The surprise announcement at the Bitcoin 2021 conference that El Salvador will make Bitcoin legal tender in the country was met with rapturous applause. A few days later, sure enough and true to his word El Salvador’s president Nayib Bukele signed into effect his country’s ‘Bitcoin Law’, a historic moment and potential turning point in global bitcoin mass adoption.
This shift represents a revolution in the way money is sent and received, has potentially huge implications for the established remittance market still dominated by a handful of traditional firms like Western Union, Remitly and MoneyGram.
What will this mean for such companies? Will they adapt to the new order or suffer extinction? Will then be forced to utilise blockchain networks in order to survive? And what does this all mean for average El Salvadorian?
El Salvador’s Economic Background — Quick Facts:
- The Central American country has a long history of economic and political upheaval Source
- El Salvador has used the US Dollar as its main currency since 2001 Source
- Around 70% of the population is not in the banking system Source
- El Salvador suffered from huge financial inclusivity, people often turn to a life of crime as a means to make an income Source
- There are over 1.5 million Salvadorans living and working in the USA who regularly send money back home Source
- Over 20% of its GDP is based on inbound remittance payments Source
- Legacy remittance companies charge fees anywhere from 1% to 10% Source
How did El Salvador get to this point?
To fully understand the reasoning behind El Salvador’s bitcoin gambit is to look deeper into its past.
Like many Central American countries before it, El Salvador was at the mercy of Spanish colonisation for centuries before eventually gaining its independence in 1821. What followed set the tone for decades. With long periods of wide scale political and socio economic strife, economic manipulation and upheaval, El Salvador became fertile grounds for crime, drugs and gangs.
In 1980, a civil war broke out between the military led junta government and the Farabundo Martí National Liberation Front, a leftist revolutionary group who sought to overthrow the country’s U.S. backed government.
The El Salvadoran government at the time was heavily financed by the Reagan Administration who pumped billions of U.S dollars into the nation’s ailing economy in the form of humanitarian aid, military spending and financial loans. The Administration felt that the gaining popularity of the leftist rebel group made El Salvador the place to draw the line in the fight against global communism.
The war was long and bloody, lasting more than 12 years and cost the lives of around 75,000 Salvadorans, with both sides accused of wide spread war crimes and genocide. The country was left in economic ruin.
The Dollarisation of El Salvador
Fast forward to January 1, 2001 and the right-wing government led by Francisco Flores imposed the ‘Monetary Integration Law’ (LIM). The law legitimised circulation of US dollar’s within the economy on par with the local El Salvadorian currency, the Colón, at a fixed exchange rate at 8.75 colones per dollar. This move was made with the promise of macroeconomic stability, lower interest rates and as a means to curb inflation.
However, as a subsequent result of the dollar shift, banks began to retain colones, and businesses started a practice of “rounding-up”. As the colon-dollar exchange rate was fractional, businesses chose to forego issuing change in Colón and instead returned change in dollars rounding up to the nearest dime, quarter or dollar. The effect on the poorest of the population was devastating.
What this meant was a labourer who once under the old system earning 875 Colónes a month now received $100, whereas before the newly imposed law they received over $200. It wasn’t just earnings that were hit, the price of everyday goods such as rice and beans skyrocketed in the years following.
Under the Dollar, purchasing power of the average El Salvadorian was effectively cut in half overnight.
The dollarisation created enormous vulnerability for the Salvadoran economy. Not only did it give away any Salvadorian claim to monetary sovereignty, but with the Dollar now as its only legal currency, El Salvador could also no longer control its own money supply or set interest rates. For better or for worse, Dollarisation left El Salvador inextricably tethered to the decision making policies of the United States Federal Reserve.
The hope that with Dollarisation would come a raft of foreign international investment that would quickly lift the country out of financial dire straits. The fresh flow of international capital never came. Public debt spiralled to almost 90% of GDP, causing the country to become dependent on overseas inbound remittance payments as a way of staying economically afloat.
Remittance Payments — El Salvador’s Lifeline?
