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  • Writer's pictureIshfaaq Peerally

Why Bitcoin Failed in El Salvador

El Salvador became the first country to adopt Bitcoin $BTC as legal tender last week. Why might this not be a good idea? It doesn't really matter whether you like Bitcoin or not. This is an interesting subject to talk about because El Salvador is one of the few countries in the world that do not have their own currency. They have been using the US Dollar $USDOLLAR as legal tender since 2001. Are they making the same mistake again?

Why did El Salvador adopt the US Dollar? After a long Civil War, many people flee the country mainly to the US with the US remaining the main economic partner. The US Dollar became increasingly more popular than the Salvadoran Colon and the government made the switch to attract more foreign investment. El Salvador has one of the highest remittance rates in the world, currently at 24% of GDP. In other words, 24% of the GDP of El El Salvador are Salvadorans living in the US sending money back home. Therefore, the switch in 2001 looked like a great idea.

The mistake they made was that currency doesn't mean anything. It is just used for transactions. It doesn't matter what you use, what matters is that your country has economic fundamentals to grow. Investments didn't flow into El Salvador for many reasons, one of which is the highest crime rate in the world. Besides having no control over their own currency backfired. They had a period of low inflation without the ability to increase the money supply by cutting interest rates.

With the Dollarization of El Salvador backfiring, they had to adopt another "foreign currency" and they chose Bitcoin with the same sales pitch, to attract foreign investors. However, Bitcoin still has a fundamental issue, it is not a currency. Most people use Bitcoin as an investment asset, not as a currency. Only some rich people can boast about buying coffee with Bitcoin every day. The average Salvadoran will not be able to do that. If Bitcoin prices go up, they won't be able to use it as a currency as it would be better to keep investing. If Bitcoin prices go down, they lose their savings.

What El Salvador needs is an economy that can grow with lower crimes, rather than switching currency every time one fails.

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