El Salvador's Bitcoin Experiment

Thursday, June 10, 2021 · 3 min read

Yesterday El Salvador passed a law that makes Bitcoin legal tender in the country. Here’s a brief overview of some potential consequences.

Bitcoin becomes legal tender in the US and other countries by virtue of the forex market. This could shake up some of the general regulatory environment around holding Bitcoin. Foreign tender is recognized in currency markets through existing legal structures and now Bitcoin has essentially become just another foreign currency.

Credibly-neutral assets continue to grow as a share of currency reserves. The US dollar is not a neutral financial instrument because dollar policies coming from the states are used to promote US interests. Bitcoin doesn’t have a monetary policy set by a central party like a Federal reserve. This is becoming an increasingly appealing point. China and Russia are already making moves to draw down their reliance on dollar-denominated assets. Compared to centrally controlled like the dollar, credibly-neutral assets like Bitcoin are attractive alternatives.

Other countries to make similar moves. There are Latin American countries like Paraguay with politicians that are vocal supporters of passing similar legislation. It’s always easier to be the second to make a large change, so we are likely to see a number of quick followers.

Clean energy bitcoin mining comes front and center. There has been some serious movement from players in the States. There are some hyped plans to use geothermal volcano energy to mine Bitcoins in El Salvador. I didn’t have that one on my 2021 bingo card, but the question about Bitcoin’s energy use is still a large one. In the long-term it will be cheaper to mine with renewable energy sources. Miners already want the lowest cost energy infrastructure as this is what ultimately determines their profits. Subsidizing mining using renewable energy will help build out clean energy infrastructure and take down some of the FUD around Bitcoin’s carbon footprint.

Crypto becomes an avenue foreign direct investment. Remittances to El Salvador can now be paid and settled in Bitcoin. Beyond that there are some provisions in the new law to facilitate investment in crypto industry including preferential tax treatment for crypto assets, residency with a 3 Bitcoin investment, and other government support around the industry. It is going to become something like a free-trade zone focused on the crypto space. There is still a huge range in how crypto is regulated and it is still technically banned in plenty of countries, so a preferential regulatory environment is likely to attract investment.

As is typical crypto, there is a ton of hype and marketing surrounding this as well. The president added laser eyes to his Twitter profile picture. Someone else added laser eyes to the El Salvador volcano. You can find every opinion for and against in the conversation surrounding the announcement. It’s a bit hard to know how to parse all of the memes and general ridiculousness in the space. Yet now we have a live experiment on making a decentralized asset a part of a country’s fiscal reserves and can watch the results in real time.