency as stipulated in article 7 of the Bitcoin Law. However, to enable all citizens to freely choose whether to hold USD or BTC, as the Bitcoin Law provides for in articles 8 and 12, the government allocated USD 150 million into a trust plus 550 bitcoin to fund the ‘liquidity pool’ enabling trading between BTC and USD.
No doubt, El Salvador made a bold move and shares the problems of any digital pioneer: technical glitches and resistance. Fact is, by using Bitcoin Lightning, El Salvador achieves targets of the UN Sustainable Development Goals set out for 2030 – capping the global average remittance fee to 3 percent and individual remittance fees to 5 percent – already today.
In the worst case the experiment will survive for some time only and help to put pressure on remittance costs for El Salvador and similar countries around the world. The opportunity is huge and goes beyond Latin America. Africa has a comparable remittance inflow of USD 83.4 billion in 2020.
In the best case, El Salvadorans will embrace the opportunity to boost digitization and economic sovereignty by becoming the first Bitcoin nation. Long term, the optimistic scenario could also become an interesting field experiment for Austrian Economists to test whether a free monetary market indeed selects the best-suited money by itself.