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On Wednesday, June 9, El Salvador’s legislative assembly made history by formally adopting bitcoin as legal tender, with nearly three-fourths of the legislature voting in favor. If the new law works as intended, it has the potential to transform El Salvador into one of the world’s most important financial centers, and to affect the way people around the globe use digital currencies.
“History!” exclaimed Salvadoran President Nayib Bukele on Twitter, after the vote took place, around 2 a.m. Eastern Time on June 9. And, indeed, the bill is historic on a number of fronts.
How the Salvadoran bitcoin standard will work
According to the legislative text, under the new law “every economic agent must accept bitcoin as payment when offered to him by whoever acquires a good or service”: a straightforward definition of what it means to be a legal currency. “Tax contributions can be paid in bitcoin,” along with all other legal obligations, and “exchanges in bitcoin will not be subject to capital gains tax, just like any legal tender.” And “obligations in many expressed in U.S. dollars, existing before the effective date of this law, may be paid in bitcoin.”
The U.S. dollar will also remain legal tender in the country, and be used as the “reference currency” for accounting purposes.
The bill anticipates a lot of the practical considerations involved with adopting bitcoin as legal tender.
First, the law creates exceptions for those “who do not have access to the technologies that will allow them to carry out transactions in bitcoin.” The Salvadoran government will “promote the necessary training and mechanisms so that the population can access bitcoin transactions.”
Second, the Salvadoran government will establish a $150 million trust at the Development Bank of El Salvador (Banco de Desarrollo de El Salvador, or BANDESAL), that will exchange the bitcoin that businesses and individuals receive back into U.S. dollars at market prices, for those who do not want to hold bitcoin. In this way, bitcoin adoption will grow organically in the country, and those who find bitcoin’s volatility too risky will not have to maintain it on their balance sheets.
“The purpose of the trust fund is not to make money, but to support this decision of having bitcoin as legal tender,” said President Bukele on a Twitter Spaces conference call hosted by Nic Carter of Castle Island Ventures. “It doesn’t involve the [U.S.] Federal Reserve or even our central bank.”
Third, while Salvadorans will be free to use any compatible wallet to interact with the new bitcoin-based monetary system, they will have the option of using an official, government-sanctioned smartphone wallet engineered by Jack Mallers’ Strike.
Strike helped pioneer the use of bitcoin in El Salvador; its Lightning Network-based backend enables fast transactions with minimal fees: essential features for everyday payments in a low-income country. (In the U.S., professional football player Russell Okung used Strike to convert his paychecks from the Carolina Panthers into bitcoin.)
A monetary version of disruptive innovation
The late Harvard Business School professor Clayton Christensen coined the term “disruptive innovation” to describe innovations that originate in “a niche market that may appear unattractive or inconsequential to industry incumbents,” but end up redefining an industry. Think of the way that low-cost Japanese automakers like Honda and Toyota entered the U.S. market with reliable, affordable, low-margin compact cars, and eventually worked their way up into the higher-margin luxury segment with Acura and Lexus. Detroit’s Big Three ignored and mocked Japanese cars at first, but eventually lost market share and required federal bailouts to stay afloat.
What El Salvador is doing with bitcoin follows exactly the same pattern. Many people in the U.S. and Europe mock bitcoin, criticizing its volatility and high transaction costs, believing that the U.S. dollar and the euro work perfectly well, with no need for alternatives.
El Salvador sees things differently. A bitcoin currency standard, undergirded by the Lightning Network, enables Salvadorans living in the U.S. and elsewhere to send money home without the significant fees common with Western Union and other international transmitters. If all Salvadoran emigrés were to use the Lightning Network for remittances, an additional $1 billion could flow into El Salvador’s economy each year.
In addition, smartphone frontends like Strike enable easy transmission of funds, denominated in dollars or bitcoin, for everyday purchases like groceries. As noted above, under the new Salvadoran system, merchants can instantly re-convert the received bitcoin back into dollars, or keep bitcoin on their accounts if they prefer.
