December 1, 2022

Donalds Hobby

World Finance Reviews

A new era for the crypto age

In January 2009, as the world was reeling from a financial meltdown of near unfathomable proportions, a new currency was born. A decentralised digital currency for the post-crisis age, bitcoin promised an alternative to the mainstream financial system for those who found themselves suddenly suspicious of the traditional banking institutions of decades past. From its earliest days of trading, bitcoin had its fervent supporters. While some dismissed it as an underground fad, others believed that bitcoin was truly the future of money, and imagined a utopia where crypto replaced cash. These voices have only grown stronger over the course of the last decade, as bitcoin has enjoyed a meteoric rise, moving rapidly from the financial margins into the mainstream.

Now a $2trn industry (see Fig 1), cryptocurrency is no longer an underground phenomenon. In September of this year, El Salvador made history by becoming the first country in the world to adopt bitcoin as legal tender. On the other side of the Atlantic, Ukraine is said to be hot on its heels, with plans to adopt bitcoin as legal tender, according to reports. For early proponents of bitcoin, this feels like a landmark moment, confirming what they always believed to be true: that the future of currency is crypto.

However, while bitcoin has its supporters, it is not without its sceptics. Many economists view cryptocurrencies with suspicion, with regulators in both Europe and the US issuing warnings on the dangers of trading with crypto. Its highly volatile nature means that El Salvador’s bitcoin experiment is something of a gamble – and we are yet to see whether it will pay off. But with one country paving the way with crypto, others may soon follow suit. For better or for worse, El Salvador could be the start of a digital currency domino effect.

Brave new world
Big problems often require radical solutions. El Salvador has long been plagued with a number of very particular economic woes: a small, central American country of just 6.5 million citizens, the nation’s economy is heavily reliant on remittances – money sent home from the two million Salvadorans who are currently living and working abroad. With expatriated Salvadorans sending more than $4bn back to their home country every year, remittances make up one fifth of El Salvador’s total GDP. Within El Salvador itself, meanwhile, two-thirds of citizens work within the informal economy, and 70 percent do not have bank accounts.

A desire to tackle this unique set of economic circumstances seems to have driven El Salvador’s decision to embrace cryptocurrency. President Nayib Bukele – who at the age of 40 is often described as Latin America’s first millennial President – has championed crypto as a path to both financial inclusion and independence for Salvadoran citizens. It is his hope that the move could save Salvadorans up to $400m a year in transaction costs on remittances, while giving access to financial services to those who are currently unbanked.

“In El Salvador, we are trying to start the design of a country for the future,” Bukele said in a video message broadcast to the Bitcoin 2021 conference in June of this year, where he first announced his plans to formally adopt the cryptocurrency as legal tender. “In the short term, this will generate jobs and help to provide financial inclusion to thousands outside the formal economy. In the medium and long term, we hope that this decision can help us push humanity at least a tiny bit into the right direction.”

Legal tender
Following the announcement of Bukele’s crypto-vision for El Salvador in June, a bitcoin bill was passed, requiring all Salvadorian businesses to accept payment in bitcoin as well as the US dollar – the nation’s existing legal tender – effective from September 7. To mark the launch of the nation’s new bitcoin era, all Salvadoran citizens were gifted a digital wallet called Chivo (Spanish slang for ‘cool’), with $30 of credit pre-loaded for each user to spend.

While this may all sound very promising, the reality proved to be rather more challenging than perhaps anticipated. The country’s landmark bitcoin adoption day was beset by technical difficulties – the Chivo digital wallet was forced offline for hours after government servers were overwhelmed by an influx of sign-ups, and President Bukele took to social media to complain that app stores on Apple and Huawei devices were not yet hosting the government-backed app. Elsewhere, it was reported that ATMs were running out of money, as citizens rushed to convert their $30 bitcoin holdings into cash. In the capital city, more than 1,000 people took to the streets in protest of the bitcoin adoption, setting off fireworks and burning a tyre in front of the Supreme Court building in an impassioned display of opposition to the law change.

