Decentralized Finance in El Salvador

  1. El Salvador becomes first country to adopt bitcoin as legal tender after passing law
  2. Scepticism grows in El Salvador over pioneering Bitcoin gamble
  3. Big Salvadoran majority skeptical of bitcoin as standard currency
  4. El Salvador Blazes The Future Of Decentralized Finance On "Bitcoin Day"
  5. Six months in, El Salvador's bitcoin gamble is crumbling

In my 1st blog post, I am going to explore how a small country in Central America with a small influence on the world economy is sending shockwaves through the blockchain and cryptocurrency industry. I will first describe what decentralized finance involves and then I will move on to breaking the topic down into 4 sections: firstly, what the Bitcoin law entails and the potential benefits; secondly, what critics have said about El Salvador’s decision to adopt bitcoin as legal tender; thirdly, the difficulty faced during the initial phase of establishing the infrastructure necessary for crypto transactions; lastly, where the country is heading in 2022 with their decentralized finance strategy.

Decentralized finance (DeFi) is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. The system removes the control banks and institutions have on money, financial products, and financial services.

Illustration showing how decentralized finance operates

On September 9, 2021, the Central American country El Salvador made a huge step toward adopting cryptocurrency as a legal tender and exploring the vast blockchain industry. They are the first country to do so.

Lawmakers in the Central American country’s Congress voted by a “supermajority” in favor of the Bitcoin Law, receiving 62 out of 84 of the legislature’s votes. This vote had an immediate impact on the price of bitcoin, causing it to go up 5% to $34,239.17.

“The purpose of this law is to regulate bitcoin as unrestricted legal tender with liberating power, unlimited in any transaction, and to any title that public or private natural or legal persons require carrying out,” the law reads.

In layman’s terms, this means that prices can now be shown in bitcoin, tax contributions can be paid with the digital currency, and exchanges in bitcoin will not be subject to capital gains tax.

The exchange rate with the reserve currency “will be freely established by the market,” according to the proposed law. El Salvador’s current official currency is the U.S. dollar. The law also states that the state will “promote the necessary training and mechanisms so that the population can access bitcoin transactions.”

In August 2021 a research note by Bank of America enthused about the new law’s ability to reduce cross border transactions (remittances account for 20% of El Salvador’s GDP), and be more financially inclusive as 70% of citizens still do not use banks, and attract FDI as a first mover in cryptocurrency adoption.

The IMF has warned El Salvador against digital currency plans to use bitcoin as a legal tender. According to the IMF, the Bitcoin Law requires significant investment as well as difficult policy choices, such as the role of the public and private sectors in offering and regulating digital forms of money. The greatest risk mentioned was the more widespread adoption of bitcoin and its relative implications on macroeconomic stability.

“I don’t think the president has fully understood the implications of the law, its potential to cause serious macroeconomic problems and convert the country into a haven for money laundering,” Ricardo Castenada, a local economist has said.

A July 2021 survey found that nearly 2/3 of El Salvadorans would not be open to accepting payment in bitcoin.

Gravengard, who knew Bitcoin Beach founder Peterson through a mutual friend, told Rest of World that “Money is social. ” He elaborated that he doesn’t really want to live in a world where no trust can be formed as the eventual outcome is an unhappy world.

Critics say the country’s Bitcoin transition leaves behind those who don’t have a smartphone — mainly older Salvadorans — and those without internet access. In 2019, about half the population wasn’t online.

The World Bank has also initially rejected a request from El Salvador to help with the implementation of Bitcoin as a national currency, due to the environmental and transparency shortcomings.

The country experienced many technical issues during the rollout of its crypto wallet. The government designed a bitcoin wallet called Chivo that was meant to be released on Huawei, Apple, and Google Play Store at midnight, but it wasn’t available to the public until the following morning.

Other issues soon followed i.e. users experienced a lot of bugs. This forced Chivos to temporarily shut down due to a lack of server capacity preventing people from entering their data and users’ inability to send funds. Further problems included accounts created through identity fraud and lost transactions.

Layout of the Chivos platform

The external effect was much greater though as it led to the drop in bitcoin’s price by almost $10,000 with traders trying to figure out if the cause was to do with El Salvador’s bumpy rollout of its crypto wallet and where the market will go from there.

Jose Bonilla, a 23-year-old Salvadoran, was one of the 1st citizens to sign up for Chivos. He runs a shoe store with his family in Concepcion de Ataco and was particularly eager to try out the technology when the country officially made Bitcoin legal tender in September 2021.

By February 2022, it dawned on him that there were a lot of problems: the only available bitcoin ATM was too far away, slow government helpline and the price was too volatile. One day, $25 was lost (a problem with the bitcoin wallet which I previously highlighted). The helpline never responded to his request for assistance.

El Salvador’s bitcoin ATM

Even on Bitcoin Beach, a rugged strip of Salvadoran coastline that has become a mecca for crypto enthusiasts, the transition has been challenging. For instance, coconut vendor Dina Ponce expanded to accept bitcoin but she remained a stranger to how the blockchain worked, and the value of bitcoin wasn’t creditworthy enough to give her the savings she expected. Other businesses around Bitcoin Beach have also reverted to using cash due to the volatile nature of bitcoin.

1st Annual Bitcoin Beach Futbol tournament

My take on the topic

Overall I believe that the cryptocurrency industry in El Salvador is quite unstable, despite the glory that the government advertised adopting bitcoin as a national currency to be. I truly feel that Nayib Bukele has taken a huge leap into the blockchain industry without much thought and taking an in-depth consultation with the people he claimed using bitcoin can protect. The El Salvadoran government should have heeded the warning given by the International Monetary Fund and the developed economies.

My solution is for the Salvadoran government to first improve their broadband infrastructure and encourage more people to use the internet since that forms the basis for any digital transactions, and then launch training programs to get the Gen Y, Gen Z, and potentially the baby boomer generations up to speed with how distributed ledgers work, the risk behind investing in cryptocurrency and ways in which everyone who uses bitcoin can minimize losses.

References to where I found my information