Saturday last, the president of El Salvador, Nayib Bukele, shook the bitcoin world when he announced he would make bitcoin legal tender in his country. The hype after that was unbelievable, as the hodlers went into overdrive. There were some more intelligent takes, as from Caitlin Long on Twitter and Peter St. Onge, but in general the impression was that we were on the cusp of the brand-new world of bitcoinization.
Well, we now have the concrete law before us and can see exactly what Salvadoran bitcoinization means. To put it in the words of Horace: Parturient montes, nascetur ridiculus mus. The mountains labor—and give birth to a ridiculous mouse! Let’s examine the law and its implications.
Legal Tender—So What?
Front and center is the according of legal tender status to bitcoin. Not only can taxes be paid in bitcoin (article 4 of Ley Bitcoin [Bitcoin law]), but every economic agent must accept bitcoin as payment for goods and services (article 7), and all prior obligations expressed in US dollars may be paid in bitcoin (article 13). This is a massive infringement of property rights and freedom of contract, and any principled libertarian or supporter of free markets should oppose it on those grounds alone. Is bitcoin really so bad a currency that it has to be imposed at the point of a government gun?
However, the devil, as always, is in the details. The detail to consider here is the end of article 1: “What is mentioned in the previous paragraph [according legal tender to bitcoin] does not hinder the application of the Monetary Integration Law.” For those not up on Salvadoran monetary regulations, the Monetary Integration Law is the statute that accords legal tender status to the US dollar. So now (or three months from now, when the bitcoin law takes effect) both US dollars and bitcoin are legal tender in El Salvador. So what?
At this point we need to reacquaint ourselves with one of the oldest insights in economics: Gresham’s law. As popularly stated, this law says that “bad money drives out good.” Or more correctly stated: artificially overvalued money drives out artificially undervalued money. If the government fixes an exchange rate between two moneys—gold and silver, classically—and this exchange rate diverges from the market rate of exchange, then people will hoard the undervalued money and only use the overvalued money in exchange. If the market rate of exchange between silver and gold is 16:1 but the official rate is 15:1, then people will only spend silver and hoard or export gold.
The application to the case of two legal tenders may not be evident. After all, the law makes clear that the market sets the rate of exchange between dollars and bitcoin. However, while there is no fixed exchange rate, you still have two currencies that are equally serviceable in canceling obligations. This fiat equivalence means that their legal power, if only due to the intervention of the state, is the same. In this scenario, the lower-quality currency is bound to be preferred to the higher-quality one. If dollars are expected to depreciate and bitcoin is expected to appreciate, would you rather spend your high-quality bitcoin or your low-quality dollars? Virtually everyone will choose to spend dollars, and since this preference will be legally enforced, bitcoin will be driven from the market.
That the government of El Salvador has enacted a provision to set up “alternatives that allow the user to carry out transactions in bitcoin and have automatic and instant convertibility from bitcoin to USD if they wish” (article 8) suggests that it is aware that legal tender provisions will not ensure adoption of bitcoin. The legislation will also promote training in bitcoin use (article 12) and set up a trust to enable the necessary conversions from bitcoin to US dollars (article 14). These provisions are clear government subsidies of bitcoin use and probably intended to foster its adoption; in reality, we will see the Salvadoran taxpayers forced to finance the use of bitcoin through the operation of these alternatives and the trust.
The Mirage of Bitcoin Beach
But is our application of Gresham’s law not contradicted by the adoption of bitcoin in some of the poorer parts of El Salvador? In reality, when we take a closer look at it, this turns out to be a case of simple private charity. A person found an old thumb-drive containing a substantial sum of bitcoin and decided to use them to promote bitcoin in El Salvador. People in El Zonte were given bitcoin on the condition that they would not exchange them for dollars but rather would use them in daily commerce. Under those conditions, most people would probably start spending bitcoin, and so long as the wealthy donor continues to pour money into the economy, they will keep using it.
