Isabella Roiz of The Washington Post contacted me by email to discuss the consequences of El Salvador’s decision to adoption bitcoin as its official currency, despite its volatility. Here’s her article, “Central America hoped bitcoin would attract tourists. It hasn’t worked.” (pdf).

The problem with a country adopting a cryptocurrency as its official currency is is how to integrate an extremely unstable asset into economic activity. Bitcoin is less volatile than other cryptocurrencies, given its widespread use, but the fact that the asset is as such in the price discovery phase makes its use, for the time being, only suitable as a store of value, due to the level of uncertainty it generates in the price of each transaction.

This limitation is even more evident in developing economies, due, firstly, to the fact that the capacity to use assets as a store of value tends to be limited due to the low saving capacity of the population. Secondly, there is the problem of access to the internet and the tools necessary to carry out transactions in an exclusively electronic currency. And thirdly, there is the problem of how to face temporary drops in value, with little savings in the form of a reserve.

The problem is particularly relevant for economies that have so far tried to take advantage of the incentive provided by bitcoin’s upside potential like El Salvador and the Central African Republic: if, as has happened, the value of the asset falls due to a cyclical situation in the market, the investments made in that asset temporarily depreciate, and it is necessary to have a solid reserve base to cover this temporary loss of value, but if business and the wider population have no reserves, major imbalances can take place.

On the other hand, the “officialization” effect that people want to see before adopting a cryptocurrency is not sufficient if the countries doing so have weak economies or are unstable, which creates the perception that some kind of speculation is going on. In any phase of value discovery, speculative processes can be generated, but in order to capitalize on them, it is necessary to be able to face eventual downward moments, something that is not particularly clear in these countries.

In countries that are trying to promote tourism, the use of a cryptocurrency can be useful in shielding visitors from the swings of a weak local currency. But again, this would require the cryptocurrency to be more advanced in its value discovery phase, something that in the case of bitcoin is not yet the case.

Educating a country’s population in the use of a cryptocurrency is, on the other hand, extremely interesting, given that we are talking about mechanisms, such as cryptography, the use of a wallet or a smart contract, which will be common in the future in environments such as the so-called Web 3. However, although this type of knowledge may be highly desirable and even recommendable, its level of priority when we are talking about developing countries is more limited with respect to the impact that a temporary loss of value of their deposits derived from an eventual downturn may have.

It is important to understand the concept of risk applied to a cryptocurrency such as bitcoin, in which the asset creation phase is close to completion and adoption has already been carried out by a large number of relevant players in the global economy: although the value discovery phase may still offer bullish and bearish periods, we are talking about an asset that is already reasonably consolidated and offers huge potential as a store of value to anyone who can afford to immobilize it for a long time. It is important to differentiate this process of value discovery derived from adoption from mere speculation, as it largely determines the risk that an investor is willing to take over time. In the long term, there is not much risk regarding both the adoption of bitcoin and the consolidation of its value, although temporarily that value may reflect all sorts of fluctuations. Whether it is interesting to leverage this evolution or not, be at the level of an investor or the economy of an entire country, depends therefore on the level of reserves available to face these eventual downturns, which in the case of countries such as El Salvador or the Central African Republic maybe risky from a macroeconomic perspective, even unacceptable for many of its inhabitants, or respond to other types of interests.

The following are the questions and answers I exchanged with Isabella on the subject:

Q. Can you explain to me, from your perspective, why the adoption of bitcoin in El Salvador has been risky?

A. Bitcoin, as with all cryptocurrencies, is still in what is called its price discovery phase, and this depends fundamentally on its level of adoption. What many consider speculation is simply that, an economic process in which the market determines the value of an asset. In this sense, cryptocurrencies are the money of the future, but for them to be also the money of the present, another assumption must be made: that their value is sufficiently stable to turn their transactional use into operational. For the moment, considering the use of bitcoin as a transactional currency is complicated, to say the least, precisely because its value discovery process is still in its initial stages. El Salvador’s bet is to become an economy that bets on the money of the future, and thanks to this, can capitalize its economy according to the increase in value that the market anticipates, given that bitcoin is the cryptocurrency with the most advanced adoption process.

Q. My article also includes Guatemala and Honduras, which are adopting it for tourists. Will bitcoin be a viable option to reduce the poverty rate and increase tourism? What disadvantages should be highlighted?

A. We can expect to see more and more countries doing this, especially those that, from a macroeconomic point of view, have a significant profit margin. The Central African Republic has also chosen to adopt bitcoin as its official currency, although its case is even more complicated considering how few people there have access to the internet. What the governments making these decisions are trying to do is leverage their revenues in a cryptocurrency that many expect to increase in value sharply, which could exceed one or two orders of magnitude in the future. If your economy, even if originally weak, capitalizes on bitcoins when the value discovery process still has a long way to go, you have the opportunity to earn very significant returns. On the other hand, we are talking about cryptocurrencies that are increasingly introduced in the regular economy, that are already part of the reserves of many companies, that follow KYC (Know Your Customer) standards in companies that intermediate transactions, and that function not only as a store of value, but also as an anti-inflation shield.

Q. What if locals don’t know how to use it or don’t know about its possible consequences? What are the disadvantages?

A. Cryptocurrencies are easy to understand, the technology involved does not have too many barriers to entry, and all that is needed to understand its use is to see good value proposition in it. At the moment, the cryptocurrency market is going through a bearish phase, but we will see what happens when the citizens of these countries find, as has happened during the many previous bullish periods, that their money consistently multiplies in value. The disadvantages, obviously, have to do with the low saving capacity of the average citizen in some of these countries, which may prevent them from taking advantage of these expected increases in value. On the other hand, it must be taken into account that the use of bitcoin implies that the population will have access to digital media, and this, in some of the countries that are implementing it, cannot be taken for granted.

Q. Also, there are people in these countries who point out that bitcoin can replace remittances. What is your opinion on this? What are the disadvantages?

A. Bitcoin is undoubtedly a simple and efficient mechanism for the movement of capital, and decidedly much more efficient than remittances. In fact, in El Salvador it is one of the effects that have been felt most rapidly. When we think about the potential problems of bitcoin, we should keep in mind that it is an actor destined to replace an international monetary system that is particularly costly and inefficient, and whose use generates an enormous amount of friction and expense. Making a country’s population literate in the use of cryptocurrencies is something that can have very positive effects on its competitiveness in the future.

Q. Any comments you would like to add relevant to the international audience?

A. In the international context, what some countries are trying to do is to try to be both cause and effect: if more countries adopt bitcoin as an official currency, the value of bitcoin should increase, and that would tend to capitalize those countries that became first movers. On the other hand, with many of the world’s largest companies, major banks and many other significant players in the economic landscape already positioned to use bitcoin, even if only for the moment as a store of value, and with more than 90% of bitcoins already produced, we can consider that most of the risk implicit in bitcoin has already dissipated.

http://www.enriquedans.com
Contributor

Login

Welcome to Empirics

We are glad you have decided to join our mission of gathering the collective knowledge of Asia!
Join Empirics