Leaving behind friends and family is an unfortunate reality for millions of people all around the globe. In 2014 the International Labour Organisation estimated that there were some 232 million international migrants worldwide. Approximately half of them, almost 120 million were estimated to be economically active. For many in developing countries, facing stagnating economies, a weak to non-existent jobs market, rampant political and government corruption, economic prospects are, at best, bleak.
Research from Allied Market Research states the global remittance industry was worth $682.60 billion in 2018, and is expected to reach $1.413 trillion by 2025, according to the Remittance market & Blockchain Technology report by BlockData. The figure reflects the sum total number of payments being made from workers in countries other than their country of origin making monthly payments home.
And it’s not just El Salvador and other Central American countries who depend on funds being sent from overseas, remittance payments are a global phenomenon. India is the leading global receiver of remittance payments with US$80 billion in 2018 (almost 3% of India’s GDP), followed by China with US$67 billion, US$34 billion each to Philippines and Mexico and Egypt with US$26 billion.
And El Salvador is no different in this regard. Every year thousands of young working Salvadorians flock to the US in their droves in their hope to earn the all mighty Dollar. El Salvador has over 2 million citizens living and working in the US who regularly send money back to their families. This income stream is not only a lifeline to the families who receive money from abroad in the form of remittance payments, but also for the country as a whole. It is thought that remittances are a direct lifeline for around 360,000 households in El Salvador
In fact, 23% of El Salvador’s total gross domestic product is based on inbound overseas remittance payments which totalled $5.92 billion in 2019. This number could be a lot higher and could contribute to boosting El Salvador’s GDP even higher if it were for the often overlooked aspect of international money transfers; fees.
Transfer Fees — The Invisible Noose
On the surface, there’s a romanticised nobility about sending home hard earned wages to loved ones from distant lands. However, the grim reality for those who do, sending money overseas is expensive. Consequently an entire industry has established itself to capitalise, quite literally, on people supporting their loved ones back home.
Legacy companies such as Western Union and large banks, even newer ‘Fintech’ companies like MoneyGram and Remitly charge huge premiums to the least privileged to send (often negligible amounts) of money back home. In an almost predatory, ethically questionable fashion, these large centralised middlemen type companies make enormous profits off of the backs of those who can least afford it.
A deeper look into remittance payment practice reveals that typical transaction cost is not usually a burden for larger financial institutions like big banks, who until very recently got away with charging upwards of 20–50% in service fees.
In 2007, the World Bank and Bank for International Settlements issued the General Principles for International Remittance Services, often referred to as the ‘5x5 objectives’ as a coordinated and global effort to drive down remittance costs to 5% of the transaction total over five years. Progress has been made, but as of today the global average transaction cost is still 6.38%.
The problem with using a legacy money moving service is three-fold. First and fore-mostly, it’s expensive, as we have seen, additional middle-men fees increase the cost to the sender; secondly, the exchange rates offered are often far below fair market prices, and thirdly; time.
Sending a transfer via a third party money moving service is SLOW. Depending on origin and destination, the process can take anywhere between 3 and 5 days, which in our everything now society, is pretty much an eternity.
So facing expensive and unnecessary service charges, rigged market rates, limited availability and painfully slow transaction speeds, what other options do migrant workers have when sending money home?
Enter Lightning Network…
A Modern Day Solution for a Modern Day Problem
Application’s are being developed that utilise the benefits of blockchain and Bitcoin. One such app is a layer 2 application called the Lightning Network that acts as a bridge between traditional banking and Bitcoin, allowing users to use Bitcoin for everyday payments. A ‘layer 2’ blockchain protocol built on top of an existing blockchain network, in this case Bitcoin core, enables users to send and receive low cost, near-instant, peer to peer style payments.
With the app taking care of all of the complicated cryptography and transaction settlement details handled behind the scenes, the user is completely unaware of the power they now wield in their hands.
What Will This Mean for the Average El Salvadorian?