“Like all innovations, El Salvador’s bitcoin process has a learning curve,” Bukele said in a tweet, reflecting on the rollout. “Not everything will be achieved in a day, or in a month.”

While there may have indeed been noble intentions behind El Salvador’s bitcoin experiment, it’s clear that creating a crypto-utopia is going to be a very hard task for tech-savvy Bukele to pull off. Opinion polls show that the overwhelming majority of Salvadorans remain unsure as to how bitcoin actually works, while the currency’s extreme volatility is yet another source of anxiety for many. At a time when pandemic-related economic uncertainty remains rife, it is understandable that bitcoin feels like too large of a gamble for some sceptics. And yet, despite the many teething troubles that El Salvador has encountered, it looks like a number of other countries are now looking to follow in its digital footsteps.

Nayib Bukele, President of El Salvador, the first country in the world to adopt bitcoin as legal tender
Nayib Bukele, President of El Salvador, the first country in the world to adopt bitcoin as legal tender

The path to financial freedom?
El Salvador is one of a growing number of developing economies that have been gravitating towards cryptocurrencies. In Mexico, Cuba and Venezuela crypto transactions are fast becoming a part of daily life, allowing for fast, cheap and reliable cross-border transactions in countries that also rely heavily on remittances. Just one day after El Salvador officially adopted bitcoin as legal tender, Panama introduced a draft bill that aims to recognise bitcoin as an alternative payment method – suggesting that the cryptocurrency domino effect may already be underway.

The phenomenon isn’t unique to Latin America, either. In developing economies across the globe, crypto appears to be gaining mainstream appeal. Each year, leading blockchain data company Chainanalysis publishes its Global Cryptocurrency Adoption Index, listing the world’s top 20 countries for crypto adoption (see Fig 2). In the 2021 ranking, 19 of the 20 countries listed are emerging and frontier markets, reflecting a surge in usage in developing markets. From South-East Asia to Sub-Saharan Africa, cryptocurrencies are gaining a significant foothold – and are quietly filling gaps in the market that traditional financial services were never able to penetrate.

It should perhaps be unsurprising that crypto has enjoyed such success in the developing world. After all, many developing countries were also early adopters of mobile payments, with citizens both urban and rural leapfrogging traditional financial products and moving straight into the world of remote, cashless payments. The best-known success story is Kenya’s M-Pesa, a mobile-money platform that has recently hit 50 million users across Africa, and that has been credited with expanding financial inclusion across the continent by enabling payments and transfers among the traditionally unbanked. While it goes without saying that cryptocurrency is an entirely different world to that of mobile payments, the early success of such technologies may have paved the way for the digital currencies of today.

Developing nations
As is the case with El Salvador, crypto’s potential to enable cheap cross-border transactions is central to its appeal in developing nations around the world. Migrant remittances are a significant source of income for low- and middle-income countries, totalling approximately $554bn worldwide at the end of 2019, according to the International Organisation for Migration. That said, sending money back home can be a slow, complex and above all, costly exercise for many migrants living abroad. The UN estimates that currency conversions and fees on international transfers eat up approximately seven percent of the total amount sent through remittances every year – a considerable percentage of what is a crucial source of income for some of the world’s most economically vulnerable people.

The Salvadoran government is currently exploring options to mine bitcoin using geothermal power

In areas of instability, conflict or hyperinflation, meanwhile, crypto is proving to be something of a safety net to many. In Afghanistan, cash all but dried up following the Taliban takeover in September, forcing banks to close and seeing citizens struggle to purchase food and other basic necessities. A freezing of foreign aid has aggravated the unfolding humanitarian crisis in the country, while money transfer services MoneyGram and Western Union temporarily halted services in Afghanistan in the weeks following the US military’s withdrawal – cutting off many Afghans from a critical source of income in a desperate time of need. For those seeking an urgent solution to the nation’s cash crisis, crypto has offered a much-needed lifeline, with the conflict-ridden country seeing a surge in cryptocurrency usage among its citizens in 2021. Indeed, in Chainanalysis’ Global Cryptocurrency Adoption Index, Afghanistan now ranks seventh in the world for peer-to-peer crypto transactions. Last year, however, it didn’t even appear on the list.