Salvadorans first piloted this system in the El Zonte “Bitcoin Beach” project, and it has been a success. In an insightful interview with Stephan Livera, Bitcoin Beach founders Michael Peterson and Nicolas Burtey described how their wallet design evolved to meet the needs of low-income Salvadorans.
“Transaction costs [with the base layer Bitcoin network] kept ramping up. And we were seeing $3, $4 transaction costs…we knew we had to shift something or else it just was not going to be sustainable,” said Peterson. That problem prompted Peterson and Burtey to deploy the Lightning Network at Bitcoin Beach, eliminating the problem of high transaction fees.
Over time, if El Salvador’s bitcoin law is successful, the country will have proven for the first time that bitcoin can be deployed by a sovereign nation state both as a store of value, like gold, and also as a medium of exchange for everyday transactions.
Once El Salvador demonstrates that bitcoin is usable in this way—in a low-income country where 70 percent of the residents lack bank accounts—the nation will have proven that bitcoin is usable everywhere, including in the United States.
Zero-carbon bitcoin mining in El Salvador
One of the most interesting things to come out of Nic Carter’s Twitter Spaces call with President Bukele was the opportunity to make El Salvador a center for zero-carbon bitcoin mining. Elon Musk and other bitcoin critics have argued that the computing power used to secure the Bitcoin network excessively increases atmospheric carbon dioxide.
Coincidentally, El Salvador is rich in clean, carbon-free geothermal energy. Nearly one-quarter of the electricity in El Salvador is generated from volcanic heat that requires no use of fossil fuels. Two-thirds of El Salvador’s geothermal energy remains untapped: enough to power 3 to 4 percent of the global Bitcoin network.
On the call, Bukele was asked about whether or not El Salvador was interested in establishing bitcoin mining facilities in the country. He said that the thought hadn’t occurred to him before, but that the idea had substantial potential:
We have a plan, it had nothing to do with bitcoin, but we have geothermal energy here…volcanoes [that turn] the water into water vapor and that makes energy. So we have produced that energy [beginning] 50 years ago. But…we lose a lot of energy by transporting the energy of the geothermal plants to the cities. So we want to promote…on the outskirts of the plants…these industrial parks, where you can set up your factory and you will receive cheap, 100% clean, 100% renewable, 0% CO2 emissions [energy]. And we wanted to do that not because of bitcoin, but because people want to invest in factories that won’t have [a] carbon footprint…Probably someone wants to set up a [bitcoin] mining facility with cheap, clean, renewable energy.
Sure enough, later in the day on June 9, Bukele tweeted that he had “instructed the president of LaGeo,” the state-owned geothermal energy company, “to put up a plan to offer facilities for bitcoin mining with very cheap, 100% clean, 100% renewable, [zero-emissions] energy from our volcanoes.”
Energy costs are the single biggest expense for bitcoin miners; in El Salvador, miners could generate significant revenue for the country and significantly lower the cost of electrifying rural areas.
Will other countries follow El Salvador’s lead?
In response to El Salvador’s bitcoin moves, politicians in several other Latin American countries expressed their desire to bring a bitcoin standard to their countries. The first was Carlitos Rejala of Paraguay, who hinted on Twitter that Paraguay was working with PayPal on such a project.
Panama legislator Gabriel Silva followed, tweeting, “This is important. And Panama cannot be left behind. If we want to be a true technology and entrepreneurship hub, we have to support cryptocurrencies. We will be preparing a proposal to present at the [legislative] Assembly. If you are interested in building it, you can contact me.”
Legislators from Brazil, Mexico, Colombia, and Argentina soon followed. None of these figures has the same influence in their governments as President Bukele does in El Salvador, but some of them may very well succeed at following El Salvador’s lead, effectively creating a multinational consortium of countries deploying bitcoin as legal tender.
Even if other countries don’t follow El Salvador’s lead, the fact that a single sovereign nation state would adopt bitcoin as legal tender is of great consequence.
El Salvador’s Bitcoin Law creates what Bukele calls “a sanctuary country for crypto,” a safe and predictable legal environment for bitcoin entrepreneurs to build new and innovative tools. That environment will attract many of the industry’s most talented and creative people to El Salvador, enriching native Salvadorans and accelerating the development of more inclusive global financial system.