El Salvador and Bitcoin: Everything you need to know

As El Salvador officially adopted Bitcoin as legal tender on Tuesday -- making it the first country to do so -- it also rolled out Chivo, its own state-sponsored Bitcoin wallet. Things did not go smoothly.

The Bitcoin Law, which the country's government passed in June, ensures the "automatic convertibility" of Bitcoin to dollars. Exactly what that means in practice remains to be seen. But in a nation where few citizens have bank accounts and foreign money transfers are a central economic driver, the move toward Bitcoin could be a game-changer. Still, a wide range of issues -- ranging from entrenched corruption to Bitcoin's own volatility -- makes the road ahead a risky one.

An official embrace of Bitcoin signals meaningful changes -- both for El Salvador and the cryptocurrency itself. Read on for a breakdown of the issues and context. 

Why did El Salvador adopt Bitcoin?

As a poor country with relatively few natural resources, El Salvador has long struggled with economic instability. Lacking its own official currency, the country previously used US dollars as its only currency. (Bitcoin will not replace the US dollar, but will serve as an alternative.) 

But El Salvador is a sovereign nation, not a US territory. That means the monetary policies set by the US' Federal Reserve don't necessarily cater to El Salvador's fiscal needs. As a decentralized currency, Bitcoin doesn't give El Salvador any additional monetary power or control -- but at least the country won't be at the mercy of a foreign government's economic policies or fortunes. 

How might Bitcoin help El Salvador?

Adding Bitcoin as a second official currency could benefit an economy that depends heavily on remittances.

Nearly one-quarter of El Salvador's GDP comes from remittances. This is money that Salvadorans working in other countries send back home. Given that so many Salvadoran immigrants work in the US, much of the remittances El Salvador receives are somewhat tied to the fate of the US economy, and the strength (or weakness) of the US dollar.

In theory, using Bitcoin as legal tender gives El Salvador more economic autonomy. And, on a practical level, it reduces the cost of money transfers. Sending dollars from the US to El Salvador currently requires intermediaries who charge transfer fees. Sending that money via Bitcoin could mitigate those fees.

Another benefit is the digital nature of Bitcoin. Roughly 70% of adults in El Salvador don't have a bank account, but the vast majority do have a smartphone. Cryptocurrency evangelists have long trumpeted the potential of new digital currencies to help the unbanked and underbanked, and El Salvador could be a real test case for Bitcoin's potential to expand a population's commercial and financial potential. 

What are the risks? 

Bitcoin is a volatile asset -- and in adopting it as legal tender, El Salvador's economic fortunes will be intimately subject to that volatility. On Tuesday, the first day of El Salvador's rollout, Bitcoin's value plunged more than 10% in the morning before recovering as the day continued. 

Wild price swings could create considerable issues for the country's population, dramatically changing the relative price for a loaf of bread from day to day. And if Bitcoin crashes again like it did in 2018, when it lost more than half of its value in a single month -- it could mean serious trouble for El Salvador and its people. 

Is El Salvador the first country to do this? 

El Salvador is the first country in history to adopt a cryptocurrency as a legal tender. The idea was championed by President Nayib Bukele, who first took office in 2019 and who has been embroiled in controversy and criticism -- both at home and internationally -- over issues including term limits, crime, narcotics and corruption. 

What's been the reaction inside of El Salvador?

The plan has not been popular. In fact, the move has prompted protests across the country, as many citizens have grown wary over the prospect of using cryptocurrency in their everyday lives. According to a recent study by Francisco Gavidia University, fewer than 20% of 1,233 Salvadorans surveyed approved of the plan. Nearly half said they knew nothing about Bitcoin.

Foreign investors and financial institutions have also been skeptical. In July, Moody's announced it downgraded El Salvador's rating, in part, due to the Bitcoin plan. In a statement, the organization said that, "These measures reflect weakened governance in El Salvador, raising tensions with international partners -- including the United States -- and jeopardizing progress toward an agreement with the IMF."

The International Monetary Fund (IMF), of which El Salvador is a member state, also criticized the adoption of Bitcoin as a national currency, calling the move "an inadvisable shortcut."

How are things going so far?

Bitcoin's first morning as a legal tender was a rollercoaster ride. As soon as Chivo, El Salvador's dedicated Bitcoin wallet, went live, the government had to pull it down due to technical issues. In a tweet, President Bukele asked users to verify that things were working.