LONDON: Many view the market for Bitcoin – the world’s leading cryptocurrency – as a game of winners and losers between hedge funds, amateur investors, geeks and criminals.
The enormous risk inherent in a highly volatile anonymous digital currency is best left to those who understand the game well or who don’t care because they can mitigate the risk or absorb losses.
But bitcoin has recently become more attractive to countries and individuals with limited access to traditional payment systems – that is, to those least equipped to manage the underlying risk.
NOT THE FIRST MONEY EXPERIMENT BUT BIG RISKS REMAIN
Earlier this month, El Salvador became the first country to adopt Bitcoin as legal tender and enacted a law that will come into effect in September. This means that Bitcoin can be used to pay for goods and services nationwide and recipients are legally obliged to accept them.
Salvadorans are not new to this type of money experiment. The US dollar became legal tender in El Salvador in 2001 and is the currency used for domestic transactions.
At that time, the government of President Francisco Flores allowed the dollar to circulate freely at a fixed exchange rate alongside the national currency, the Colón.
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Dollar proponents argued that the expected benefits of macroeconomic stability would outweigh El Salvador’s loss of economic sovereignty, monetary independence, and even seigniorage – the difference between the cost of making coins and banknotes and their face value.
But purchasing power suddenly collapsed, making the economy even more reliant on remittances, which averaged around 20 percent of GDP per year for the past two decades.
The use of Bitcoin as legal tender will exacerbate the monetary constraints exposed by dollarization – particularly the lack of an independent macroeconomic-institutional framework around which domestic politics could be shaped.
In addition, Bitcoin is much more volatile than the dollar. From June 8 to June 15, it ranged from $ 32,462 to $ 40,993, and from May 15 to June 15, it ranged from $ 34,259 to $ 49,304.
Such large fluctuations – and the fact that they are completely market-driven and have no leeway for politicians to control the fluctuations – make Bitcoin an inadequate tool for macroeconomic stabilization.
THE COSTS: REDUCTION OF TRANSFER COSTS
El Salvador President Nayib Bukele tweeted that Bitcoin will make transfers easier and significantly reduce transaction costs. The fees that migrants have to pay to send their money home are scandalously high, despite many calls by the United Nations and the G20 to lower them.
According to the World Bank, the average global cost of $ 200 international shipping is about $ 13, or 6.5 percent, which is well above the 3 percent sustainable development goal.
Still, low- and middle-income countries received remittances of $ 540 billion in 2020 and foreign aid ($ 179 billion in 2020).
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Reducing fees to 2 percent could increase remittances by as much as $ 16 billion a year.
The large but globally fragmented remittance business relies on electronic transfers via commercial bank payment systems, and banks charge high fees for using this infrastructure and the benefit of a secure and reliable international network.
But high fees are not the only problem. Many migrants do not have a bank account in the country they work in, and their families back home could also be among the 1.7 billion people without a bank account in the world.
In addition, some migrants may need to send money to countries that are either not integrated with the international payment system or have limited ability to receive cross-border transfers – such as Syria or Cuba.
BITCOIN THE WRONG TOOL
Bukele is right about the need to challenge this system, including by providing inexpensive, low-risk alternatives. But Bitcoin is the wrong tool.
Yes, it enables people to transfer values directly and globally without the costly mediation by third parties. But its volatility makes it an asset at best – and an extremely risky store of value – rather than a medium of exchange.
The risk of a sudden drop in prices means migrants and their families back home can never be sure how much money is being transferred.
Rather than dismissing the Bitcoin rollout in El Salvador as just another example of the crypto craze, let’s think about why many people around the world are willing to accept cryptocurrencies for non-speculative purposes.
Perhaps the answer is that the current international financial system is either serving them poorly or not at all.
Innovations in the field of digital money, such as the M-Pesa mobile money service in Africa, have made significant strides in the payment systems of many developing countries.
However, more needs to be done to provide the infrastructure and regulatory framework to support digital money. The terrain remains patchy for the time being.
Coordinated cross-border measures are urgently required so that Bitcoin and its variants do no more harm than good in developing countries.
Unless both the public and private sectors undertake critical reforms and make basic banking services available to all at low cost, people and governments will increasingly be drawn to Bitcoin and other low-cost, high-risk, and opaque alternatives to traditional banking.
Paola Subacchi, Professor of International Economics at the Queen Mary Global Policy Institute, University of London, is the author of The Cost of Free Money.