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September 7, 2021updated 08 Sep 2021 10:37am

El Salvador’s bitcoin experiment has already gone wrong

By Eric Johansson

El Salvador’s experiment with bitcoin as legal tender is not off to a great start. Mere hours after the central American nation made the cryptocurrency its new official currency, it seems as if the government-backed Chivo digital wallet has already run into some issues. Then Chivo appeared to have been briefly unplugged.

“For a few moments Chivo wallet will not work, we have disconnected it while increasing the capacity of the image capture servers,” president Nayib Bukele tweeted (translated via Google Translate). “The installation problems that some people had were for that reason. We prefer to correct it before reconnecting it.”

The El Salvadoran leader followed up the tweet by arguing that while Chivo digital wallet will be down until engineers have installed new servers, the plan is to make the digital wallet available for Salvadorans around the world, especially in the States.

 

Chivo was apparently taken down because it couldn’t cope with surging user registrations. To add insult to injury, Apple and Huawei users couldn’t initially access the digital wallet on those platforms.

As the day went on, things did seem to improve as more platforms – as well as vendors like McDonald’s and Starbucks – began to accept the digital wallet.

The service outage fuelled contention among citizens who were already hesitant about the new legal tender. More than 1,000 protestors gathered outside the country’s supreme court on Tuesday to protest the nation’s new currency. During the protests they set off fireworks and burned tires.

“It was a very bad day for President Bukele, his government and his bitcoin experiment,” opposition politician Johnny Wright Sol told the BBC.

“The majority of the population knows very little about cryptocurrencies. What we do know is it’s a very volatile market. Today that was surely made manifest.”

El Salvador and its cryptocurrency project

Despite his bullishness, this is not a great start for Bukele’s new cryptocurrency project. He personally pushed the new legislation through parliament in June.

Since then the initiative has been marred by scepticism from Salvadorans, with polls showing that as many as 67.9% of El Salvadorans disagree or strongly disagree with the use of bitcoin as legal tender. Just over 32% agreed with using the cryptocurrency, according to a poll from UCA, a Jesuit university based in El Salvador.

Many of those concerned about the issue were worried about bitcoin’s volatility. The cryptocurrency went through a massive bull run during the pandemic, reaching a $64,863 high in April just as US exchange Coinbase went public. The price of the cryptocurrency fell dramatically during the summer to a $29,608 low in July, but has recovered since.

Others have lamented El Salvador’s bitcoin project because of its environmental impact.

“The news that El Salvador has become the first country to accept bitcoin as legal tender is worrying for the environment,” said Joe Baguley, VP and CTO EMEA of VMware. “It is a timely reminder of the fundamental mistake the founders of bitcoin made by building the cryptocurrency on a proof-of-work blockchain, which consumes an incredible amount of energy.”

It’s true that bitcoin uses more energy than altcoins like ethereum that mine coins using proof-of-stake. Nevertheless, as Verdict has reported before, the environmental impact of bitcoin is negligible compared to almost anything else.

Of course, those woes don’t seem to have extended to the members of the worldwide bitcoinati who have welcomed El Salvador’s initiative en masse.

Michael Saylor, founder and CEO of Microstrategy and a well-known cryptocurrency evangelist, was one of the people who encouraged investors to buy $30 worth of bitcoin head of the start of El Salvador’s cryptocurrency experiment. El Salvadorans who download the Chivo digital wallet get $30 in BTC to spend from the government.

On Tuesday, the price jumped by 2.58% from $51,393 to reach $52,722, partly due to enthusiasm from investors like Saylor. However, the enthusiasm and attempts to inflate the blockchain-based currency didn’t help and on Wednesday the price of bitcoin had shrunk to $46,006.

Spotty internet

Another concern is how using the cryptocurrency would actually work given that internet coverage in El Salvador is spotty at best. In January, internet penetration in El Salvador only stood at 50.5%, according to Datareporatal.

