A man holds up a phone displaying a Bitcoin wallet app on June 16, 2021 in Chiltuipan, El Salvador

El Zonte is a small coastal town located about an hour’s drive south of El Salvador’s capital, San Salvador. The palm-fringed Pacific resort has long been known to surfers, but more recently it has gained fame in the cryptocurrency community. In 2019, he launched an experiment to make the local economy work on bitcoin. El Zonte had never had a bank before, but it now has an ATM where people can buy crypto with US dollars (the country’s official currency since 2001), which earned the city the Bitcoin Beach nickname.

In June 2021, El Salvador’s President Nayib Bukele announced that bitcoin would be adopted as legal tender across the country, making his government the first in the world to designate cryptocurrency as the primary means of payment.

John Wu is president of Ava Labs, developer of the Avalanche blockchain platform. He believes that the adoption of bitcoin by El Salvador is “extremely important. This shows that governments really believe that it is something that can be widely adopted and safe enough to be used as legal tender. Philosophically speaking, this turns the whole crypto space into utility, as opposed to something people speculate on.

Switching to a digital payment method is a step forward, although I am not convinced that they are doing it the right way

Bukele’s decision is rooted in the fact that El Salvador hasn’t had its own currency for two decades, after abandoning the colón for the dollar in 2001. About 70% of the country’s citizens are unbanked, and many depend on dollars returned by relatives. abroad. The total paid in this way each year is equivalent to 22% of El Salvador’s annual GDP, according to Deutsche Bank.

“It’s an interesting experience,” says Frances Coppola, independent economist, blogger and author. “Given that 70% of the country’s economy runs on physical dollars that can only be obtained outside the country, introducing something more accessible online could make life a little easier. for Salvadorans. Switching to a digital payment method is a step forward, although I am not convinced that they are doing it the right way.

Bitcoin volatility poses problems for payments

One problem with the government’s decision is that it forces traders to accept bitcoin whether they like it or not.

“It is not legal tender; it’s a forced tender, ”says Steve Hanke, professor of applied economics at Johns Hopkins University in Baltimore and a struggling currency expert.

For Hanke, who helped El Salvador draft parts of the legislation that replaced the colón with the dollar, it’s unclear why the government is abandoning a system that has served the country relatively well for the past 20 years.

“Inflation has been a little over 2% per year on average. It’s the lowest in Latin America, ”he says. “El Salvador’s economic growth and GDP per capita have also been higher than that of most countries in the region. Exports are also strong, so you must be wondering why they would want to change something that is not broken.

Additionally, there are downsides to using bitcoin as a payment method. First, it’s notoriously volatile – its value has fallen by about half from its April 2021 high, for example.

Coppola notes that many Salvadorans are very poor and / or dependent on money sent from abroad. “If these remittances are in bitcoin and its price drops by 30%, say, they’ve lost a substantial amount,” she says. “To be fair, they have an equal chance of winning on price movements. But such volatility is bad news for people looking for a safe way to save and a reliable way to pay.

It’s fine as a store of digital value, but in the long run, bitcoin won’t be the right solution for payments

Another catch is that bitcoin attracts high transaction costs.

“At the moment, there is no reliable way to make low value bitcoin transactions, so using it is expensive,” says Coppola, who adds that networks such as Lightning, which allow faster payments. and cheaper, remain relatively unproven. .

A superior cryptocurrency could replace bitcoin

Despite caveats surrounding the adoption of bitcoin by El Salvador, Hanke still believes in the potential of cryptocurrencies to transform the way people use money.

“As a means of payment, this is the future,” he says. “It will come to pass, but higher cryptos will come in and take bitcoin out of the picture altogether.”

Wu believes El Salvador has been too eager to embrace bitcoin. The government should, according to him, have resisted the emergence of a cryptocurrency more suited to payments.

“It’s like El Salvador has seen what Yahoo can do, but is impatient for Google to appear,” he said. “The reason he chose bitcoin is because it is the largest and most liquid crypto. But part of legal tender is to be a payment system – and unfortunately bitcoin is still a long way off, a long way from being a good payment system. It’s still a good store of digital value, but in the long run, bitcoin won’t be the right solution for payments.

Wu adds that for cryptocurrencies to be widely adopted as a payment mechanism, their transaction times need to be faster. Currently, with bitcoin, it takes too long to confirm a payment. In addition, crypto-payment systems must be able to accommodate a much larger number of users.

There are several emerging platforms, including Avalanche, which attempt to solve the problem of speed, scale and cost. Which cryptocurrency will win this race is open to debate, but it may not be private cryptocurrency at all.

While other dollarized emerging market economies may follow El Salvador’s experience closely, countries like China, the United States and the United Kingdom and monetary blocs like the euro area are all at risk. various stages of development or review of their own cryptos in the form of bank digital currencies (CBDCs).

“People often ask, ‘Would a power like the United States ever adopt a cryptocurrency produced outside? The answer to that is a categorical ‘no’, says Coppola. “But the likelihood of them issuing their own cryptocurrency is quite high.”

CBDC’s issuance is unlikely to be greeted with much enthusiasm among traditional crypto users, given that their use would remove their anonymity.

“The problem with CBDCs is that they go against the ethics of why cryptocurrencies became popular around the world in the first place,” Wu said. “A CBDC like the yuan digital technology in China makes it easier for a government to interfere with the individual. “