In the early years of Bitcoin, people spoke of it as a cash alternative. In time, due largely to high transaction fees and slow speeds, the narrative in the cryptocurrency space has shifted to viewing bitcoin as more of a global reserve currency, a gold 2.0. However, a bitcoin protocol change, dubbed the Taproot upgrade, is set to shift the narrative back to cash, and some countries are poised to take advantage.
El Salvador’s Experiment
On September 7th of this year, El Salvador adopted bitcoin as a legal tender. The government simultaneously commissioned the development of a digital wallet app (the Chivo wallet, developed by US payments company Strike) which converts between USD and BTC at no cost to the user. This lowers the barrier to entry for the unbanked; those who the traditional banking system deemed too risky or not lucrative enough to provide suitable services for.
The “bitcoin law” has been celebrated by many but criticized by parts of the broader community, the local community, and some within the cryptocurrency industry.
Primary opposition from within the crypto community comes from unease with the government's top-down, forced adoption approach, particularly Article 7.
Article 7: Every economic agent must accept bitcoin as payment when offered to him by whoever acquires a good or service.
In response to the criticism of Article 7, President Bukele says, “you cannot look into Article 7 without looking into Article 8 and Article 12”.
Article 8: Without prejudice to the actions of the private sector, the State shall provide alternatives that allow the user to carry out transactions in bitcoin and have automatic and instant convertibility from bitcoin to USD if they wish. Furthermore, the State will promote the necessary training and mechanisms so that the population can access bitcoin transactions.
Article 12: Those who, by evident and notorious fact, do not have access to the technologies that allow them to carry out transactions in bitcoin are excluded from the obligation expressed in Art. 7 of this law. The State will promote the necessary training and mechanisms so that the population can access bitcoin transactions.
So, if you don’t have access to the technologies required in Article 7, you are excluded from having to adhere to it.
The roll-out of the Chivo Wallet has been filled with technical difficulties, and businesses accepting bitcoin were initially hard to find. Nevertheless, on September 25th their President claimed, over Twitter, that 2.1 million Salvadorans are actively using the Chivo wallet and that “…in less than 3 weeks, it now has more users than any bank in El Salvador and is moving fast to have more users [than] all banks in Salvador combined.” While this seems like an extremely fast progression, one should consider that driving this adoption, each Salvadoran who registers to use the Chivo wallet is given $30 US worth of bitcoin. This is equivalent to nearly half a week's salary for the average person. Additionally, several gas stations are now providing a $0.20/gallon discount if you use the Chivo wallet. Chivo has also installed ATMs in US locations where Salvadoran expats can deposit USD or bitcoin to send to their relatives in El Salvador, instantly with zero transaction fee. This should put roughly 6.4% back into their economy, since that is roughly what the average cost of remittance payments is through traditional financial system incumbents.
In addition to the concerns with Article 7, several other outstanding criticisms and concerns regarding El Salvador and their President do warrant further discussion and may be included in future work. Namely:
Authoritarianism. Many would categorize the Salvadoran government’s actions as authoritarian. The “Bitcoin law” was passed and implemented quickly, and some claim it was done so without the opportunity for substantive debate from government opposition. Their President has called himself “Dictator of El Salvador,” “the Coolest Dictator,” and “Emperador de El Salvador” on his Twitter account, which I guess is a joke. The Guardian reports that their President has “removed judges to permit future re-election” which from the outside seems very authoritarian.
Security. Many anecdotal reports claim that the Chivo app isn’t transparent and could be a way for the President to syphon funds. Since there is no way to see what is happening in the backend of the app, some speculate that it doesn’t function like a bitcoin wallet, but more like a centralized payments app. There are also reports that it is easy to fake the KYC features of the app so that one can claim the $30 from someone else if you know their ID number.
Their President tweeted on October 15th that “People are inserting way more USD (to buy [BTC]) than what they are withdrawing from the Chivo ATMs.” The current price of BTC has gone up since the wallet's launch, which likely has a big impact on its use. Time will tell what their people will do when the price of BTC swings dramatically down, as it tends to do from time to time. Perhaps if one is living day to day or paycheck to paycheck, price volatility would have less of an impact. Despite the bumpy roll-out of the app, and criticism directed at the government, El Salvador has made a bold move. El Salvador’s fate is now intertwined with that of bitcoin. It will be very interesting to see what happens in the years to come.