An app built using the Lightning Network such as Strike (currently only available in the US and El Salvador), is a potentially tectonic shift in the way money is moved around the world. For the first time in human financial history, we now have a censorship resistant way to send and receive capital that cuts out all third-party intermediaries. Plus, it’s cheaper than anything else out there, and allows for boarderless, permissions transactions — true innovation.
To demonstrate this innovation, let’s do a quick comparison transaction.
Let’s say you’re a Salvadorian migrant worker in the US who typically sends $500 back to your family every month. Taking the current global average service fee percentage of 6.38% is applied to the $500 you wish to send, meaning the family actually receives $468.10. And don’t forget, it will take anywhere from 1–4 business days to reach them if sending from a bank account, hardly ideal incase of an emergency.
Now let’s use a Lightning Network enable exchange.
Using bitcoin and the Lightning Network your family will now receive the full $500 you send, near instantly in real-time which they receive directly to them on their mobile phone. And because there are significantly less fees (amounting to a few cents per transaction), your family will now receive that extra $31.90 per month or $382.80 per year — that’s a lot of extra money.
Lightning Network powered exchanges have the potential to revolutionise the global remittance industry, not just for El Salvador, but the world over. As we have seen, using a legacy company like Western Union is very inefficient and expensive. Now that companies are building on bitcoin and the Lightning Network, how can current legacy remittance companies compete?
The simple and honest answer is; they can’t. Or at least not in their current form. It would be like comparing dial-up internet with high-speed broadband, they aren’t even in the same league. Just as Netflix killed Blockbuster, the digital camera killed Kodak, and the iPhone killed just about everything else, Western Union, and companies like it, are unfortunately doomed to share a similar fate.
Tying it all together — El Salvador, Bitcoin and Money Printing
Circling back, Bitcoin as legal tender is not only a revolutionary monetary step for El Salvador, but for humanity. El Salvador’s vote of confidence in Bitcoin is a big step towards securing it’s own financial freedom. In choosing Bitcoin as its reserve currency, El Salvador has sent a clear message to the US Federal Reserve, the International Monetary Foundation (IMF) and the World Bank.
And it’s a sentiment being realised in other ‘Dollarised’ developing nations. Central banks are increasingly taking actions that may cause harmful effects to the economic stability of developing countries and emerging markets. Large scale printing of fiat money has an unintended spillover consequence that manifests as rapid price inflation and currency devaluation and drastically affects those in developing markets much quicker than developed. Hidden inflation and rising rates further crush emerging markets and it’s happening not only in El Salvador, but in every emerging economy around the world.
To get an idea of the unprecedented extent to which the US Federal Reserve’s has recently printed the dollar, just look at the fact that one fifth of the total supply of US dollars in human history were printed in 2020 alone. Or to put it another way, try imagining spending a dollar bill every single second for the next 31 thousand years. That’s a lot of dollars. And the printing machine isn’t done printing yet, with further stimulus money printing planned for the remainder of 2021.
The ingenuity of Satoshi’s Bitcoin protocol and its fixed supply of 21 million coins means that unlike fiat printed currencies, bitcoin’s supply cannot be altered by anyone, not ever, and certainly not by a central bank. Bitcoin’s monetary policy is unanimously enforced by a distributed network of user run nodes, making it open, accessible and completely transparent. The network is permissionless and truly global, meaning anyone can participate and from anywhere.
In recognising Bitcoin as legal tender in the country, El Salvador has chosen to take a completely unknown path in what can only best described as a last ditch attempt at regaining its economic self sovereignty.
Fix the money, fix the world
Since the news from El Salvador broke at the Bitcoin Conference 2021, a spark has been ignited. Countries in Central and Southern America, Africa and the Pacific have all expressed interest in exploring the benefits of blockchain and what having Bitcoin on their national balance sheets could do for them.
In these unprecedented and uncertain times, Bitcoin offers hope to developing countries looking to avoid the crushing impact of rapidly rising inflation caused by rampant fiat money printing. Thanks to advances in technology, in particular blockchain technology and Bitcoin, perhaps for the first time in its history this is now a genuine possibility.