El Salvador moves to make bitcoin legal tender; other countries may follow suit
- El Salvador’s popular president, Nayib Bukele, over the weekend laid out his plans to make bitcoin legal tender
- Key motivations: increase remittance income, improve financial inclusion, reduce poverty. The publicity is also helpful!
- If successful, other countries could follow suit: Ecuador, Haiti, Guatemala in LatAm; South Sudan, Liberia in Africa
El Salvador’s move to make bitcoin legal tender signals a further shift into the mainstream for cryptocurrency. The country’s position as a key remittances recipient, where most transactions are carried out in cash and with most adults are excluded from the banking system, are key motivations behind this move. If Congress approves this change, and if El Salvador subsequently benefits from higher economic activity, other countries with similar profiles could look to follow: we highlight Ecuador, Haiti and Guatemala in Latin America; South Sudan and Liberia in Africa. Key downside risks include the high price volatility of bitcoin, which limits its utility as a medium of exchange, and the potential for criminal elements to misuse the system. A potential upside risk is that if it is recognised as a currency, bitcoin holders could be exempt from capital gains tax, globally.
Why El Salvador is making this change
El Salvador’s president, Nayib Bukele, said over the weekend that he plans to make bitcoin legal tender, making it the first country to do so. A bill to this effect will be presented to Congress in the coming days.
There are several motivations behind this move:
El Salvador is primarily a cash-based economy; around 70% of its workers are employed informally. Accordingly, a shift from cash to bitcoin should not materially reduce the government’s tax take or its visibility on the income and profits of its citizens and businesses.
Remittances are a key source of income. The diaspora is roughly 3.5mn (2.3mn of whom live in the United States), which is meaningful when compared to the local population of 6.4mn. Annual remittances total cUS$6bn, equivalent to 24% of GDP. The cost of remittances averages around 3% of transaction value, but can be up to 10% for smaller tickets. Bitcoin transfers should be cheaper, meaning more money feeds its way into the El Salvadorean economy
Only 30% of El Salvadorean adults have a bank account; financial exclusion is a big drag on the economy. In Africa, we have seen that increased adoption of mobile wallets can dramatically improve financial inclusion, allowing more people to benefit from payments, savings, lending insurance and investment products. The El Salvador government is working with payments app Strike to bring its bitcoin plans to fruition. One factor in favour of mobile wallet adoption is the high level of mobile phone penetration, with almost 1.5 subscriptions per capita.
The proportion of the population living in poverty is elevated, at 23%. By helping to remove frictions within the economy, bitcoin adoption could lift more people out of poverty.
The official currency of El Salvador is the US dollar. Therefore, the country does not have control of monetary policy and making bitcoin legal tender does not result in any loss of sovereignty.
Other countries could follow El Salvador’s lead
If Congress approves legislation to make bitcoin legal tender in El Salvador, and improvements to financial inclusion and economic activity ensue, it is possible that other countries could seek to follow suit. The table below highlights some emerging markets that are dependent on remittance inflows, have high poverty and low financial inclusion. We also include Ecuador in this table, for the simple reason that like El Salvador it also does not have its own currency, which removes a key downside element of shifting to bitcoin (loss of sovereign control over monetary policy). A simple ranking of countries based on these three criteria is presented in the Appendix.
Key risks include elevated price volatility and the threat of sanctions
Risks inherent to the bitcoin platform include its elevated price volatility and scope for it to be used for criminal purposes. International sanctions could be levied against El Salvador if it were to be viewed as a major money-laundering destination, for example.
One key upside risk would arise if bitcoin were to be classified as a currency by tax authorities in major economies. In this case, holders would be exempt from capital gains tax arising from changes in bitcoin’s value.
We highlight below markets that have high remittances inflows, high poverty and poor financial inclusion. Based on the rationale presented by El Salvador's president, these markets may also benefit by adopting bitcoin as legal tender.
- 1 Strategy Note/Global 10 best Emerging Market tech stocks in 2021 so far
- 2 Weekend Reading/Global Surf the money tsunami or drown? New index shows countries most ready for MMT
- 3 Flash Report/Asia Why the Baby Amazons that thrived in the pandemic have faltered in 2021
- 4 Strategy Note/India India sues Twitter
- 5 Strategy Note/Kenya Kenya 2022 election will be intensely competitive, not violently disruptive
This report is independent investment research as contemplated by COBS 12.2 of the FCA Handbook and is a research recommendation under COBS 12.4 of the FCA Handbook. Where it is not technically a res...