In a similar vein, Libya, Palestine and Syria are all near the top in global online searches for bitcoin and other forms of cryptocurrency, while downloads of bitcoin wallet BlueWallet grew by 1,781 percent in Lebanon in 2020, as the country continues to grapple with an ongoing financial meltdown. In times of conflict and crisis, it would seem crypto offers a way to circumvent broken systems and to provide some financial protection to those in real need.

No safe bet
Cryptocurrency is far from being the perfect cure to the world’s many financial ills. It has, undoubtedly, been a useful – and at times, necessary – tool for some of the world’s most vulnerable citizens. But it is not without its flaws.

In more developed economies, there remains a more sceptical outlook on crypto, both among economists and the wider population alike. Indeed, in the US and Europe, cryptocurrency payments are far from being an everyday occurrence for most citizens. The world of crypto remains something of a niche subculture, largely dominated by semi-professional traders and blockchain aficionados. There is also a significant gender imbalance among traders, too – in the US, 76 percent of current crypto holders are men.

The main criticism of crypto, however, is that it is notoriously volatile in price. Thought to be 10 times more volatile than most major currencies, the market value of cryptocurrencies such as bitcoin can fluctuate by hundreds of dollars in a single day, making crypto a high-risk investment for many. Regulators have repeatedly warned about the dangers of investing and trading in cryptocurrency, citing this unpredictable and extreme volatility as one of their most pressing concerns. Price fluctuation not only puts people’s personal finances at risk, experts warn, but could potentially threaten financial stability across multiple different markets. In October, Bank of England Deputy Governor Sir John Cunliffe called for urgent cryptocurrency regulation, citing financial stability concerns. In a speech given at Sibos, an annual banking conference, he compared the current crypto boom to the rocketing value of US subprime mortgages before the catastrophic 2008 global financial crash. Without rapid intervention, he argued, a potential crypto crash could plunge the global economy back into another 2008-level crisis.

“When something in the financial system is growing very fast, and growing in largely unregulated space, financial stability authorities have to sit up and take notice,” he said. “They have to think very carefully about what could happen and whether they, or other regulatory authorities, need to act.”

In 2021 alone, cryptocurrencies have surged by around 200 percent to an estimated value of $2.3trn – up from $800bn in 2020. As Cunliffe noted in his speech, subprime mortgages were valued at around $1.2trn in 2008, and triggered a global financial meltdown of unprecedented proportions when borrowers began defaulting on loans. With the fallout from the 2008 crash still fresh in economists’ minds, it is hardly surprising that regulators are setting alarm bells ringing when it comes to crypto’s seemingly unstoppable growth (see Fig 3).

 

Environmental issues
And crypto’s inherently volatile nature isn’t the only cause for concern. There is also growing unease among sceptics and aficionados alike over bitcoin’s environmental impact. Bitcoin mining – the process through which ‘new’ bitcoins are created – is incredibly energy intensive. In order to be awarded a new bitcoin, ‘miners’ must use their computers to solve a series of incredibly complex puzzles. Whoever solves the puzzle first is awarded a new coin to their computer.

However, solving the problems requires the use of incredibly powerful specialised computers, which then need to run at full capacity, burning through an extraordinary amount of energy during each mining operation. As a result of this energy intensive process, the Cambridge Centre for Alternative Finance estimates that a single bitcoin transaction has the same carbon footprint as 680,000 Visa transactions. Already, this considerable carbon consumption is beginning to damage bitcoin’s reputation on the global stage. In May, Tesla CEO and long-standing crypto advocate Elon Musk announced that his electric car company would no longer be accepting bitcoin for car purchases, due to pressing concerns over the currency’s environmental impact.