Or, rather, they will keep using the existing intermediaries. As anyone familiar with bitcoin knows the transaction fees are much too high to use it for one’s daily purchases. For years now the Lightning Network and other second-layer solutions have been touted as the solution to this problem (the simpler solution would have been to simply let the block size increase, but I digress). By setting up an intermediary, or a “side chain,” you can economize on costly blockchain transactions. And this is in fact what has happened in El Salvador: the transactions all appear to be through intermediaries, first Wallet of Satoshi and now primarily the Strike app, which set up shop in El Salvador back in March. This is in fact a third-layer solution, as it is built on top of the Lightning Network. All the bitcoin users are customers of the same intermediary, although they presumably are free to withdraw their bitcoin from the app—but what poor Salvadoran has enough funds to pay the resulting fee? So much for peer-to-peer cash!
Sending and Receiving … Dollars
Remittances from abroad have been touted as a second obvious use case for bitcoin in El Salvador. Remittances constitute about 20 percent of Salvadoran GDP, and the fees for sending dollars are quite high—6–10 percent. Although this is quite costly, bitcoin on its own would not really be competitive in the Salvadoran case, as the transaction fees would easily be as high as Western Union’s fees. Again, the Strike app is the proposed solution, as it supposedly allows smooth integration of one’s bank account and bitcoin wallet. Since Salvadorans who receive remittances would thus accumulate bitcoin, this could be an extra impetus toward wider bitcoin adoption, as they could choose to spend it directly instead of converting it into dollars. Yet the provisions made in the present law for those who are unable or unwilling to receive bitcoin payments make it likely that bitcoin balances will simply accumulate in the government’s bitcoin trust, as the receivers of bitcoin—whether from abroad or from those insisting on using it in daily commerce—will exchange it for dollars through the official channels. Thus, the fund becomes a further government subsidy of bitcoin use, as its legally mandated acquisition of bitcoin must be financed somehow and in the absence of a central bank, taxation seems the only means. Alternatively, we will see Salvadorans de facto forced to engage the services of Strike and keep their funds on deposit with this company. But why should we consider such monopoly privileges as something to be celebrated?
In fact, we shouldn’t. If Strike becomes the main vehicle for remittances and for spending bitcoin in El Salvador, this will not be due to Salvadorans preferring its services in the competition of the market. Its use will, in effect, be massively subsidized by the promised official trust. Good news for the people behind Strike, but not really something for Salvadorans—or anyone else, for that matter—to celebrate.
The “New Ideas” of President Bukele
Apropos of celebrating, President Bukele’s embrace of bitcoin has led him to become somewhat of an icon overnight. Since most bitcoiners are supposedly in favor of liberty and free markets, this is puzzling. I’m not here referring to his authoritarian tendencies and alleged connections to the underworld. I know nothing of Salvadoran politics, and this might simply be business as usual there. It is, in any case, no worse than the totalitarianism on full display in Europe and the US. However, when we look at the president’s policies so far, they can be summed up as: spend, spend, spend! Whether on new infrastructure projects, free computers to all children, or increased pay to police officers, the Salvadoran government sure is happy to increase its budget and thereby its depredations on the private economy. These are not sound free market policies, Austrian or otherwise; if there is any philosophy behind these policies, it’s standard Keynesianism. The bitcoin law is simply a continuation of these policies: it gives the government access to additional funds for spending through the new bitcoin fund, and it is a disguised handout to the president’s American friends behind Strike, who are set to make beaucoup bucks from bitcoin intermediation. That some supposed free marketeers have been taken in by this is simply obscene. But then again, a large contingent of bitcoiners appears to be interested in nothing else than “number go up.” And forcing Salvadoran taxpayers to finance a bitcoin fund will of course generate some extra demand, so bullish for bitcoin!
Hopefully, El Salvador is on a path to a more prosperous future; its long-suffering people surely deserve as much. For that, new ideas are indeed needed. But an oily Keynesian president with slick American advisors? That’s nothing new, not even when they put their plans in modern language about bitcoin and put laser eyes on their Twitter accounts. If the president really wants monetary freedom for El Salvador, he should not have presented them with what, effectively, is a government handout for bitcoin hodlers and the companies behind the Strike app and other potential intermediaries. Instead, he should simply have repealed existing legal tender provisions and announced that people would be free to use whatever medium they prefer for their transactions. Of course, that wouldn’t have enabled him to set up a giant government program of forced bitcoinization, but that’s how it is with real freedom and truly sound monetary policies: there’s no money to be made on them for the politicians or their cronies.