Introduction
Due to a recent decision, El Salvador has become the first nation to officially recognize Bitcoin as a legitimate currency. However, its use has sparked skepticism and concerns about its practicality. Opinions constantly emerge that the cryptocurrency’s volatile nature, characterized by rapid and unpredictable value fluctuations, makes it challenging for everyday transactions.
Alfaro et al. (2022) review the recent announcement by the president of El Salvador to accept Bitcoin as a legal tender. Based on the assessment of this decision, the authors analyze the objectivity of this initiative and its significance for the country’s economy (Alfaro et al., 2022). The risks associated with introducing Bitcoin as a legal tender do not allow for speaking about the unequivocal merits of such a solution.
Case Background and Context
Two years have passed since El Salvador made history by becoming the first country in the world to make Bitcoin a legal tender. However, little has changed in the country with the introduction of this initiative (Alfaro et al., 2022). The level of cryptocurrency adoption in El Salvador remains low, with few businesses accepting Bitcoin as a means of payment, and even fewer people prefer to pay with cryptocurrencies themselves (Alfaro et al., 2022). As a result, the ideas of the president, who promised prosperity to the country due to the introduction of Bitcoin, did not materialize.
One of the main problems is that Bitcoin is an unstable cryptocurrency. Since the beginning of the experiment, it has lost substantially in its dollar value, and the country is experiencing an economic downturn and a high public debt-to-GDP ratio of 78% (Alfaro et al., 2022). The law was expected to help solve several problems, particularly revitalizing the financial sector. About 70% of the population did not have access to traditional financial services (Alfaro et al., 2022). Nevertheless, those who used the crypto wallet faced technical problems and scams; in general, the initiative has not proven effective.
Possible Beginning of a New Monetary Era
Even though some financial analysts see El Salvador’s embrace of Bitcoin as a potential indication of a new era in monetary policy, some experts approach the situation cautiously. The future remains uncertain as to whether other nations will pursue a similar path, but some aspects speak against the global acceptance of cryptocurrency as a legal tender. If the growth of this sector continues, it could quickly reach the point where it becomes a threat to global financial stability. This may be due to growing ties with the regulated financial system, liquidity mismatches, and credit and operational risks (Mnohoghitnei et al., 2022). Today, among the states with the most stringent regulation of cryptocurrencies, countries with emerging markets dominate, and risks for them are higher (Alfaro et al., 2022). Thus, as the existing trends show, not all governments are ready to use Bitcoin in domestic economies, which casts doubt on the thesis of a new monetary era.
Acceptance of the New Digital Currency by Salvadorans
There are different opinions on whether or not Salvadorans will use Bitcoin as a legal tender. As mentioned, some local residents have expressed concerns about the accompanying risks, such as the cryptocurrency’s volatility and the possibility of fraud (Alfaro et al., 2022). Despite the government’s initiative to promote financial inclusion and offer greater access to financial services, not all Salvadorans are satisfied with the changes.
Although, according to Biju et al. (2022), people globally took the news from El Salvador with enthusiasm, the experience of this Central American country shows that such efforts do not always bring the expected result. This can be explained by citizens’ relatively low standard of living and the lack of sufficient assets and savings to convert the local currency into Bitcoin. Therefore, the likelihood that all Salvadorans, without exception, are unambiguously satisfied with the innovations is low.
Possibilities of Exposing the Population to a Highly Volatile Cryptocurrency Market
There is reason to be concerned that Salvadorans, who have low levels of financial literacy and few economic safety nets, could be particularly susceptible to the dangers presented by the volatility of Bitcoin. According to Alfaro et al. (2022), to help people understand how to use cryptocurrency safely and how to reduce the risks associated with its volatility, the government will need to offer education and social support. At the same time, given the country’s economic development, it is unlikely that the authorities will take active measures to assist the population.
The decision to implement Bitcoin as a legal tender was not agreed upon at the national level and is a consequence of the interests of individuals in power. As Yen and Cheng (2021) argue, countries with economic uncertainty, including El Salvador, largely depend on foreign investors’ activity. The state’s dependence on Bitcoin may result from a drop in the interest of partners in working with local companies, thereby exposing the population to risks.
Opportunities to Hedge Bitcoin’s Benefits
As the details of the case show, other countries, especially those in the Central American region, have become intrigued by El Salvador’s decision to make Bitcoin a legal tender. If the state successfully uses the advantages of cryptocurrency, it might pave the way for other developing nations to follow suit in the future. However, Alfaro et al. (2022) express concern about the potential risks connected to the volatility of Bitcoin, arguing about the local economy’s weakness and the financial infrastructure’s unpreparedness for such changes.
According to Nekhili and Sultan (2022), who assess the features of combining a digital currency with a traditional one, conventional assets have more potential to “hedge wild swings in Bitcoin,” and the opposite is unlikely (p. 641). In other words, if the country has a stable economic base, adding a new form of money circulation will not cause enormous inconvenience. Nonetheless, El Salvador lacks the financial background to mitigate potential risks. Therefore, in the case of this particular country, it is unlikely that it will become an example for other economies.
Risks for Governments
Potential risks associated with governments using cryptocurrencies as legal tender are critical. For instance, Bitcoin’s value is notoriously erratic, as shown by the wide price swings observed over a limited period (Alfaro et al., 2022). Governments find it challenging to maintain economic control in the face of such fluctuations. Because of inadequate regulation, money laundering and other fraudulent activities are more likely to occur. As a result, scams have caused substantial financial losses for Salvadorans (Alfaro et al., 2022).
Governments may find it difficult to defend consumers and ensure the security of financial transactions without appropriate regulations. Allen et al. (2022) note that because doing this necessitates sizable investments in both technology and infrastructure, it may be hard for authorities to implement payment systems based on cryptocurrencies. Additionally, the widespread adoption of Bitcoin as a legal tender could increase energy usage, which might not be sustainable in the long run (Gaikwad & Mavale, 2021). Risks are, therefore, essential and necessitate a careful review of an action plan.
Recommendations: Action Plan
To benefit from the introduction of Bitcoin, the El Salvadoran government should adhere to certain principles of cryptocurrency management. As Alfaro et al. (2022) argue, creating a favorable trade environment implies safe transactions. The authorities need to ensure tight controls to prevent fraud. In this case, large investors can come to the country, thereby strengthening the national economy (Taçyildiz & Yorulmaz, 2022).
Another valuable initiative is to encourage Bitcoin’s introduction as a legal tender by the country’s trading partners – Guatemala, Nicaragua, Honduras, and other Central American countries. Such a step is an opportunity to strengthen the trade union in the region and open up new possibilities for strengthening local economies (Hernandez, 2023). Finally, capitalization on the introduction of Bitcoin in the country at the expense of related areas can be successfully implemented. With the introduction of cryptocurrency into everyday life, the influx of tourists to El Salvador has increased, which indicates the readiness of foreigners to use this means of payment (Vázquez, 2022). While following these recommendations, the state government can profit from its initiative, minimizing the risks of high Bitcoin volatility.
Conclusion
Introducing Bitcoin as a legal tender in El Salvador cannot be considered an unconditionally positive decision of the authorities due to the numerous risks and barriers that this initiative entails. Based on the case study presented by Alfaro et al. (2022), many challenges exist. The low indicators of the country’s economic development, the lack of state support for citizens, the high level of fraud, and some other difficulties do not allow the planned prospects to be fully realized. The high volatility of this cryptocurrency is one of the main barriers. As recommendations to the Salvadoran authorities, several relevant steps are presented, including tightening control over trade, active interaction with neighboring countries, and gaining profits by attracting investors and tourists.
References
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