What can a tiny country like El Salvador do for bitcoin and the cryptocurrency market?
We’re all wondering that, especially after bitcoin lost $400 billion in market value Tuesday, the first day that the popular cryptocurrency was accepted as legal tender in El Salvador.
You may not think of Central America as a hotbed of financial innovation. But in a lot of ways, it is by virtue of being small.
This may be the start of a financial experiment that changes the way money works around the world.
Research analyst Matt Clark and I unpack this momentous occasion in this week’s Investing With Charles.
Watch the video above for our entire conversation. Here’s a preview:
The Problem With Countries Relying on the U.S. Dollar
Countries within Central America have always had unstable currencies. This has led a couple of them to give up on managing their currency altogether and just use the U.S. dollar.
That brings stability, but it also brings a host of other problems because monetary policy is no longer yours to control.
Federal Reserve Chair Jerome Powell sets interest rates in such a way to benefit the U.S. economy. He has a dual mandate of maximum employment and minimum inflation in the United States of America. He does not care about El Salvador, or Ecuador or Panama. El Salvadorian unemployment is not important to him.
So, a country that uses a foreign country’s currency as legal tender surrenders that power to another country. That solves the immediate problem of currency instability, which is a big deal.
I’m in Peru at the moment, which is further south in Central America. But I know a thing or two about currency instability. The Peruvian sol, the currency here, was three to the dollar before COVID hit. And now it’s about four to the dollar. So it has depreciated a lot.
That’s not such a bad thing for me because my dollar goes a lot further here at the moment. But that is bad for the stability of this country.
Bitcoin in El Salvador
The problem with bitcoin is that it is wildly unstable. Its price varies a lot from day to day. So that makes bitcoin as legal tender in El Salvador an interesting proposition.
I don’t know how well this is going to work out for the small Central American country. A sophisticated financial system would have issues implementing any cryptocurrency. This would be hard for the Swiss to manage, for crying out loud.
Imagine a local gas station owner trying to figure out: “OK, this is the price in dollars. Oh, let me check the internet. Oh, this is the price of Bitcoin right now. But if you ask me in five minutes, maybe a different price. So you better hurry up and pump gas now.”
How would you hedge against that? Yes, there are Bitcoin futures, but it’s not like the average person on the street is going to be able to do that.
This is going to be an interesting experiment. We will see how this goes.
But this is a big deal — not just for Bitcoin, but for cryptocurrency in general. This shows that the asset is maturing. A sovereign nation has chosen to use it as a legal tender. That is a major step forward, and it gives Bitcoin major credibility.
The question is: What’s the next step?
Click here to watch Investing With Charles and see what Matt and I think this means for the future of Bitcoin and other cryptocurrencies. We touch on some of the pitfalls El Salvador could face and how the rest of the world might respond.
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Co-Editor, Green Zone Fortunes
Charles Sizemore is the co-editor of Green Zone Fortunes and specializes in income and retirement topics. He is also a frequent guest on CNBC, Bloomberg and Fox Business.