“When there’s confirmation of reasonable (~50 percent) clean energy usage by miners with positive future trend, Tesla will resume allowing bitcoin transactions,” Musk said in a tweet, clarifying his position. Environmental concerns also played a role in the World Bank’s decision to decline a request from El Salvador to assist with implementing bitcoin as legal tender. The central American nation approached the World Bank earlier this year, seeking technical assistance with its plans to formally adopt bitcoin as an alternative national currency. “While the government did approach us for assistance on bitcoin, this is not something the World Bank can support given the environmental and transparency shortcomings,” a World Bank spokesperson told Reuters in July.

If crypto continues on its current upwards trajectory, the inconvenient truths surrounding its environmental impact and its inherent volatility will surely become increasingly difficult to ignore.

An undefined future
Like all modern innovations and technological advances, the world of cryptocurrency is a fast-moving one. In little over a decade, crypto has gone from a niche, abstract idea to a $2trn industry. Bitcoin’s introduction as legal tender in El Salvador marks a pivotal moment in the history of cryptocurrency, but the journey certainly isn’t over yet. In many ways, it feels like this could just be the beginning, as countries around the world look to potentially follow El Salvador’s lead. No matter the outcome of the Salvadoran bitcoin experiment, one thing is for certain – governments across the globe will be watching closely, and taking notes.

Less than one month on from the Bitcoin Law coming into effect in El Salvador, more people are said to have a Chivo bitcoin wallet than a traditional bank account. According to President Bukele, three million Salvadorans are now using Chivo – almost half of the country’s total population. By contrast, only a third of Salvadoran citizens are believed to have a bank account. It’s amongst these unbanked citizens that bitcoin is likely to be having the greatest impact. For those with access to a smartphone but not to a bank, payments, deposits and money transfers are now available to them at the touch of a button. While financial inclusion may have previously been a real economic hurdle for El Salvador, now digital literacy is perhaps the most pressing challenge, as the Bitcoin Law means little if citizens don’t fully understand the financial options available to them.

In developing economies across the globe, crypto appears to be gaining mainstream appeal

Despite the initial glitches and setbacks, El Salvador’s bitcoin gamble has already achieved some undeniably impressive results. As of October, 30 bitcoin ATM machines have been installed in major cities in the US, including Los Angeles, Houston and Chicago, in the hopes that Salvadoran expats will use Chivo to send money back home. The plan appears to be working – in a tweet posted on October 16, President Bukele told his followers: “today, we received 24,076 remittances, adding up to $3,069,761.05 (in one day).”

When it comes to the environmental aspect of bitcoin, too, the country also appears to be making some progress. Aware of the growing concerns surrounding the cryptocurrency’s carbon footprint, the Salvadoran government is currently exploring options to mine bitcoin using geothermal power. A pilot project has been set up at a geothermal power station near El Salvador’s Tecapa volcano, where 300 state-of-the-art mining computers are currently being powered by electricity generated from the volcano’s high-pressure steam. In El Salvador, where geothermal electricity already accounts for a quarter of domestic energy production, volcano-powered mining could be the solution to bitcoin’s dirty problem.

The world watches on
It is still far too early in El Salvador’s bitcoin journey to draw any firm conclusions on its success or lack thereof. But it certainly seems likely that the country’s bold experiment will fuel a new flurry of activity in the world of digital currencies. Most of the world’s central banks are already looking to create their own versions of digital currencies, with the Bank of England announcing in April that it is exploring the possibility of launching a new form of digital money to exist alongside cash and bank deposits. According to a report by PwC, 60 governments around the world are currently working on some form of Central Bank Digital Currency (CBDC), with 88 percent of those under construction said to be based on blockchain – the same technology that powers bitcoin. With so many CBDCs being tested, the question is not if they will be introduced, but when.

As for whether any countries will be as bold as El Salvador in adopting any form of cryptocurrency as legal tender, that remains to be seen. For now, the future of crypto remains as unpredictable as its market value.