While El Salvador is entering a new era, so too is Bitcoin because it is nearing the implementation of the taproot upgrade. The taproot upgrade will increase Bitcoin’s contract capabilities and security. One way this is done is by using the Lightning Network, which the Chivo wallet uses.
The Lightning Network
The Lightning Network is a second layer protocol that uses the bitcoin network's security while offering reduced transaction fees and increased transaction speeds. The network is made up of a system of channels that allow people to exchange value without using the Bitcoin blockchain to verify transactions. The Lightning Network is not a simple concept to grasp. Still, the idea is that some bitcoin is collateralized to allow two addresses to exchange a portion of that sum of bitcoin back and forth without putting every transaction onto the Bitcoin blockchain. A connection between two nodes is a channel, and payment can be routed (hopped) through as many channels as necessary. Each time a node is involved in a payment, it may receive a portion of the transaction fee.
Even though the Lightning Network launched in May of 2017, it has yet to gain widespread adoption or solve Bitcoin’s scaling problem. There are significant technical challenges in establishing your own node (which is required to establish payment channels). There are fees for opening and closing payment channels and routing fees for channel hopping. However, much of the efficiency gains of the Lightning Network will be realized once the Taproot upgrade is fully implemented in November this year. The Taproot upgrade in its final state will allow for cheaper complex transactions and a new address format that obfuscates the use of the Lightning Network, thereby decreasing the chance of targeted attacks. Taproot makes it possible for Lightning settlements to look just like any other bitcoin transaction. With the efficiency and security improvements to the Lightning Network, Bitcoin may see a resurgence in use as a cash alternative.
We are in an interesting period for bitcoin. It launched over eleven years ago and stayed in the fringes until 2017, only used by criminals and nerds until it reached a local peak price of around 20k USD in January 2018. For 2018 the price and interest mostly went down, reaching a bottom around 3500 in January 2019. The price then went up to $12,000 until the price crashed, along with the stock market in March of 2020. In April this year, we saw it reach a new all time high of around 63k then tumble down to the mid 30s again by June. Today we see a new all time high of over $66.5k!
During the price run-up in 2017, many companies began to offer bitcoin as a payment method, Subway and Microsoft come to mind. But since the price crash of 2018, most have stopped offering it. Lots of people lost money, and those with a long-term perspective on bitcoin shifted into accumulation mode. This was when the discussions of bitcoin shifted from being decentralized peer-to-peer cash to decentralized storage of wealth.
The taproot upgrade, which will unlock new capabilities for second layer scaling, will be implemented in November of this year. While countries like El Salvador are making it legal tender, the Chinese government is doing the opposite, banning mining and cryptocurrency exchanges. Meanwhile, large publicly traded US companies (MicroStrategy and Tesla) are swapping some of their cash for bitcoin to hold as a hedge in their reserve.
Since the start of the Covid pandemic, much business has moved online, furthering the trend of increased digital transactions we’ve discussed before. With the taproot upgrade and the Lightning Network, Bitcoin will pose a significant threat to the incumbents of the transaction market such as Visa and Mastercard and push the narrative back towards being a cash alternative. El Salvador is providing us with a very interesting experimental test case.
Shortly after El Salvador made public their intentions to adopt bitcoin as legal tender the IMF issued a sort of warning in a blog post titled: Cryptoassets as national currency – a step too far. Although many considered this a direct warning to El Salvador to not pursue the adoption of bitcoin recent news indicates that the loans they are hoping to secure from the IMF are not at risk. The blog post recognizes some of the potential benefits of using a cryptoasset as a national currency but recommends using new forms of government controlled digital money (ie CBDC) to ensure the country maintains control of their monetary policy and issuance. While many of their comments are unfounded and frankly show their ignorance the question that lingers is: to who’s benefit are they writing this blog? Seems like themselves and their banker friends.
By adopting a decentralized cryptoasset as legal tender El Salvador is trailblazing. Several countries have already given up their sovereign currency by adopting the USD, so following El Salvador’s lead might make a lot of sense. At a minimum, the citizens can save approximately 6.5% of their remittances due to the removal of fees. Is this the start of a trend of countries adopting Bitcoin?