El Salvador, Part I – Riding High on Crypto’s Gateway Drug

Bitcoin is seen by many as a radical option to attract fresh global capital to El Salvador. International crypto players could be seeing a new tax haven destination emerge with the implantation of a planned immigration reform programme. Permanent residency in El Salvador may be on sale soon for 3 Bitcoins.

The millennial President of El Salvador, Nayib Bukele, has been both praised and criticised for his authoritarian approach to leadership: using military presence to influence fellow politicians and discipline street gangs, and establishing ‘containment centres’ for those non-compliant with pandemic rulings. He’s made neon-noticeable history this month as the force majeure for El Salvador becoming the first country to adopt Bitcoin as legal tender, giving it the same legal standing as the US dollar.

By Presidencia El Salvador from San Salvador, El Salvador, América Central – Lanzamiento de las Fuerzas Especailizadas de Reacción El Salvador, FES.

Reductions in remittance costs; improvement of quality of life for impoverished families; attracting foreign talent and investors; innovation and ‘clean’ Bitcoin mining potential; and cleaning up the cartel scene – helping more people to live well in the country, are all favourable factors for the adoption of Bitcoin.

The underhand role of the US in this narrative, the case for formalising (and taxing) the informal unbanked economy through ‘government-supported’ electronic wallets, and eventual Tokenisation of Everything based on a USD stablecoin, are deeper questions explored in Part II of this series. (Published next week.)

For two decades following the civil war in 2001, El Salvador has been using the USD as its native currency. El Salvadorian families, especially those living in poverty, are dependent on billions of incoming remittance dollars each year. Money sent internationally from family members working mainly (and often illegally) in the U.S., increases Salvadorians’ financial exposure due to both U.S. monetary inflation–including the apparently endless printing of dollar bills by the Federal Reserve–and exorbitant fees, gobbled up by intermediaries, of sending money home.

Photo by Pepi Stojanovski on Unsplash

Some figures state that remittances make up 23% of the country’s GDP, and constitute approximately 50% of monthly household income for at-risk families. Despite the pandemic in 2020, it’s estimated that more than $6B was sent back to El Salvador from the US. That these payments will soon be transferable via the Bitcoin Lightning network using a cheap phone connected to the internet, effectively means a lot more funds will end up in the hands of those millions of low-income humans needing it most.

Furthermore, currency exchanges made using Bitcoin in El Salvador will be exempt from capital gains tax. The implications for all world currencies as a result of this declaration are undeniably huge: Bitcoin would get status as money, and would be treated as foreign currency by banks.

Legal tender (currency) is not subject to capital gains tax, nor is a capital loss claimable as a deduction. If banks and governments want to transact with countries where Bitcoin is deemed legal tender, they’ll have to provide an exchange rate for local currencies for that operation. They’ll have to recognise Bitcoin as money. If one country starts, then others follow. It stands to reason that Bitcoin would no longer attract capital gains tax in other legislatures, just like cash doesn’t. What’s more, with the precedent of El Salvador adopting Bitcoin as legal tender, it’s highly unlikely that the U.S. or other nation states would attempt to outlaw Bitcoin, since they’d then have to outlaw the USD or the AUD, for example.

Both the World Bank and the International Monetary Fund are expressing doubts about the adoption and are so far largely unsupportive of Bukele’s requests for financial assistance. The World Bank even goes so far as to comment on the environmental issues associated with Bitcoin despite the much-discussed possibility of using El Salvador’s geothermal energy for carbon emissions-free Bitcoin mining.

Bukele, during the open Twitter conversation hosted by Nic Carter, mentioned that geothermal energy generated by volcanic activity, which currently supplies electricity to cities (with a lot of wastage en route), could potentially become a clean source of electricity, generating 100% renewable power for Bitcoin mining. Apart from meaningful potential for Bitcoin mining, it’s a practical means to attract innovators, investors and talent into the country.

Geothermal Bitcoin mining potential in El Salvador

Adam Back, Blockstream CEO, (a well-known British computer scientist and cryptographer also mentioned in the Bitcoin whitepaper) may be assisting in implementing internet connectivity in El Salvador by deploying satellites that will make it possible to transfer Bitcoin in areas with poor internet.

While there are serious questions about the powerful gangs (the origins of which started with displaced emigrants in Los Angeles), the crime scene and syndicates with the highest homicide rate in the world, cleaning up the economy in El Salvador could also help clean up the streets.

As Bukele points out in his Twitter chat, the cartels have largely operated in USD until now. The use of Bitcoin is not going to aid these groups to hide their illegal transactions since they’re already doing that with USD. Introducing Bitcoin, if anything, would add more transparency to transactions. Cash is much easier to hide.

By theoretically levelling the playing fields between the extremely wealthy and the desperately poor using the store of value of cryptocurrencies, the esteemed hope is that more people in El Salvador could experience a healthy economy, an improved quality of life building happier communities, thus socially dismantling the drug cartels from the inside out. Nice ideas. What’s reality, is another question.

Photo by Nathan Costa on Unsplash

Join us for Part II of the El Salvador story: The Unbanked Become Digi-Banked, (published next week) where we explore the role of the U.S. in Bukele’s Bitcoin adoption; tax and privacy implications for Salvadorans using the Strike wallet; other countries following suit; and the further question of The Tokenisation of Everything.

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