El Salvador recently passed a law that will make Bitcoin – the world’s most popular of more than a thousand cryptocurrencies – a legal currency there from September. The response was immediate, although there was disagreement about the importance of the move. Nor has there been much discussion of the important underlying questions of whether a combination of cryptocurrencies will challenge the US dollar as the world’s dominant reserve and trading currency, or whether non-government digital currencies could potentially challenge government currencies.
The stakes couldn’t be higher and the cast of characters is breathtaking.
The dollar has been the basis of international trade since the 1940s. All countries and their central banks must hold dollars in order to trade, and the US government has enjoyed unique controls over international trade, such as its ability to impose harsh sanctions on adversaries and enemies. Also, because the US government controls the supply of dollars, it has a unique ability to handle trade and other deficits through dollar pressure. Anything that challenges this arrangement threatens fundamental features of America’s greatness.
Unlike the Chinese Renminbi (RMB) or the EU’s Euro, cryptocurrencies began as private sector inventions to make payments easier by avoiding the time and expense of currency exchange, banking, processing fees, credit card companies, etc. Therefore, they are widely classified by many governments as “financial assets” rather than currencies. However, since these are often large transfers of wealth on the internet, cryptocurrencies require extremely secure, internet-centric processes, the most popular of which is called blockchain.
Blockchain-based, internet-oriented, private cryptocurrencies have emerged both as investments and as de facto currencies.
For many governments – especially China – private sector cryptocurrencies pose a threat to the role of governments, and worse, a threat controlled by companies, most of which are American. From this point of view, companies or individuals play no role in money creation. For these and many other governments, too, free-standing cryptocurrencies represent a fraud when they are used as an investment. Since most cryptocurrencies in the private sector are not backed by a state currency, they are – from this point of view – play money that is only worth that is what a sinister seller or deceitful buyer charges and pays for. Still, free-standing cryptocurrencies, including the leading example Bitcoin, have caught on and are being accepted as a means of payment by a growing number of companies and as an investment by investors around the world.
Enter big tech.
To offset the fact that many cryptocurrencies are not backed by governments or dollars, some tech companies – notably Facebook, Uber, Spotify, etc. – have experimented with cryptocurrencies that are legally and explicitly backed by currencies / dollars and real cash is redeemable for the cryptocurrency : so-called “stablecoins”. Like free-standing cryptocurrencies, stablecoins bypass currency exchanges and bank fees and offer global, fast and inexpensive payment options.
Enter Venezuela and Russia.
To circumvent American economic sanctions, the Venezuelan government introduced the Petro in 2018 (with alleged support from Russia), which it described as a state stablecoin with Venezuelan oil, and recognized the Petro as a currency within Venezuela. Mainly – but not only – because the Petro is an attempt to circumvent US sanctions, Venezuela’s experiment was controversial. And almost certainly not a success, as it is not clear that no country (except perhaps Russia and Iran) or large corporations are accepting Petros as a currency yet. This probably has as much to do with the size and diversity of the Venezuelan economy as it does with the active opposition from the US
Everyday payments in China are not based on cash, credit cards or banks. They are mainly based on two Chinese RMB-centric electronic payment systems: WeChat Pay and Ali Pay, which have 800 million and 520 million users, respectively. These encrypted digital payment systems have low fees and enable over a billion Chinese people to use their smartphones to transfer money or make purchases in RMB. Due to the success of these digital wallets, the Chinese government has announced that it will issue an all-digital RMB (d-RMB). The d-RMB is an online version of RMB cash (with virtually no fees) that has been tested in China. It is likely to be promoted by China as the new global currency.
The d-RMB will almost certainly challenge the dollar as the currency for international payments, with d-RMB holders being able to exchange their d-RMB for other currencies or spend in China or some other countries.
Enter El Salvador.
With a GDP per capita of around $ 4,000, El Salvador is the smallest country in Central America, but the most densely populated. Since the end of the Civil War in 1992 (which drove at least one million refugees to the US), successive governments have pursued different development plans. These ranged from tourism and textiles to the country’s official currency, the US dollar. But nothing was more important than the estimated $ 4 billion in annual payments from about 1-2 million El Salvadorans in the US to about 360,000 households in El Salvador.
In 2019 Nayib Bukele, the 37-year-old mayor of San Salvador, was elected President of the “New Ideas Party”, which also won a majority in Congress. Although accused of authoritarian tendencies, his approach has in part focused on poverty alleviation through technology.
In June, Bukele proposed and Congress agreed to make Bitcoin their second currency, as it would reduce fees for expatriates sending money home, free the country from exclusive American money control, and attract technology investment. The first two are not controversial, although the degrees are widely used; and the risks completely separated. Regardless, El Salvador has now made Bitcoin an officially recognized currency within that country.
Whether this is an important step in global cryptocurrency adoption or another minor distraction in a much larger economic, geopolitical, and technological battle, likely depends on whether other countries follow El Salvador in recognizing Bitcoin and, more importantly what happens as China-led governments are promoting their own national digital currencies.
In any case, the United States must be careful.
Roger Cochetti provides advisory and advisory services in Washington, DC. From 1981 to 1994 he was an executive at Communications Satellite Corporation (COMSAT). From 1994 to 2000 he also directed Internet public policy for IBM and later served as Senior Vice-President & Chief Policy Officer for VeriSign and Group Policy Director for CompTIA. During the Bush and Obama administrations, he was a member of the State Department’s Advisory Committee on International Communications and Information Policy, testified numerous times on Internet policy issues, and served on advisory committees of the FTC and various UN agencies. He is the author of the Handbook for Mobile Satellite Communications.