But even though the nation is still only working on expanding 4G and 4.5G at the moment – whereas other parts of the world are busy rolling out 5G and have even started to contemplate what 6G may entail – a recent GlobalData thematic research report suggests that El Salvador is committed to bridging the technological divide in the next decade.

“El Salvador is promoting a digital economy by expanding connectivity and promoting digital solutions under the National Digital Agenda 2020-2030,” the report said. “The policy focuses on five core areas: Digital Government, Digital Identity, Modernization of the State, Innovation, Education, and Competitiveness. The initiative is aimed at improving international fibre optic access, promote deployment of mobile technologies, and promote digital literacy.”

Still, the current lack of coverage doesn’t bode well for the people who want to use bitcoin just as they use physical money.

In the run-up to the 7 September launch, Bukele’s government has installed ATMs compatible with its Chivo digital wallet that will allow the cryptocurrency to be converted into dollars and withdrawn without commission. The president has, however, warned that “not everything will be achieved in a day or in a month.”

And there are ways to skirt the rules. Ian Bradbury, CTO of financial services at Fujitsu UK, notes that “a crucial get-out clause for local traders” enables them to not “take bitcoin as legal tender if they do not have the technology to support it.”

So buying coffees with the cryptocurrencies may not be a reality for all El Salvadorans yet. Still that wasn’t really the point of the new national currency.

Instead, Bukele has argued that introducing the new national currency is to help El Salvadorans save the $400m spent annually in commission on remittances sent home by Salvadorans working abroad, mostly sent from the United States.

Last year alone remittances to El Salvador amounted to almost $6bn. That represents roughly 23% of the nation’s gross domestic product, one of the highest ratios in the world.

Similarly, Venezuelan president Nicolás Maduro introduced the petro cryptocurrency in 2017  in a bid to skirt US sanctions prohibiting transactions to Venezuela.

Whatever the case may be, the adoption of bitcoin could be part of something bigger.

“Crucially, what comes next will be most important,” Bradbury says. “The El Salvador government may begin to use bitcoin for its own financial trading including receiving taxes, paying employee benefits and funding contracted services between businesses. It should be expected that the focus of trading will remain on stable currencies such as the US dollar. Consideration will also have to be taken towards the volatility in the bitcoin market.”

Tougher bitcoin regulations coming

El Salvador making a cryptocurrency its national currency bucks the global trend of regulators seeking to toughen up regulations around blockchain money.

This week, the chair of the UK Financial Conduct Authority (FCA), Charles Randell, called for stricter rules for cryptocurrencies.

“There are no assets or real world cashflows underpinning the price of speculative digital tokens, even the better known ones like bitcoin, and many cannot even boast a scarcity value,” Randall said. “These tokens have only been around for a few years, so we haven’t seen what will happen over a full financial cycle. We simply don’t know when or how this story will end, but – as with any new speculation – it may not end well.”

While recognising that regulating tokens is a great challenge, he argued that any “effective system of regulation” should require industry players to register and be regulated by the FCA.

In what seemed to be a thinly veiled jibe against the cryptocurrency exchange Binance, Randall added: “We are not going to award FCA registration or authorisation to businesses which won’t explain basic issues, such as who is responsible for key functions or how they are organised. That would be token regulation in the worst sense.”

In late June, the FCA issued a warning against Binance Markets Limited, a subsidiary of Binance. In the notice, the FCA accused the company of having failed to provide sufficient information about its business operations, corporate structure and how its customers used the product.

Similarly, the new chair of the US Securities and Exchange Commission (SEC), Gary Gensler, has also called for more powers to regulate the market. As part of the drive to tame the Wild West of cryptocurrencies, the SEC filed another lawsuit involving BitConnect, a defunct bitcoin exchange, making accusations of a $2bn fraud last week.

The People’s Bank of China has also imposed a cryptocurrency clampdown over the past few months.

This story has been updated to include reports protests and the continuing fall of bitcoin.