el salvador and bitcoin

Bitcoin is now legal tender in the Central American nation, but banks are keen to keep cryptocurrency off their balance sheets.

El Salvador’s adoption of bitcoin as legal tender on September 7 was met with protests in the capital city San Salvador.

The country implemented a law in just 90 days to allow the cryptocurrency to be used to settle transactions. Its government, led by president Nayib Bukele, argues that the move will support development and attract foreign investment in El Salvador, which has one of the lowest incomes per capita in Latin America.

Under the country’s new law, all businesses must now accept bitcoin as payment for goods and services, alongside the US dollar, which has been the national currency since 2001.

Andrés Pineda, treasurer at Banco Cuscatlán, owned by conglomerate Grupo Terra, says many of the country’s 6.5 million population are struggling to under understand the wider implications. “It’s been very challenging for many people,” he says.

In common with other banks in the country, Banco Cuscatlán had about three months to reconfigure its operations after the country’s legislature passed the bitcoin law in June. “It was a relatively short period of time,” Mr Pineda says. “To get everything in place by September 7, we had to educate ourselves to better understand what changes we might expect.”

El Salvador’s adoption of bitcoin is calculated to draw attention, but it could create more problems than it solves

Haydn Jones, PwC

The bank rushed through a plan to accept bitcoin and then immediately convert it to dollars to mitigate the risks of holding the notoriously volatile cryptocurrency on its balance sheet. Bitcoin was trading at $58,367 on October 14, according to CoinDesk. However, it did rise as high as $63,255 on April 16 and fall as low as $29,790 on July 21.

Fellow Salvadorian lender, Banco Agrícola, owned by Colombian banking group Bancolombia, has adopted a similar approach and converts all bitcoin it receives into dollars. “We do not hold an open position in bitcoin,” says Sebastián Mora, vice-president of product development, Banco Agrícola, adding that the bank has adapted its digital channels and mobile app to allow customers to pay with bitcoin.

Marcelo De Gruttola, an analyst focused on financial Institutions at Moody’s, says the speedy conversion of bitcoin into US dollars has been a priority for domestic banks. “Banks are not keen to have bitcoin on their balance sheets,” he notes.

Additional risks

The introduction of bitcoin as legal tender carries other risks for banks, Mr De Gruttola says — notably disintermediation, as more US dollars are held in digital wallets allowing people transact or invest directly.

Under the bitcoin law, providers of digital wallet services are required to hold 100% of customers’ US dollar balances in a non-interest-bearing account at the central bank — meaning those deposits will not be held at banks. “It could increase competition between banks for [non-bitcoin] deposits, which will increase funding costs,” Mr De Gruttola says.

Other risks for banks relate to compliance with anti-money-laundering guidelines, which could increase when customers use bitcoin, he adds.

To facilitate bitcoin transactions in the country, the Salvadorian government established a digital wallet, Chivo, offering citizens who download it an initial $30 of free bitcoin. According to the government, three million people have downloaded the wallet. Other third-party wallet providers registered in the country include Strike and Binance.

“These wallets create competition for banks’ payments and transfer businesses by offering low or zero fees for some services, including remittances,” Mr De Gruttola says.

The Chivo wallet allows instantaneous conversion of bitcoin to and from dollars, and the government has also established 200 Chivo ATMs across El Salvador, which allow people to make withdrawals in dollars and recharge their accounts.

Limited uptake

Despite the government’s efforts, only 12% of consumers have used the cryptocurrency, according to the Salvadoran Foundation for Economic and Social Development.

“El Salvador’s adoption of bitcoin is calculated to draw attention,” says Haydn Jones, a blockchain and crypto specialist at PwC. “But it could create more problems than it solves.”

He continues, “Bitcoin’s underlying flaw is that it’s not state-backed. The principle of the state is that it creates trust. In the event that bitcoin fails, who would step in to save it?”

Other countries, however, have indicated they may follow in El Salvador’s footsteps. In September, Ukraine adopted a law that legalises cryptocurrencies, while a congressman in Panama has proposed legislation to make bitcoin legal tender.

Such moves are unlikely to represent the start of a global trend unless bitcoin can achieve similar levels of accountability as central bank digital currencies (CBDCs), Mr Jones argues.

El Salvador has already spent millions of dollars to support its initiative and purchased 700 bitcoins in September. At the same time, other developing countries, such as the Bahamas and Cambodia, are establishing CBDCs. “The amount of money El Salvador will need to spend [on bitcoin] would have been much better invested in a CBDC that would provide more benefits and less risks,” Mr Jones adds.

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